Session 4. Managing the risks at the markets of developing countries

FDI from the BRICS

This collection was collated by Yuriy Zaytsev as teaching material on the FDI from the BRICS course at the Institute of Development Studies.

Questions of the session

• The main investment risks existing in developing countries;• The role of governments and donors in reducing the risks for

investors;• The engagement of international business for improving the

business climate in those countries, where it operates; • CSR and PPP as mechanisms in mobilizing resources for

development needs and investment climate improvement. • The methods to overcome investment-associated risks in

developing countries, employed by BRICS business;• How do these methods create an added value, which help

them to compete with other investors?

The risk chain

Note: The feedback arrows in the risk chain diagram represent the potential for the outcomes of past shocks to affect exposure and internal conditions, as well as the propensity for future shocks. Similarly, the effectiveness of people’s risk management can significantly affect the nature of and propensity for future shocks.

The nature and extent of outcomes depend on shocks, exposure, internal conditions, and risk management

Source: The World Development Report, 2014

The role of risk-management in developing countries

• The goal of risk management:– mitigate the losses and improve the

benefits that people experience when they face risk and opportunity.

NB: Risk management can both increase economic returns and reduce the propensity for crises: there need not be a trade-off between resilience and growth.

Source: The World Development Report, 2014

The mechanisms to cope with risks in developing countries

• Knowledge– Increased information about risk can help people better understand the nature and likelihood of

risks they may face, thus reducing uncertainty.

• Protection– action to prevent negative shocks from occurring or to mitigate their impact; – actions to increase the propensity for positive shocks and gains from them; protection can be

self-provided, purchased from the market, or provided publicly by the community or the state.

• Insurance– instruments that transfer resources between good and bad times (savings, formal insurance

contracts, loans, credit lines, hedging instruments), – means of transferring resources to those especially in need in bad times:

• Social safety nets, community support, or other risk-pooling mechanisms.

• Preparation– together, knowledge, insurance, and protection constitute preparation (or ex ante risk

management);

• Coping – (ex post risk management) encompasses all actions that are taken once a risk (or alternatively

an opportunity) has materialized. – updating relevant knowledge by assessing the new situation and then implementing necessary

and available responses.

The measures to cope with risks in developing countries

• Worker, consumer, and environmental protection:– facilitating the development and implementation of

employment standards and production processes that protect workers, consumers, and the environment.

• Resource reallocation and innovation:– enterprises shift resources, expand and contract, and

enter and exit markets;• Risk sharing

Obstacles in managing risks

NB: Identifying risks is not enough: the obstacles to risk management must also be identified, prioritized, and addressed through private and public action.

Source: The World Development Report, 2014

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Interdependence of Risks for Business

Business Risk

OperationalRisk

FinancialRisk

IT and business process

outsourcing

Derivatives documentation and counterparty risk

risk in a new foreign market

Enterprise-Wide Risks Financial Risks

MarketRisk

LiquidityRisk

CreditRisk

Credit Risk Associated with

Investments

Credit Risk Associated with Borrowers and Counterparties

Funding Liquidity

Asset Liquidity

Risk Management Dept. 9

Integrated Framework

Risk and Economic

Capital Measurement

Performance Measurement

& Management

Business Portfolio

Management

Investment

Strategy

Pricing

Reinsurance Optimisation

Limit Setting

• Common measurement standard leading to common language

• Common risk ‘currency’, interpretation as capital

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Integrated Framework

2. Line Management

Business strategy alignment

3. Portfolio Management

Think and act like a “fund manager”

4. Risk TransferTransfer out

concentrated risks

5. Risk AnalyticsDevelop advanced

analytical tools

6. Data and Technology Resources

Integrate data and system capabilities

7. Stakeholders ManagementImprove risk transparency for key stakeholders

1. Corporate GovernanceEstablish top-down risk management

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Benefits

• Broadens risk awareness

• Aligns risk profile and strategy

• Minimizes surprises and losses

• Rationalizes capital requirements

• Assures regulatory compliance

• Improves ROE and shareholder value

Risk Impact Analysis

– Input: • System mission• System and data criticality• System and data sensitivity

– Analysis: Adverse impact described in terms of loss or degradation of

integrity, confidentiality, availability

– Output: Impact Rating of High, Medium or Low

A set of screens for assessing obstacles to risk

management, and formulating policy responses

Source: The World Development Report, 2014

PPP mechanisms

• Public-private partnership is a very efficient way to expand the operations of transnational corporations (TNCs) in developing countries – effective tool for integrating businesses into government IDA-related projects.

• Public-private partnership in international development assistance offers a number of positive effects. – PPP projects solve the problem of inefficient state regulation and market failures, as well as mitigate the

risks related to financing development programs, offering an alternative for handling development problems;

– PPP mechanisms within IDA present a novel approach for combining the resources and competencies of traditional and new IDA participants, who may share equally the risks and benefits of implementing non-hierarchical projects, while retaining their own goals and tasks at the same time;

– PPP projects generate added value through optimization and synergy-related effects, which would be impossible if partners operated separately. • In fact, the tool of PPP in IDA promotes the creation of a unique product able to promptly resolve problems within

the poorest countries, i.e. helping solidify factors encouraging sustainable development. As far as the production of economic effects is concerned, both in the near and distant future such projects are not likely to be replaced by alternatives, in view of the low growth rates in the poorest countries. IDA appears to have acquired a trend where traditional PPP approaches are transformed through the emergence of multilateral partnerships that unite representatives of the public sector, private firms and NGOs. In many cases, this effect is triggered by the complexity of the IDA process which involves multiple goals of economic development of the poorest countries, the possibility of the negative net present value of the project, and the need for strengthening national institutions to ensure continuity in IDA project outcomes in the long term.

Types of PPPs in Basic Education, Public Health, and Water and Sanitation

Source: World Economic Forum

CSR mechanisms

• Corporate social responsibility is another track for business participation in the IDA and managing the risks in developing countries;

• Usually, firms regard CSR programs as an instrument to lower social risks and maintain the loyalty of current and potential clients in developing countries.

• The public sector regards CSR programs through the prism of lowering ecological and social risks, with multilateral and bilateral donors accentuating this point as well. – CSR often becomes a realm where the activities of the businesses and donors in

recipient countries play in tune.• CSR projects in developing countries are primarily related to the companies'

implementation of certain international principles regulating socially responsible financing, first of all those recommended by international development banks like the IFC and IBRD, Asian Development Bank, and the African Development Bank, which vigorously support the processes of socio-economic development in the poorest countries.