A big boost for business from pricing local risks: international standards for assessing country risk

RMA Journal, The, May, 2003 by George J. Vojta, Carl F. Adams

This article presents a cogent argument for a set of international standards that can be used in pricing risk, thereby ensuring proper rewards for risks taken and better pricing for those customers and jurisdictions using best practices in their operations. The private sector has power: Use it, say the authors.

National and subnational jurisdictions use varied and unique local business behavior that may or may not conform to acceptable international "best practices." Banks that price for distinctions in lending, trading, investing, custody, and financing services--using valid accounting for the risks inherent in the institutions and the practices within local jurisdictions--can realize an enduring boost for business, competitive advantage, and fiduciary protection.

Pricing for country and local risk is a unique power reserved only for the biggest force in world capital markets-the private sector. And risk managers have an obligation to assume leadership in recognizing and using this power.

The Financial Standards Foundation seeks to serve as advocate for the private sector s leading role in pricing for country compliance with international financial standards. Currently, there is no global sovereign power or regulator to enforce compliance with standards and codes of best practices, as can be seen in the numerous offshore activities and off-balance-sheet vehicles in use. However, the natural laws of economics, and the consensus of civil societies acting in their own self-interests, do set global financial limits--again, guided by market prices that even the mightiest sovereign superpower must respect! The private sector can harness this reality with sharper, more informed pricing of commercial risks.

It's perfectly logical. Why would any good risk manager tolerate holding financial risks for which his or her firm is not fully paid? Why would any financial professional fail to exploit the ability to deliver less costly financial products and services to less risky clients for competitive advantage? Yet in the current geopolitical seizures of global financial markets, most of the private-sector players fail to charge risk premiums for products and clients in countries where the risk of global architecture conformity is very great. They also fail to discriminate and discount products and clients where the risks of global architecture compliance are measurably very low and going down!

Weak prices and low demand in financial markets during the past few years suggest that competitive pressures are not the reason for missed business growth from global financial architecture. Rather, it's the private sectors lack of awareness that country compliance with international standards and codes can be a potent, positive business tool.

A Starting Point for International Standards & Codes

The private sector can use its power and authority to demand compensation for the risk assumed from financial exposure to contracts and business risk in countries that do not comply (or refuse to acknowledge any intention to comply) with global policy standards. While there are no global regulations or sovereign disciplining authorities, global standards do exist for best practices and infrastructure competence required to sustain capital markets and prudent but effective finance.

A good starting point for a list of such standards has emerged from efforts by the official sector since the early 1990s. The policy standards for best business behavior are outlined by the Financial Stability Forum of the Bank for International Settlements (BIS). Both the science and the art of global financial architecture are contained within the guidelines of these principles, which are based on work by the global public sector, by international financial institutions, and by global self-regulatory professional associations. (See Appendix, "Key Codes and Standards for Sound Financial Systems.") The 12 policy standards fall into three topic categories as follows:

Macro Fundamentals

1. Transparency in monetary and fiscal policies.

2. Fiscal disclosures.

3. Special data dissemination standard.

Institutional and Market Infrastructures

4. International accounting standards.

5. International auditing standards.

6. Principles of corporate governance.

7. Insolvency guidelines for enterprise bankruptcy, recovery, and/or liquidation.

8. Core principles on payment and settlement systems.

9. Money-laundering rules for market integrity.

Financial Regulation and Supervision

10. Core principles for banking supervision.

11. Objective rules of securities regulation.

12. Supervisory principles for insurance oversight.

With such a complete list of international standards (and there are explicit principles for each), the question might be, Why aren't businesses using this checklist, determining differences of risk from country to country according to the country's compliance with these standards, and then pricing for such risk with the powerful and positive results suggested above? For a possible answer, check your own awareness of this topic and these 12 international standards and codes: