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Cross Border Risk

Posted by arenburg
29 August
Cross Border Risk - How to scale a business - Arenburg Consulting
Cross Border Risk – The volatility of returns on international investments caused by events associated with a particular country as opposed to events associated solely with a particular economic or financial agent.  NASDAQ.com Financial Glossary

The challenges associated with cross border business activity, i.e. cross border risk (XBR), are underappreciated in the global market place.   XBR is typically viewed in terms of volatility returns on international investments caused by events associated with a particular country. This definition is widely used but most commonly in the context of payment risk. However, the problem with this definition (even when used in a wider context) is the implication that XBR is caused by, and therefore should be viewed entirely in terms of, the risk presented by the foreign country in which the global enterprise is conducting business.  This approach pulls the focus on to country risk factors such as political and economic stability and understates the wider range of cross border related considerations that an international business needs to managein order to be successful.

A better understanding of the nature of XBR comes from appreciating that it represents the potential conflict between the local business environment and the global business model.In other words, the extent of the potential XBR (which includes payment risk but also regulatory risk, market risk and legal risk) is the extent to which an established global business model accommodates the local business environment. Any mismatch between these two components will generate XBR and the nature of the mismatch will determine the nature of the XBR.

As an example, let us assume that to hedge against a counterparty’s non-performance our global business typically includes taking some form of security over the local assets of a counterparty (i.e. our global business model for managing legal risk is to take local security) and the counterparty’s country is vulnerable to political and economic upheaval (meaning that local security over assets may not be enforceable). Using the standard definition of XBR risk one might correctly identify that we are facing a significant XBR but it will not help us identify the nature of the XBR or how we can manage it.

 

 

Arenburg Consulting have seen numerous occasions of lawyers, facing exactly this scenario, who dutifully proceed to obtain (often rather expensive) local legal opinions in an effort to provide some comfort that the local security will be enforceable while acknowledging the absence of the rule of law and the ineffectiveness of local courts.  A better approach starts with recognising that the global business model of local security is incompatible with the local business environment and that the only way to manage to the resulting XBR is to modify the global business model to accommodate the local conditions.  In our example this might include foregoing local security in preference for some other form of collateral that can be held off-shore.

Another example would be where the global business model utilises a central hub for processing client data. As the business expands into new jurisdictions it is important to anticipate that established processes for obtaining client approval to process their data off-shore will need to accommodate local business environment as represented by local data privacy standards. The same can be said for client qualification requirements if the global business model relies on sophisticated investor exemptions and outsourcing, if the global business model involves a hub and spoke arrangement for systems and operations.  The potential XBR points are numerous and include payments (FX), regulatory (data privacy, outsourcing, licensing, client qualifications), culture and language, client appetites and behaviour (especially relevant for food but also buying patterns, life-style etc). 

An international business should not assume that what works in one location will work in all locations, even where apparent language and cultural differences are minor. Every combination of country, activity, product and client generates a unique XBR profile that must be accommodated. Therefore, each new jurisdiction that an international business enters needs to be assessed against the established global business model to avoid generating XBR. And while it might be tempting to establish local, self-sufficient operations it is rarely economical to do so and increasingly impractical in today’s interconnected world.

To effectively manage XBR it is important to understand how the local business environment differs from your global business model and then assess how you can accommodate the requirements within your global business model.

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