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COUNTRY RISK. A BENEFIT TO TRADING?

Global Banking and Finance Review interviews Dr Elizabeth Stephens, Head of Credit & Political Risk Advisory at JLT Specialty. We discuss the benefits of the investor’s tool, “The World Risk Review Roundup”. Dr. Stephens outlines the benefit of this tool with regards to country risk analysis, the benefits and time saving uses of employing it and cites two examples of how the system works to benefit trading decisions. 

Explain a little bit about JLT Specialty’s World Risk Review Roundup to our readers.

 The World Risk Review Roundup is a new, regular publication from JLT Specialty’s World Risk Review (WRR), which is our in-house country risk analysis tool. We founded the WRR in 2006 to extend the capabilities of JLT’s Credit, Political and Security risk broking team. Often, political, economic and security risks, which can be broadly categorised as ‘country risks,’ are misunderstood to be ‘catastrophic’ risks, in that many investors and multinationals trading in emerging market territories believe that these risks cannot be mitigated or managed. We wanted to illustrate that not only can these risks be insured; but there is in fact a clear risk management process for country risks that can, if implemented in a strategic and robust fashion, actively reduce the likelihood of a loss from a country risk incident. It is the initial identification and analysis steps of that risk management process that can be the most challenging, on account of the fluidity of global trends and risks, however, tools like the WRR can assist with that process in terms of highlighting changing risk trends, but also providing a quantitative method for benchmarking country risk. The new WRR Roundup is a quick overview of the most important topics that we have been analysing and monitoring on WRR and that we want to highlight as ‘up and coming’ risk trends.

Dr.Elizabeth Stephens
Dr.Elizabeth Stephens

How do the reports help with investment decisions?

The difficulty for those trying to make investment decisions in the face of increasing levels of geopolitical risk is that the risk environment in any country, be it the economic, security or political risk environment, can change extremely rapidly. For time-pressured professionals with a global portfolio, there simply is not enough time in the day to dedicate sufficient time to read and analyse pages and pages of country risk reports. Indeed, the primary reason why JLT developed the World Risk Review was to provide our clients with a strategic decision-making tool for country risk. Using our country risk ratings, anyone that needs to quickly and succinctly benchmark country risk can do so – even without any prior knowledge about the countries in question.

The WRR round-up is an evolution of that objective; it seeks to cut through the sea of information that is available to professionals to highlight several key topics requiring greater attention. Those needing to make investment decisions can check our roundup and then carry out far more focused and detailed research to understand these highlighted risks if there is a possibility that these risks might impact on that proposed investment. Alternatively, readers can contact us if they want us to give them advice on these risk issues in respect of a specific investment.

 Where and from whom do you collect the areas and advice you choose to focus on in the reports?

The WRR Roundup is edited by JLT’s country risks analysis team and the subjects of focus are chosen for a variety of reasons. The WRR’s ratings and analysis are always forward looking, so where possible, we seek to select those trends that may not yet have hit the news headlines, and we seek to identify risk ‘triggers.’ Other subjects are centred around those countries where our Credit, Political and Security risks broking team have seen an uptick in insurance enquiries, which is always an indication that the investment community is noticing changes ‘on the ground’ in respect of a country’s risk environment. Finally, we also take into consideration the views of our WRR Advisory Board, a group of leading economists, academics, security and NGO specialists, journalists and corporate leaders. This board acts as a check to what is otherwise a very quantitative-driven analysis process; they have specific regional and industry knowledge which can give WRR a clearer insight into the true risk environment of any given country and how risk developments may impact investors.

 I understand the reports can be personalised to specifically benefit individuals’ particular investment areas, how does this work and do you have any future plans to further increase the benefits of the service over 2014?

JLT has always prided itself on its country risk consultancy capabilities, which are underpinned by the WRR. In the past we’ve carried out a variety of consultancy projects for investors in a variety of industries, from banking, to mining, to telecoms, to logistics. We use the WRR country ratings as a starting point, and then adjust them to reflect the specific nuances of the region, country, industry, project and company in question as country risk is always project-specific. These bespoke ratings are then complemented by a variety of services, always including written analysis, depending on the needs of the client and their risk management strategy; some services are designed to act as a check on a company’s existing risk management strategy, where advanced processes for identifying, analysing and managing country risk are already in place, while other clients secure our services when they are embarking on designing and implementing a new risk management strategy for country risks. Later this year JLT will be launching a brand new WRR website platform which will over time showcase a variety of features designed to support professionals that are managing country risk and throughout 2014 we will also be expanding our consultancy practice.

Operational risks continue to grow within the financial sector, what are the key factors affecting both companies and their employee’s?

The main operational risks affecting companies within the financial sector is ever increasing regulation, sanctions and directives like the 2010 Bribery & Corruption Act. Increased onus is put on employees to ‘know their clients’, their ownership structure and business dealings. It can be challenging to obtain this information and the oversight and conduct of these functions adds to operational costs. Greater emphasis has been placed on
employees to declare client entertainment and gifts and likewise entertainment and gifts received to avoid charges of bribery and to facilitate internal monitoring.

Extra territorial sanctions like those imposed by the US on Iran create significant operational risks for companies. While it is relatively straightforward not to trade with Iranian entities it is more challenging to guarantee no financial transaction flows through a third party institution that also does business with Iran.

Basel III will tighten capital adequacy requirements for banks and financial institutions, impacting on available funds for investment and thereby curtailing potential returns.

In the February issue you cite two examples our readers have shown a particular interest in at the moment, “the unrest in Thailand” and “the Economic Slump in Turkey”. Can you expand on the impact to inward investors and what should be watched for?

Thailand – the impact for inward investors depends on type of sector and asset class. The overall risk is that continued protests and political instability will depress the economy, thereby lowering investment returns. The value of the currency is susceptible to downward pressure as investment sentiment diminishes, lowering the value of returns in hard currency. Protests have the potential to disrupt business operations either directly or indirectly.

Turkey – For the Gulf sheiks Turkey remains a safe investment haven and it is Arab money that has flooded into the country, fuelling a financial bubble and high inflation. These investors are unlikely to be concerned about the tactics Erdgoan employs to quash protests and will continue to view Turkey as a safe investment haven after the Arab Spring as they are wary of investing in Western countries because if unrest breaks out, their assets could be frozen.

Western investors have a different view – partly driven by concern over returns – and partly by the reputational risk that could arise from investments in Turkey if protests escalate and Erdogan instigates another crackdown against them. The financial outlook is also worrying.

Turkey has seen its risk premia narrow in recent years. Capital inflows have almost offset the current account deficit which has narrowed to some 6% of GDP from the alarming 9.6% recorded in 2012. The banks are in good shape and, despite incoherent use of monetary policy tools, the financial system is stable. Inflation has receded, to some 6% from over 9% last year, though unemployment has only nudged lower, and remains high, at 9%, as GDP growth is still only moderate, albeit stronger than last year’s feeble 2.2%. With its favourable structural dynamics of a growing middle class and a young, decently educated workforce, observers had reappraised the outlook and after Turkey secured two investment grade ratings, many were expecting another ratings upgrade.

Political stability played a part in this improvement, but recent events have undermined the optimism, leaving the economy vulnerable at a time when the liquidity emerging economies have benefited from as a result of quantitative easing in the US, may be coming to an end. The absolute size of the current account deficit and its majority financing by portfolio inflows makes the lira vulnerable to shifts in market sentiment.

Protests continue and the state continues to round up those it considers responsible. Intimidation of journalists has risen from an already high level – Turkey imprisons more journalists than Iran. This will further harm relations with the EU at a time when the organisation has already postponed the latest round of membership talks with Ankara to October.

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