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Country-Level Treasury

Country Looks Good but What Are the Risks?

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June 23, 2017

In an ever-more volatile world, companies need to know the risks of the countries in which the operate.

Foreign currencyHow should companies evaluate the risks of operating in high-risk countries – either political risk, social risk, financial risk, economic risk, environmental risk, or other types of risk? How do companies make investment decisions in such high-risk countries and evaluate risk vs. return parameters on short-term as well as long-term investments? And how should one calculate exposure in any given country – fixed assets, working capital, receivables, what else?

These are some of the questions considered by one members of the Asia Treasurers’ Peer Group at a recent meeting. They were also questions one member’s financial risk committee thought about after reviewing some risk events in other regions and determining their country risk evaluations needed improvement. In this session that member shared her company’s findings to date and solicited member input on their own approaches.

Risk classifications and their drivers. The presenter’s company has three classifications for countries which is simply A, B and C with C being the highest risk. The drivers that determine which classification a country receives include: CDS spreads, equity volatility, country ratings by S&P and Moody’s, and ratings by the World Bank. These variables determine basic risk/return decisions, i.e., the greater the risk in a country the greater the required return threshold. Another factor considered is whether the business in the country is strictly domestic or is there import/export activities involved. This additional complexity will have upstream and downstream impacts if there is a disruption.

Another approach to evaluating country risk is CNED, which evaluates for confiscation, nationalization, expropriation and disaster. Think Venezuela, with its extreme political unrest and collapsing economy. Anyone selling to corporates there should make sure they receive payments in advance.

How to prepare for blow-ups. The purpose of such an exercise is to be able to mitigate risk and be better prepared for when things go wrong. One member offered his experience from his time at the financing arm of his company. It monitored short-term and long-term rates, equity volatility, sovereign risk volatility and also looked for early warning indicators they could also monitor. It also developed rules around what to do as metrics started blowing with different actions as the severity increased. But they always contingency plans in place for funding.

Country risk will always be with us and will likely increase. MNC’s presumably have an evaluation matrix for assessing risk and formulating return requirements accordingly. The key to being successful will be identifying the most appropriate variables to monitor and measure to determine those risk levels, especially those leading indicators. Of course, a countries risk assessment is only as good as the contingency plans in place for responding to negative events. Members had a good discussion on this topic and hopefully have some new ideas to bring to this table.

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