Companies Can Mitigate Risk in a Risky Business Environment

Companies Can Mitigate Risk

In a Risky Business Environment

C0mplicating the current credit crunch crisis and worldwide economic downturn is the fact that some 75% of emerging markets have a political risk rating of medium high or extremely high.   This is critical information to North American- and Europe-based business involved in and interested in expanding to new markets in the natural resources and manufacturing sectors, according to London, UK-based Control Risks, an independent, specialist risk consultancy. 

This red flag should serve as a wakeup call to those expanding companies when engaged in the process of entering these markets to be more aware of these added political risks and seek to alleviate these risks.

Preston Keat, Director of Research at political risk advisory and consulting firm Eurasia Group. New York City, offers that, in order to moderate these risks,  “… with some mining or extractive companies do is that over a 10- or 15-year period, they offer to give the asset back to the government.   It also helps if you work with local partners that are making profits.”

Mr. Keat suggests that Conoco, which worked with a local partner out-performed Royal Dutch Shell and other, oil majors in the controversial Sakhalin Island oil and gas development project.   In the end, such majors as Royal Dutch Shell who entered the project alone were later forced by the federal Russian government to sell assets.

Mr. Keat further adds that these extractive companies are always aware of political risk and usually work hard to lessen or avoid the risk.  “They cannot help where natural resource deposits are.  It is not as if they can go to another country.  They are where they are.”

In another perspective, insurance firm London, UK-based Jardine Lloyd Thompson’s Head of Credit and Political Risk Analysis Dr. Elizabeth Stephens notes that the highest risk foreign firms face is “contract repudiation.”

She adds that when some companies in the extractive industry sectors are drafting agreements with hosting governments, they should include a more equitable share in order to intercept any attempts by the government to compulsorily re-negotiate terms later.  “If oil prices are low, the host government should get 50%, for example, and if commodity prices are high, the percentage the government gets should reflect that.  The government and the company need to profit in good times.   The more a company understands the different components of risk and managing them positively, it is possible to mitigate them.”

Usually, extractive companies are aware of political risk as they investigate business possibilities in these types of markets.

Mr. Keat adds that “… they cannot help where natural resource deposits are.  It is not as if they can go to another country.  They are where they are.”

However, more and more of the companies outside of the oil and mining sectors must also evaluate the risk involved.  These other companies do usually tend to look at political risk when they first enter an emerging market but then tend to ignore or fail to supervise the risk as the business relationship develops.

Mr. Keat warns, “Their supply chain is then put in jeopardy.   There is inconsistent monitoring of political and regulatory risks.  But, in a competitive environment, those companies that seriously monitor political risk are more likely to get their products to market.”

To complement OECD member countries’ own agencies to provide their domestic companies with export credit and political risk insurance, the World Bank also established MIGA (the Investment Guarantee Agency) in 1987 to facilitate these types of trade.

Neil Henderson, director of political risk and crisis management for reinsurance intermediary Aon Capital, says that the political risk insurance market has approximately US$1.9 billion in product capacity.

According to Mr. Henderson, research indicates that political risk is among the top five concerns for companies doing business in emerging markets.

Increasingly, the fast growing ship high jacking involving Somalian pirates may create an intolerable situation where the added costs of insuring the trade in this region may spark the major powers to enact a military solution if such continuing disruption of business threatens their own national security and economic well-being.  

By: Mark Borkowski is president of Toronto based Mercantile Mergers & Acquisitions Corporation. Mercantile specializes in the sale of privately owned mid market companies. Mark can be contacted at mark@mercantilema.com or www.mercantilemergersacquisitions.com

My Top Five ‘Things That Could be a Problem (I Didn’t Say Crisis) For the Global Economy’

 

September really is like a New Year.  Not only does school get into full swing, but everyone is back and work – and the real trading begins.  Maybe that’s the reason that financial crises are more likely to start in the Autumn than in any other season.

 

Let’s be clear: I am not looking for a wholesale world economic crisis to unfold anytime soon. I do, however, think that the world economy is a little shaky right now, and there are a lot of things that are going to come together to cause some volatility over the next few months, and that investors need to understand them.

 

Here are my top five ‘Things That Could be a Problem for the Global Economy’ :

 

  1. Europe

 

Well, what else could I start with? Yes, the policy-makers have pledged to make things work, and yes the most recent plan by the ECB to buy bonds will help.  Still, Europe is in recession and the Eurozone is unlikely to look the way it does now a few years from now.  That means the risks coming from Europe are not over, not by a long shot.

 

  1. China

 

With Europe as weak as it is, the rest of the world desperately needs China to a source of strength.  Sadly, the last batch of numbers shows this economic powerhouse struggling and growth at the lowest in three years.  Policymakers have made some effort to boost growth – in July they cut the key lending rate for the second time in a month – but they are moving slowly lest they re-ignite an already crazy property market.

 

It is so far so good for commodity prices (and stocks) but a little more slowing from China could hit hard.

 

  1. The U.S. Fiscal Cliff

 

Tick-tock: unless some major compromises are reached in Washington, the U.S. falls off the ‘fiscal cliff’ in a matter of months.  The term refers to the menu of tax hikes and spending cuts that will go into effect at the beginning of 2013 as a deficit measure, and the corresponding havoc they would cause. Unless something changes, the U.S. is headed into at least a short recession- or maybe a longer one – in 2013.

 

Chances are there will be some kind of band-aid measures to stop the worst of the damage – but look for some slowing just the same.

 

  1. Oil Prices

 

Since the end of the Second World War, there have been 11 U.S. recessions  – and eleven of them have been preceded by sharply higher oil prices.  Which makes sense: the U.S. consumer sector accounts for about 70 perent of total U.S. GDP, and the generally speaking, there is not a whole lot of room in U.S. budgets to pay more to fill up the car (let alone the SUV).

 

If the U.S. sees a surge in growth and incomes, rising oil prices may not matter too much.  Barring that scenario, even if Europe and China keep chugging along and there is a compromise reached on the fiscal cliff, high oil prices could pull the U.S. economy into a downturn anyway.

 

  1. Lender Caution

 

Not that you can really blame them, but since the end of the last recession   lender have been notoriously careful about issuing credit.  That’s why interest rates at generational lows – and even at zero in some cases – are not sparking global growth the way they should be. Canada, by the way is a bit of an exception ot the rule – the Bank of Canada’s second quarter Senior Loan Officer Survey showed lending standards loosening up a bit – but that’s probably because our lenders were cautious to start with.

 

If things get shakier over the next few months, credit could get squeezed even more –in North America, and around the world too.  That is not good news for the economy or the markets.

 

Now, none of this is to scare anyone out of the market or to have them pulling their money out of financial institutions.  Still, better to understand and monitor the risks than to blindsided if Autumn gives us more than falling leaves.