Dealing With The Wild Cards

This year has already proven to be a wild one when it comes to emerging markets risks. Preparing for what is to come in volatile and disparate markets is ever more central to the treasury and risk management functions.

Doing business in developing countries was never for the faint of heart-whether a multinational was setting up a garment factory in Monterrey, Mexico, 25 years ago or is selling pharmaceuticals today in Jakarta, Indonesia. But the magnitude, complexity and speed surrounding emerging markets risks have only expanded the workload of today's corporate risk officer and made protecting people, property and reputations even trickier.

As political risk consultancy Eurasia Group noted in its Top Risks 2014 report, there are a number of key concerns that companies must keep an eye on as they manage operations in emerging markets. The Middle East region is still seething under the surface, and countries such as Iraq could erupt at any time. China has new leaders set on reform-whether that is ultimately good news or bad for global corporates is yet to be determined. And Russia and Vladimir Putin are clearly wild cards. Meanwhile voters in six of the largest emerging marketsBrazil, Colombia, India, Indonesia, South Africa and Turkeywill hit the polls in 2014 to choose legislators and presidents.

According to Eurasia Group president Ian Bremmer, energy costs and supply will need diligent monitoring, even if oil prices remain low for now, given the Middle Eastern turmoil that has engulfed Syria and that stretches from Egypt to Turkey. The popular unrest that ousted Ukraine's president and motivated Russia's move into the Crimea, and its amassing of troops along the Eastern border of Ukraine, could have wide-reaching effects on everything from energy prices to reemerging West-East frictions. Bremmer was right on target when he said in a blog in January: "Expect the unexpected from Putin in 2014."

INCREASINGLY COMPLEX MARKETS

"The countries are different today, [and] the risks are bigger," said Chris Baudouin, chief executive officer of Aon Global Client Network. "They are more complex. And the time that risk officers have to react and deal with any risks is much less. Twenty years ago, companies were perhaps dipping a toe in emerging markets to see if it works. Now these investments are more substantial, and the risks are immediate."

In addition, corporate boards have greater expectations of their risk managers' role in helping them navigate a politically volatile world, says David Bidmead, global multinational client service leader at insurance broker Marsh. In the past, a risk manager's role was largely buying insurance; risk management was a small part of the job, he says. "Now their role has evolved. They are facing a myriad of real time data. It feels like we are on a moving carpet, and the world feels riskier." Given the increasing political volatility in many parts of the world, the job of the risk manager is going to get even harder over the coming years.

The risks faced by a multinational can shift, depending upon a host of factors, including its home country and industry. "All risks vary according to image and perception of the company involved," says Tim Holt, head of intelligence at insurance broker Willis's risk and crisis management consultancy in London. "Where its [company] activities or intentions are perceived to threaten the needs and interests of any group or favor anotherwhether a nation, business rival or political movement-the vulnerabilities and exposure to that risk will naturally differ."

Despite the concerns, the persistent pressure to reduce costs is driving more companies' supply chains into less-developed economies, where the risks may be greater. "This [dynamic] is made more complex by increasing insured values and by greater concentrations of risks in key areas," says Volker Muench, global practice group leader at the global property unit of Allianz Global Corporate & Specialty in Munich, Germany. He points to the collection of electronics producers in the Pearl River Delta in Guangdong province in southern China as an area of high concentration: Should a natural catastrophe, for example, occur and numerous suppliers get knocked out, it could have a magnified impact.

Companies often overlook evaluating how resilient their suppliers or production facilities are to a local catastrophe. It is essential to pinpoint how quickly the supplier can recover or transfer production to an alternative facility. "They [risk managers] are asking: 'Is the local infrastructure sufficiendy robust to allow a fast recovery in the event of a flood or windstorm?"' notes Muench.

Bidmead of Marsh agrees that business resiliency plans, which take a company beyond the immediate conditions of the crisis and keep it operating smoothly, are crucial. "Companies need to be nimble in a number of ways," he says. Using a muld-stage approach to gauge a country's risks will help executives pinpoint which risks need to be transferred to an insurer.

BIGGER FOOTPRINT

And the key reason the risks are greater is that companies have more substantial investments in emerging markets today. "Years ago, a company might enter Brazil by setting up a sales officethat would be a way to dip a toe in the market," says Baudouin. Now companies are setting up subsidiaries and gaining greater portions of their revenue from operations in emerging markets. "There's a lot more moving parts."

Holt at Willis believes, however, it is smaller multinationals that are most at risk. "It tends to be the medium-size companies or branches of multinationals with no incentive or capacity to analyze risks in-country that fail to spot the threats. [They] are therefore reactive in terms of risk and possibly in terms of business opportunity," says Holt. "Risk prevention and response are dramatically dulled by an inadequate understanding of the political, economic and security dynamics of the arena of business."

The key is holistic management of global risks. Allianz, for example, works with its corporate clients to develop an integrated solution covering the growing value of corporate assets and the greater complexity of today's risks. With more information and insight, Allianz can help a company manage its business interruption and contingent business interruption exposures wolrdwide. "So data is key, and this involves looking beyond first-tier suppliers," says Muench, adding that the insurer helps risk managers pinpoint the key weaknesses in their supply chain by mapping out the company's suppliers.

Edward Buthusiem, director of corporate compliance and risk management services at Berkeley Research Group, says it is vital for multinationals to understand the complete risk profile of the countries in which they are operating. That means carrying out a rigorous risk-modeling process-before entering the country-of all the risks, from legal to supply chain to research and development. The risk assessment should encompass an inventory of the compliance and control mechanisms a company has in place to avoid running afoul of bribery and corruption laws.

Buthusiem points to the recent corruption scandal surrounding GlaxoSmithKline's pharmaceutical sales in China as an incident that can anger local authorities and potentially violate laws such as the US Foreign Corrupt Practices Act of 1977 and the UK Bribery Act, which took effect in July 2011. Last year Chinese police authorities accused the company of channeling about $490 million through travel agencies to bribe doctors and officials. Buthusiem left GlaxoSmithKline in late 2010 after spending two decades with the company in various positions in its global legal department.

"You have to know your environment...to understand the culture and the business models [if you want] to understand how bribes happen in the local culture," says Buthusiem.

With compliance officers sitting at head offices in London or New York or Tokyo, multinationals frequendy fail to build the mechanisms that could help monitor corruption and bribery risks in an overseas office in an emerging market. "Ninety percent of bribery risks happen through third-party relationships. A company needs to carry out due diligence regarding those risks. You need to build a controlled environment with enough checks and balances," Buthusiem adds.

Another oversight sometimes made by companies is sending inexperienced executives to run their operations in obscure markets with reputations for corruption. "Human resources will take a CFO or IT person and send them to Kazakhstan. They see it as a stepping stone...grooming them for bigger markets," says Buthusiem. "They're green management. Who is training them?" *