Over the years, businesses have evolved a number of innovative ways to manage the risks associated with global operations. They have developed sophisticated ways to insure their infrastructures and their operations and to hedge their currencies. They have learned how to distribute information resources globally, using highly resilient computer networks with geographically dispersed backups. They have put in place sophisticated new internal controls systems to monitor performance and tease out fraud on a global basis. They have developed intricate taxonomies to enable different divisions to rate and communicate their risks in a consistent manner around the world. They have even created a new global role — the chief risk officer — to watch over the company as a whole. And many boards of directors have made risk management one of their top priorities. But despite these initiatives, gaps remain.
Global companies face two distinct types of risks: large-scale, low-frequency risks and small-scale, high-frequency risks. Although the large-scale risks — earthquakes, wars, coup d’états and major acts of terrorism — are front-page news, the small-scale risks — fraudulent transactions, bribery, legal and regulatory complexity, and unenforceable contracts — represent the real costs to business. These risks interfere with commerce, add to costs, slow growth and make the future even more difficult to predict. They also deter investment. “The key to any good investment relationship is clarity — the ability to see, and even be in communication with, what’s really going on. It’s the same whether it’s a company, a country or a region,” said Matt Feshbach, chief investment officer of MLF Investments Inc., a midsized hedge fund in Largo, Florida. “If the risk picture is unclear, capital is less likely to go where it’s needed.”
Annually since 2000,1 we have been studying a variety of countries, seeking to identify their degree of opacity — that is, the degree to which they lack clear, accurate, easily discernible and widely accepted practices governing the relationships among businesses, investors and governments that form the basis of most small-scale, high-frequency risks. Greater awareness of the risk factors that may impede commerce can enable companies to make better portfolio and direct investment decisions regarding where to develop markets, locate productive resources or find the best outsource partner and can also help governments understand how to measure their progress and make their countries more attractive locations for investment.