Country Risk Mitigation Strategies

Abstract

Organizations face various choices as they seek to manage Country Risk. If they understand their exposure to this risk, they can further evaluate (i) the approaches available to mitigate it; (ii) the costs relative to the benefits; and (iii) any additional or new issues they may incur, including credit, market, and operational risk. The foundation or any strategy to mitigate Country Risk is careful assessment based on rigorous research. Among the most traditional approaches to mitigate Country Risks are risk limits and diversification of suppliers, trading counterparties, and banks. Other approaches involve guarantees, financial hedging transactions, master netting agreements, and collateral. Various governmental and multilateral organization provide sources of additional support to protect against the risks relating to exports and trade financing, including the World Bank, the Multilateral Investments Guarantee Agency, the International Finance Corporation, the Overseas Private Investment Corporation, Coface, and various export credit agencies.

Appendix 15.1 Best Practices for Mitigating Risk in FX Transactions

In May of 2017, the FX Global Code was issued by a group consisting of central banks and participants in the global foreign exchange trading market. The document, which reflected feedback by individuals in sixteen jurisdictions, was intended to summarize sound practices for the foreign exchange trading market. The goal of the initiative was to “promote a robust, fair, liquid, open and appropriately transparent market in which a diverse set of Market Participants are able to confidently and effectively transact at competitive prices that reflect available market information and in a manner that conforms to acceptable standards of behavior” (https://www.globalfxc.org/fx_global_code.htm).

The Code includes fifty five principles, including Principles 24-41 devoted to risk management and compliance. The overarching theme for risk management was described as follows: “Market Participants are expected to promote and maintain a robust control and compliance environment to effectively identify, manage and report on the risks associated with their engagement in the FX Market.”

The Code expressly recognizes the following “key risk types”:

• Credit and Counterparty Risk

• Market Risk

• Operational Risk

• Technology Risk

• Settlement Risk

• Compliance Risk

• Legal Risk

To manage these risks, the Code calls for a range of practices, including:

• Clear ownership of the business decisions by the business unit

• Independent risk management function

• Independent compliance function

• Independent audit function to review internal control systems

• Timely reporting of understandable risk and compliance-related information to senior management

• The use of master netting agreements and collateral

• Independent reporting of the current market value of trading positions

• Adequate resources and employees with clearly specified roles, responsibility, and authority

• Appropriate processes to identify and manage operational risks

• Documented policies, procedures, and controls

• Robust risk assessment and approval processes for both new and existing products and services.

Although the Code does not explicitly contemplate Country Risk as a separate “key risk type,” it must be carefully considered by regulators, market participants, and other stakeholders. It is relevant to the assessment of all applicable risks in foreign exchange trading (and any other forms of bilateral transactions, including derivatives). Particular emphasis must be given to scenarios where a problem in one country or region has the potential to give rise to problems in other countries and regions.