LEGAL
This excerpt is from Thomson Reuters’ report “Going Global: Assess the Risk and Seize the Opportunities of International Expansion.” The report was compiled through telephone interviews with 250 C-suite individuals from around the globe.
When companies decide to enter new markets or expand existing operations – whether by acquiring a company, investing fresh capital in an overseas division, or joining forces with a local partner – risk increases alongside the variables involved. But so do potential rewards. And while risk cannot be entirely controlled, it does need to be examined and communicated effectively at the company board level for it to be better mitigated by senior executives and their teams. A chief risk officer within the energy sector told us: “I think the responsibility that a risk team has is to make sure the conversation happens at the right point.” And as Warren Buffet, CEO of Berkshire Hathaway, once noted, “risk comes from not knowing what you’re doing.”
Few predicted the rolling series of events in Ukraine that began with Moscow’s annexation of Crimea and culminated in Western sanctions against Russian corporate and financial interests. It seems that large firms (those with more than 50,000 employees) are more than twice as concerned about the impact these sanctions will have on their organization globally than firms half their size. Corporations based in the U.S. and Europe are more likely to be worried about sanctions (because they stand to lose the most from their governments’ restrictions against Russian interests).
However, regulations emerged as the most common threat to an organization in the survey, selected by respondents as one of their top three threats more often than any other. From speaking to customers, Karan Batra, head of corporate coverage at Thomson Reuters, echoes these thoughts and says regulation and managing risk exposure are keeping executives up at night. In particular, clients are especially concerned about how they manage their risk exposure and keep on top of regulations in emerging markets. This is because business laws may not be clearly defined on these markets or consistently enforced by local regulators or court systems. One CFO from a chemicals firm commented: “The local and global regulations cannot be overstated enough.”
Sneha Shah, managing director of sub-Saharan Africa at Thomson Reuters, agrees with this sentiment. “The innovation landscape is fantastic in Africa, with incredible potential, especially around technology in areas like mobile payments and rural healthcare,” she explains. “As a result, we are seeing a lot of interest in partnerships and cross-border technology and investment projects. However, each African country has its own set of regulations with its own set of risks, and international companies are cautious about establishing partnerships because not only do they have to be compliant, but also they must vouch that their local partners and suppliers are too.”
The pressure to move quickly and enter a new market can appear at odds with the seemingly slow-and-steady nature of the need to understand and comply with a new legal landscape. However, in recent years, chief legal officers and general counsels of global and expanding organizations have taken heed of the expansion of the world’s largest retailer, Walmart, into Mexico. Amid allegations of multimillion-dollar bribes to Mexican officials to speed up store expansion and the permit process, as well as other possible violations of the Foreign Corrupt Practices Act (which bans payments by companies or their agents to foreign governments to obtain or retain business), it is reported that Walmart has spent more than $439 million hiring lawyers, auditors, and other compliance specialists. Indeed, the costs of noncompliance can be unpredictable and considerable.
The high legal costs of entry when expanding into a new territory cannot be underestimated. It is imperative that an organization understands the new legal system in which it hopes to conduct business. The Going Global survey shows that corporate leaders from a wide range of industries ranked the overwhelming and unpredictable legal costs as one of the highest financial risks associated with an international expansion. In advance of any overseas venture, a great amount of both time and money must be spent with legal counsel to ensure compliance with the myriad laws and regulations that may be applicable when doing business in a new jurisdiction: tax laws, customs laws, import restrictions, corporate organization rules, intellectual property protection, and agency/liability laws. Local legislation also needs to be investigated for issues arising under labor, immigration, customs, and agency laws, and other producer/distributor liability provision.
In today’s business environment, organizations are held responsible for the actions of suppliers, vendors, and partners in addition to their own internal activities. Knowledge and understanding of supplier and third-party risk is therefore of the utmost importance. It is critical that a robust risk management program includes due diligence in the selection of business partners and third parties as well as in ongoing monitoring activities. “Corporate supply chains can contain hundreds – if not thousands – of counterparties, both upstream and downstream,” says Sanjeev Chatrath, managing director of Asia Pacific and Japan at Thomson Reuters, “making effective due diligence a nearly impossible task without assistance from technology”.
As a result of working with Thomson Reuters to conduct due diligence on their partners, one large global IT firm discontinued using a particular agent in Africa. It was found that the agent was banned from participating in government bids, and a year later the executives at that agency were found guilty of bribing public officials.
When an organization is looking to expand, an important concern is protecting their intellectual property (IP) such as trademarks, domain names, and patents. This is because some countries have very weak IP laws, especially those in emerging markets. For example, car makers might find their products blatantly copied in important markets with weak IP laws, as Jaguar Land Rover found when a Chinese competitor, Jiangling Motors, made a seemingly identical copy of the Range Rover Evoque and named it the LandWind X7. Thomson Reuters has found that the global automotive industry loses close to $12 billion annually to counterfeiting, a process in which a business partner steals or copies the most prized patterns and patents.
When asked about the financial risks of expanding into a new territory, corporate leaders highlighted the pressing issue of taxation. Only in two industries did the issue of direct and indirect taxation not emerge as the primary financial concern. Those industries were real estate, where legal costs were the greatest ongoing concern to industry leaders, and the energy, utilities, and commodities space, where cash flow trumped taxation worries – though not by much.
The World Bank’s Paying Taxes 2015 report found that the average global company makes 25.9 payments to various authorities each year (this number ranges from 3 in Hong Kong to 71 in Venezuela), and pays an average corporate tax rate of 40.9 per cent. Firms typically put aside 264 man hours to assess their annual tax spend (with consumption taxes being the least time-consuming), a number that rises to 2,600 hours in Brazil, where tax departments can often be strung out across a city and even the entire country.
Uncertainties over a country’s tax program can significantly hamper corporate attempts to enter new markets. After taxes were hiked on North Sea oil at the height of the financial crisis, energy firms shelved new local projects. Multinationals view India’s retroactive policy, which allows the Government to levy additional late corporate taxes against firms, with understandable suspicion. Corporates ranging from Vodafone to Shell have felt the sting of this policy, which is often viewed as arbitrary and opaque. Recently a CFO within the pharma industry remarked: “The world is getting more and more regulated. BEPS (base erosion and profit shifting) is a buzzword now, especially for those that know what’s going on in the world. It’s about the changing environment within the regulations in terms of taxes.”
As they expand, corporations also face the pressing need to manage currency and commodity price risk, as these factors are constantly in flux and can have a big impact on the bottom line. The Going Global survey found that manufacturers view commodity price fluctuations as the greatest single threat to their business. A good example comes from June 2015, when severe droughts in Russia led to a 41 per cent wheat price increase, and the impacts were felt by a major UK bakery chain through significant cost increases. Recently, for some industries, that pressure has been mitigated by tumbling prices for everything from copper to iron ore, though this could also have a negative impact on global growth, as the International Monetary Fund warned in September 2015. One chief risk officer within an energy firm recently spoke about how important it is to have “a lot of linkages with the front office to really understand the trading strategies and commodity exposures.”
Corporate leaders surveyed by Thomson Reuters singled out foreign exchange as the number one greatest threat to their organization globally. Looking at the situation with the global economy, it’s easy to understand why. The dollar continues to firm as investors price in a tighter U.S. monetary policy, and capital continues to retreat from emerging markets toward developed economies. Emerging-market currencies are in turmoil. In September 2015, the Malaysian ringgit and Indonesian rupiah were trading at their weakest levels to the US dollar since the Asian financial crisis of 1998. In January 2015, Switzerland unpegged the franc from its fixed exchange rate with the euro. And in August, China’s central bank devalued the renminbi twice, in an attempt to shore up its flagging economy.
Foreign exchange volatility, notes Thomson Reuters’ Ron Leven, FX pretrade strategist, is now “definitely higher” than it was a few years ago. The reasons for this are many, from a fluid global fiscal and financial environment to the prospect of higher interest rates, plus economic turmoil across much of the emerging world. And all the while, large and ambitious companies, more determined than ever to tap into new markets, have “a lot more foreign exposure than they used to,” adds Leven.
This dichotomy is a threat and an opportunity to everyone. On the one hand, notes Neill Penney, head of FX workflow at Thomson Reuters, “the world is less predictable than it seemed a few years ago,” even while globalization has made the business world more interconnected than ever. Moreover, banks, fearful of failure, are more loath than ever to offer precise FX advice. In the past a bank might call in the morning with targeted FX news, Events, and insights. Yet now, notes Penney, “banks feel more exposed sharing these sorts of ideas with customers – placing the onus on the customer to create a more informed view by themselves.”
Mitigating foreign exchange fluctuations is of paramount importance to every corporation, small or large. It’s worth noting that the largest U.S. company by market capitalization, Apple, saw its fourth-quarter 2014 revenues reduced by $3.7 billion, or around 5 per cent, owing to currency fluctuations. And while foreign exchange risk will never be entirely mitigated, every corporation can now access a wealth of sophisticated and inexpensive real-time FX data and information. A proactive, forward-looking hedging strategy is critical, and should be supported by appropriate technology, data, and analytical tools that provide accurate and timely information to effectively reduce risk. A senior treasury executive supported this sentiment, saying: “If you can easily forecast revenue, you can hedge your revenues.”
It is human nature to be risk-seeking adventurers. But it is also human nature to worry. Every C-suite leader interviewed for this survey knew of the risks to be found in expanding into new markets. And a majority – 55 per cent – said they expected the risks and potential costs of doing business to rise over the next ten years. Overall, the message from the Going Global survey is clear. Opportunities through globalization are everywhere, as is risk. However, risk can be effectively managed if the right tools and information are available to help make these critical decisions.
View more on Going Global with the full report, which can be found on the Thomson Reuters website.
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