Risk Management in Emerging Markets

Risk Management in

Emerging Markets

Risk Management in

Emerging Markets

How to survive and prosper

CARL OLSSON

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First published in Great Britain in 2002

© Pearson Education Limited 2002

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To Stewart for inspiration.

To Hilary for patience.

“Companies increasingly have to do business with emerging markets to

keep their competitive advantage, but the risks involved are quantitatively

and qualitatively different from these in more developed economies and

have important cultural dimensions. In Risk Management in Emerging

Markets Carl very clearly helps the reader understand the nature of the

unique risk encountered in emerging markets and discusses a variety of

methods for managing such risks in a clear and accessible way. The book

captures significant practical experience in a field and markets that risk

managers can no longer afford to ignore.”

Michael (Mike) Frow, Chief Executive Office, Harris Trust Bank

“Carl’s lively, comprehensive and refreshingly readable book is built on his

extensive practical experience in emerging markets banking. It is characterized

by easily understood explanations of the technical concepts, as well as real–life

insights and examples, from the Titanic to Thailand, that will often prompt a

wry nod of recognition. This is essential reading for positive–minded risk

managers in changing markets, whether emerging or developed.”

Mick Green, General Manager, Retail Risk, ANZ Banking Group

“Much needed, practical and very readable. This excellent book will be

welcomed by those with business in emerging markets and especially by

banks operating in these risk challenging environments.”

Tony Jennings, Senior Advisor, Bank Training Centre, World Bank

Group, Mekong Region

“There can scarcely have been two more salient concerns for senior managers

in multi-national companies over recent years than the management of risk

and the exploitation of emerging markets. It is something of an achievement,

therefore, for Carl Olsson to have brought these two key issues together under

one heading. Olsson’s text not only provides a comprehensive introduction

to the subject of risk management in all its many and varied guises but also

shows how the principles of risk management can, and indeed should be,

extended to exploiting opportunities in emerging markets. Many case studies

enliven this text and make it an indispensible guide for managers and students

of management, seeking to explore this very topical subject.”

Ian Turner, Director of Graduate Businss Studies, Henley

Management College

“This book offers a refreshing approach to the appreciation of risk man￾agment. Olsson is to be congratulated for his practical and novel approach

to the subject – an essential read for all students.”

Professor Joseph Nellis, Head of Economics Group, Cranfield

School of Management

It is said that everyone has at least one book in them but in reality most

never get past the idea stage. In my case, I must thank ex-boss Mike Frow

for handing me the task of putting together an internal training course

which meant I was required to think about risk and risk management,

determine what the key messages were and consider the best way to get

them across to an audience of recently joined graduates. Over the past

four years I have delivered many such courses and have updated the con￾tent regularly as risk issues have come to the fore and techniques for

managing risk have changed. Preparation for and feedback from these ses￾sions helped me develop a number of the ideas which have formed the

core of the risk management section of this book.

For actually suggesting the idea of writing the book and moving it

beyond just an idea I owe a significant debt to Stewart McNaughton who

conceived the project and then helped me through the initial stages. Since

then he has provided constructive criticism as the book has passed through

many iterations.

Along the way I have had input from a number of colleagues at

Standard Chartered Bank, past and present, as well as others who have

helped me to understand risk and risk management better and/or have

provided useful feedback on various drafts of the text. Those worthy of

special mention are Geoff Burgess, Mani Ilangovan, Daniel Mwagi and

Ting Zhang. There are countless other friends, colleagues and customers

that I have worked with around the globe over more than 20 years that are

too many to name but should be recognized. They have provided me with

a wealth of experience, “war stories” and case studies that I have been

able to draw on to highlight some of the issues that arise when seeking to

do business in emerging markets.

vii

Acknowledgements

I must also thank Laurie Donaldson from Pearson Education who was

receptive to the idea of the book and has guided and encouraged its

progress as it has unfolded chapter by chapter.

A final thank you has to go to my wife Hilary who lost sight of me for

many an evening and much of the weekends for several months during the

preparatory and then drafting and redrafting stages. A thank you goes to

sons Ian and Neil who also did not see as much of their father as they

probably should have during this period.

Needless to say I take full responsibility for the ideas and concepts

explored within the book. Comments and feedbacks would be most wel￾come. I can be contacted via e-mail at [email protected].

Carl Olsson

viii Acknowledgements

Carl Olsson studied Economics at Cambridge University before joining

Standard Chartered Bank, a UK based banking group with operations in more

than 50 countries largely in Asia, the Middle East, Africa and Latin America.

After initial training in the UK Carl was relocated overseas and lived and

worked in various emerging market countries, including India, Hong Kong,

Bahrain, Turkey, Thailand and Brunei, over a period of nearly 20 years. He is

currently London based where he works in Group Risk Management function

of the bank where he is involved in a variety of risk related projects which

have a global reach. In the last few years he has become more involved in

developing and delivering risk training to internal and external audiences.

During his time overseas Carl held a variety of positions in both front and

back office which included senior management positions in business and risk

units. A substantial period of time was spent working with multinational

companies who were either running or seeking to establish operations or

undertake contracts in emerging markets. In addition, he had considerable

exposure to business issues in these countries from dealing with large local

corporates and small businesses as well as non-profit organizations such as

the Royal Brunei Yacht Club where he was Honorary Treasurer.

In addition to a degree in Economics he has obtained ordinary and degree

level banking qualifications and an MBA from Henley Management College.

ix

About the author

Introduction xiii

PART ONE Risk and risk management 1

1 What is risk? 3

2 Identification of risk 29

3 Measurement of risk 67

4 Management of risk 99

PART TWO Emerging markets and risk management 145

5 The nature of emerging markets 147

6 Culture and language 183

7 Risk management in emerging markets 209

PART THREE The future of risk management 257

8 Trends and developments in risk management 259

9 Postscript 297

Index 301

xi

Contents

“Risk Management can help you seize opportunity,

not just avoid danger.” DAN BORGE

Imagine that you are called in by your boss and told you have been chosen

to set up a new call centre. You feel good as it's a new job and a new chal￾lenge. Then he tells you the call centre will be in India. That's definitely a

challenge, so do you feel excited or concerned? If concerned, is it because

of what you know or what you don't know? You know call centres but not

India, then again, life is all about seizing opportunities. To obtain rewards

from opportunities it is necessary to take risks. What we intend to explore

is very much this scenario – the combination of risk and emerging markets.

A basic premise that we will explore is that operating in emerging mar￾kets is riskier than doing so in the developed world. This is largely because

they are often characterized by greater economic and political instability

and are more vulnerable when external shocks, such as natural disasters,

occur. This is, however, no reason to steer clear of these markets because

there are higher levels of return on offer for those that understand and can

manage risk effectively.

Think about setting up that call centre. Why would your company want

to do it? A prime reason will be lower costs. A major cost in such opera￾tions is labour so, with technology having shrunk the cost of calls between

New York and New Delhi to a fraction of what it was ten years ago, it now

makes sense to set up operations at a considerable distance from cus￾tomers ... provided the associated risks can be managed. What sort of risks

they are and how they can be mitigated is a question we will seek to

enable you to answer.

xiii

Introduction

xiv Introduction

Many of the risks that exist in the developed world also exist in emerg￾ing markets but there are other new twists that mean they appear in

different guises. In addition, there are a number of new risks that you will

have to face and deal with, some will undoubtedly be unexpected. A prime

reason for these differences is the cultural differences

that exist between developed and emerging markets.

Different backgrounds, different religions, different

values and different languages all bring a diversity

which impact on how people see situations and how

they deal with them. People that live in cultures

based on deference and respect for elders, for

instance, sometimes have difficulty dealing with risk

when they see things being done by senior manage￾ment that they think is wrong as speaking up would

be seen as disrespectful. At a more basic level, simple translation errors can

cause enormous problems unintentionally.

If this was not enough, the nature of risk itself is changing because the

world has become more complex and interconnected. On top of that, the

pace of change has accelerated and people have become less tolerant of

risk. All this means that events that happen in one country have an impact

in unexpected places and in unexpected ways. Russia defaults and threat￾ens the US financial system. An earthquake in Japan brings down one of

Britain's oldest investment banks. A downturn in the US threatens textile

suppliers in Malaysia. The stories go on.

This accelerated pace of change affects countries in the developed world

as well as emerging markets. Developed countries, however, have greater

depth and resilience and are not so easily impacted by sudden and unex￾pected events. Emerging markets can be like spinning tops – one nudge and

they go off in an uncontrolled direction. Developed countries are more like

oil tankers – it takes a lot to push them off course and a long time to take

effect. Part of the reason for this vulnerability is poor economic manage￾ment which is often linked to political factors such as strong or charismatic

leaders remaining in power for decades and looking after their own inter￾ests. The spread of democracy appears to be no protection against this.

The purpose of this book is to help those who are faced with situations

described in the opening paragraph, those who have business connections

with emerging markets, or students with an interest in risk management

and how it must be viewed differently in the more volatile climate of

emerging markets where risks are different and solutions that work in the

developed world are not always available.

xiv

Many of the risks that

exist in the developed

world also exist in the

emerging markets but

there are other new

twists that mean they

appear in different

guises.

In order to meet this task the book is in three sections. Part One deals

with the basics of risk and risk management. Chapter 1 covers what risk is

and explains why it is important to think of risk in a positive light – the

corollary of risk is opportunity, but we mostly think of risk avoidance rather

than risk exploitation. A key objective of this chapter is to convince you

that there are many ways to look at risk and that we all do it differently.

Understanding other people's point of view is a definite asset when dis￾cussing risk and how to deal with it.

Part One then deals in sequence with the key elements of risk identifi￾cation, measurement of risk and risk management. It may sound obvious

that the failure to identify risks up front will make it difficult to manage

them effectively, but risks are often taken on by line managers whose first

thought is revenue not risk. In emerging markets this can be lethal. It is

increasingly important because of the changing nature of risk. Hacking, for

example, did not exist before computer systems were connected to tele￾phones. Reputational risk was less of a threat before green activism started

in the seventies and the activists’ actions started hitting the headlines.

Identification of risk is only the starting point, however. Being able to

measure risk is important as a basis for decision making. How big the risk

is and what the impact would be if it occurred are important dimensions

to understand when thinking of risk strategies. Unfortunately, not all risks

are easy to measure and in emerging markets data is often not available

and is rarely of good quality.

The need to overcome these first two hurdles means that by the time

we start thinking about risk management in emerging markets we are

already at a disadvantage. Managing risk in all environments is a critical

success factor for the future but in emerging markets the skills needed are

different. It is not about blindly following the rules, often set in Head Office

thousands of miles away, because the environment is changing too fast for

the rules to keep up and people in Head Office could not write a sensible

set of rules that would apply in all countries in all situations. What is

needed are managers who are risk aware and able to use judgement and

common sense. People that understand the environment and who have

been entrusted with sufficient authority to act when necessary without

calling the folks back home. By risk aware managers we mean people in

line functions, salesmen, production management, technology support

and so on, not people in the risk management department. This is impor￾tant as everyone is a risk manager, though many would not say so if you

asked them. Everyone in business performs some sort of risk management

function day in day out but they often do it subconsciously.

Introduction xv

The risk management process starts with setting the right strategy and

involving risk professionals in the debate, as partners not adversaries. It car￾ries through to the development of a risk framework appropriate to the

company's strategy. That risk framework must be adequately resourced so

it can operate effectively with a degree of flexibility which will allow it to

respond to an ever-changing environment. Today the problem is that risk is

like a bar of soap. No sooner do you think that you have it under control

than it shoots off in an unexpected direction and you have to scrabble

around to get it back in your grasp. This requires flexibility and good people

– not a rigid command and control approach that parent companies have

tended to adopt when managing their emerging market subsidiaries.

Having looked at some basic building blocks in Part One, Part Two looks

specifically at emerging markets and explores what works and does not work

well in that environment. Chapter 5 looks specifically at the nature of emerg￾ing markets. This is an interesting area to explore, as there is a dearth of

literature on it. Though there are many books with emerging markets fea￾tured tantalisingly in their title, they are virtually all about investing in stock

markets. Very few even consider defining what constitutes an emerging

market though they all have long lists of countries that they classify as such

without explaining why. Our stance is somewhat different. We are more con￾cerned with the risks facing long term investors who put their money in real

not financial assets. Companies that are committed to the long term and do

not flee at the first currency crisis or political upheaval. More specifically we

seek to answer the question of what makes emerging markets different and

how this impacts on risk, not how it is possible to make a quick return. The

key points here are that familiar risks appear in new guises or behave quite

differently while completely new and unexpected risks can assail the unwary

newcomer more or less anytime. In particular, it is these new and unexpected

risks which are often the downfall of new ventures in these markets – secu￾rity risks, corruption and religious and tribal conflicts being just some of them.

Chapter 6 looks at a particularly important distinguishing area for

emerging markets – culture and language. Anyone working or dealing

with emerging markets must understand and respect the culture of the

country they are operating in. Not only that, they must be acutely aware

of their own culture and how it differs from that of the countries they are

dealing with. In addition, they must be aware of language traps.

Communication is only effective if the recipient understands exactly what

you wanted them to understand. This can be difficult, even where both

parties speak the same language, if the coding and decoding process

breaks down. Where one party is not a native speaker of the other lan￾guage being used this problem is compounded.

xvi Introduction