Rethinking country risk

Traditionally, companies measure their country risk with one factor in mind: physical locations. As evidenced by supply chain and payment issues during the pandemic, using this measure alone is outdated. The interconnected global economy makes it crucial to also look at companies’ counterparties.

To more accurately determine an organisation’s true risk exposure, take a broader view of physical presence and examine its supplier footprint and customer base. Learn more about each of these parameters and how to mitigate the risk each represents.

Company presence

Some of an organisation’s exposure comes from the countries where it has physical locations with personnel and production, offers services, or is legally incorporated.

But an organisation’s presence is not just physical. In each country, it is also important to measure the following:

• Local activities and involvement: Risk exposure does not just stem from having a locally incorporated entity. If an offshore entity doing business or handling activities in a country – that is a point of exposure. In some cases, the exposure can be greater if regulations are stricter for foreign entities doing business in the country versus local entities.
• Transportation routes: During the first weeks of the pandemic, some products got stuck in transit with no alternative routes simply because companies did not identify the routes’ risk. Consider the path goods travel. For example, if an organisation ships goods through a Japanese port of call – even if you do not have a physical presence there – you need to include Japan in your risk analysis.
• Financial presence: Make sure the balances held onshore in each country and currency are known. It is also important to understand the mechanism and rules for extracting and converting those balances, including how much manual intervention is involved.

Supplier footprint

Beyond a company’s physical presence, the organisation should also examine its supplier footprint, including where its suppliers source from. Factors to consider include:

• Suppliers’ physical presence and materials: Depending on the location of counterparties’ manufacturing plants, warehouses and other major operations, companies may have exposure in other countries. It’s important to learn about suppliers’ supply chains as much as possible, including their locations and disruptions. For example, if wildfires lead to decreased mining of a natural resource key to a company’s production, it will need to prepare for critical shortages. Compiling the value and percentage of supply chain materials sourced from each country can also provide a more nuanced risk picture. Don’t forget that work-in-process (WIP) items contribute to risk if disruption occurs before shipment.
• Track currency exposure: Doing business in the country’s local currency can also present a risk. Be sure to track invoices issued to the company in local currency. Examine the company’s liquidity structures and foreign exchange practices to ensure it is effectively managing local currency and in-balance country exposures.
• ESG alignment: Make sure that the company and its vendors are on the same page about environmental, social and governance (ESG) practices. Operating and payment processes are an important place to look. In some countries, for example, local business customs may not align with official governmental processes. Adopting these practices may be commonplace, but they can add reputational risk in the public’s eyes.

Customer base

Perhaps the largest exposure comes from customers. Thoroughly assess where a company’s customer base is located to prepare for any behavior or revenue changes. Ask the following questions:

• Where do your customers have headquarters or delivery addresses? Company’s face risk exposure in those countries as well. Consider the impact of existing or looming sanctions that could delay or halt the delivery of goods at delivery addresses.
• What is the value and percentage of revenue attributed to customers located in a country? A company’s customer base is the most important factor when considering risk. Quantify its exposure by calculating the value of each country’s outstanding account receivables and attributed write-offs, as well as demographic trends. When tracked, these metrics may indicate changes in its risk exposure that merit a closer look.
• How does your work in process (WIP) factor in? WIP items tie a company’s working capital to specific customer orders. Country disruptions can impact a customer’s ability to honor a purchase order, which can turn into a loss for the company. This is especially true for highly customised products. If a customer isn’t able to receive the order, a company is rarely able to resell it to another client.

How to mitigate your country risk

In addition to mitigation strategies for individual issues, there are also steps companies can take to manage their overall risk.

1. Conduct a thorough risk analysis: Find out where exposure is concentrated – for example, supplier or customer base – and diversify.
2. Stay on top of due diligence processes: Run an onboarding due diligence process on suppliers and customers frequently.
3. Establish performance and risk indicators and a reporting cadence: Review and update each regularly. Stay close to sales and procurement teams so it is possible to recognise patterns and potential risk early on.
4. Leverage traditional trade solutions to reduce risk exposure: Be sure to balance letters of credit and other trade solutions with the cost of reducing risk exposure from specific counterparties or scenarios in a new location.
5. Look at a newer supply chain finance or receivables financing program: Consider the viability of these options, which can support the liquidity needs of customers and suppliers, as well as the needs of the company.
6. Set up liquidity structures to manage local currency and balance exposures: Aim to install mechanisms that not only simplify cash movement in and out of a country but enable real-time visibility and access to funds individually or in aggregate.

Treasury’s role in managing country risk

As the pandemic revealed, the advantages of global connection come with risk exposures. From supply chain disruptions to the inability to fulfill contracts, these exposures can be devastating. Actively monitoring and managing the real country risk, which encompasses multiple business dimensions, requires a more holistic view. Leverage treasury’s interfacing role to work with all internal parties to identify and measure threats and vulnerabilities before they cause real damage.