Chapter 4 Integrating cash and trade
served to downscale or end its relationship
with that counterparty.
Insure against loss.
The third alternative is to arrange some
form of credit insurance. Credit insurance
is available from both commercial insurers
and export credit agencies (see below).
Work with counterparty to improve
creditworthiness.
The final alternative is to work with the
counterparty to reduce the chance of
failure. In the case of strong credits, this
can include arranging a supply chain
finance structure to support suppliers and/
or end customers (see below).Country risk
The second broad type of risk that
companies face when trading internationally
is country risk. This is the risk that action by
the government or regulator in one of the
parties’ jurisdictions results in a counterparty
not being permitted to pay, or a company
having difficulty in repatriating funds from
one jurisdiction to another. Companies
must also be aware that it may be difficult to
pursue redress through local courts in the
event of non-payment. (This is most likely
when a company has not taken sufficient
care or advice over the preparation of
contracts to meet the local jurisdiction’s
standards. In some jurisdictions, political
interference may affect the ability of the
company to seek redress. Finally, in
certain circumstances, uncertainty over the
likelihood of getting redress may make the
cost of funding legal action prohibitive.)
Companies must also recognise that in
today’s environment there is a much greater
focus on counter-terrorist financing and
money laundering. This will add cost to the
process of establishing local bank accounts,
which may otherwise make collecting
payment easier.Action to manage country risk
Treasurers will want to assess the country
risk associated with a particular transaction
before agreeing a contract. Official export
credit agencies, in particular, tend to grade
countries according to their risk, providing an
opportunity to identify a clear charge for thegoods or service. In most cases a company
would become exposed to country risk when
it is considering expanding operations to a
new jurisdiction. However, a treasurer should
always monitor government activity; for
example, it is possible that the company’s
goods could be caught in an emerging trade
protection dispute. Any change in government
should also be assessed.^1
In the case of country risk, the company
has three main choices.
Start or continue trading.
The first option is to continue to trade
or to pursue any plans to expand into
a particular jurisdiction, factoring in a
sufficient return to compensate for the risk.
Cease trading.
A decision to cease trading could be made.
However, it might be difficult to resume
trading at a later time in that country, as
competitors will have been able to replace
the company in that market.
Arrange insurance.
The third option is to arrange some form of
insurance to protect against loss.The use of insurance to manage counterparty
and country risk
It is possible to take out insurance against
credit and country risk. The cost of doing
so will be related directly to the insurer’s
evaluation of the company’s likely loss and the
cost of loss. In other words, for the same sum
insured, when a company is likely to claim
against a policy the premium will be higher
than when a claim is unlikely. The key point
when assessing the cost of credit insurance
is to evaluate the cost of the premium against
the impact of a loss if uninsured. Where
a company faces likely losses, it might be
more appropriate to self-insure, probably by
charging the end customer a higher price to
reflect the risk. The big danger with reliance on
credit insurance is that a loss event may prove
to be exempt from the insurance policy, and
the insurer may be able to avoid paying.
Insurance is usually available from two1 Aswath Damodaran provides a range of data that quantifies
country risk and other measurements. It can be found at
http://pages.stern.nyu.edu/~adamodar/, with the data sets
accessible from the ‘updated data’ section on the main menu,
then look for ‘risk premiums’.