Risky Business

Businesses are continuing to rely on an interdependent global network for a number of links in the supply chain. Offshore manufacturing in China and other parts of Southeast Asia, and business process outsourcing (BPO) in India are growing steadily. Not far behind those two giants are smaller emerging markets in Eastern Europe and Latin America. But, on the flipside of these foreign opportunities is what is at risk — quantified at close to US$312 billion worth of goods and services in 2004.

Whether it is raw materials, production or distribution, the political, economic and social situations in other countries are interconnected. We have to accept that instability in seemingly remote areas can potentially disrupt supply chains. Essentially, there are no areas too remote and no issues too distant to affect global trading patterns. But once a company gains acceptance and understanding of the global risks that affect it, it can maximize its investment in the global economy.

MAXIMIZING OPPORTUNITIES

Although recent events have brought a greater awareness of supply chain disruption, it can be difficult to keep abreast of all of the issues that might impact a business. “Even in a post-Sarbanes-Oxley world, risk managers and board members can underestimate the financial threat posed to a firm’s balance-sheet, assets and revenues by supply chain disruption,” says Michel Leonard, chief economist at Aon’s Trade Credit division.

“For example, as South Korea accounts for nearly half of the worlds’ production of computer chips, severe tensions on the Korean Peninsula could throw the high-tech industry into turmoil with repercussions on trade throughout the region, including trade disruptions between North America and China,” Leonard observes.

Events in a single country or area of the world can have a ripple effect of consequences for a number of different types of businesses. Banks and financial institutions for example must deal with defaulting clients or lack of hard currency. Buyers of imported goods must deal with potential risks to their assets. Changes in government, labor disruptions and political violence can also impact exporters, foreign investors, lenders and traders.

With so many variables and processes on the line, it is no wonder that the top six concerns of Global-1000 companies are related to external factors. A recent survey of the Global-1000 released by A.T. Kearney Research reveals that their number-one concern is government regulations, followed by country financial risk, currency risk, political and social unrest, rule of law and threats to the supply chain.

RISK OUTLOOK

In order to address the concerns of global companies, Aon conducts an annual risk analysis, collecting data from trade credit and political risk insurers, as well as its own sources of intelligence. The findings are published each year in the “Political and Economic Risk Map” (see accompanying map), a visual guide that gives an overall picture of risk throughout the world. The map focuses on implications for business, including events that can affect the outcome of a foreign investment, a contract, a loan or an outsourcing arrangement.

The outlook for 2005 presents a more simplified picture than that of 10 years ago. Political risk underwriters are seeing greater stability in currency and fewer countries that are rated as high risks. Does this mean the world is safer than it was a year ago? Not necessarily. Political violence is still a very prominent threat and terrorism-related concerns can lead to downgrades, such as that in the case of Saudi Arabia. Underwriters are currently more concerned and cautious about risks in the oil-rich region, which was downgraded from medium to medium-high risk this year.

Other key downgrades include Bolivia and Haiti, as a result of increased violence and instability. Conversely, underwriters are now looking more favorably on Uruguay and Argentina. Both countries have been upgraded from high to medium-high. In Eastern Europe, Romania and Bulgaria have been upgraded as they make the move toward EU membership. Although countries like Ukraine and Libya are being regarded more positively by insurers, they have not yet had their ratings change due to ongoing concerns and the lack of a solid track record demonstrating stability.

On the agenda for many Canadian businesses are questions over expansion into China. Despite enormous foreign investment, China is still a question mark in the minds of insurers. With an unpredictable legal system and several other risk factors that have not been mitigated, the growing number of contracts in the region could be a cause for concern for political risk underwriters. While China carries medium risk in the general index of countries, it rates as a low risk on Aon’s new “Supply Chain Risk Index”.

The Supply Chain Risk Index rated 50 countries on the basis of their economic situation, trade openness, potential labor unrest, political violence, war and terrorism. Other influencing factors include a country’s infrastructure, epidemic risk and currency inconvertibility. Countries rated with high risk on the index include Angola, Cote d’Ivoire, Haiti and Malaysia.

MOVING FORWARD

As foreign capital cautiously returns to emerging markets, the demand for political risk insurance is increasing. Directors and officers are becoming more risk focused in this post-Sarbanes-Oxley world, conducting systematic reviews of political and economic risks in their trading relationships with other countries.

Analyzing political and economic risk goes beyond monitoring headlines. It is a complex process requiring in-depth investigation and ongoing monitoring of all the reasons for entering into trading relationships, as well as safely maintaining them once they are established. The knowledge residing in relatively few specialty brokerages and insurers providing risk solutions and risk transfer capacity is one of the more effective sources of current market intelligence for firms looking to the rewards of the global economy.