TOOL J2
Definition
The risk that funds in foreign currencies are not transferred out of the risk country as a result of action(s) by the authorities of the country, or by other events impeding transfer.
How Cross Border Risk Arises
| Actions by the Authorities | Actions by the Authorities |
| Affecting Payment | Affecting Ownership |
| Moratorium | Confiscation |
| Transfer stop | Nationalisation |
| Convertibility stop | Expropriation |
| Withholding tax | No clear title to property |
| Contract law difficult to interpret / enforce |
| Others |
| Civil War |
| Revolution |
| Invasion |
| Social unrest |
| Strikes |
| Natural disasters |
| Embargo |
Mitigants
1. Funding – without recourse to the parent bank
- Issue Debt Capital Market products in the name of the local entity
- Enter into funding agreement with development bank (e.g. IFC)
- Raise local foreign currency deposits
NOTE – non-payment of these liabilities carries reputation risk and a potential moral pressure on the Bank to repay
2. Insurance (outside the risk country)
Take professional advice
3. Comprehensive (commercial and political)
- ECA (care re residual risk)
4. Credit Derivative
5. Political (see choice of legal counterparty below)
Care on definition of political. It normally covers:
- Convertibility, non transfer
- Confiscation, expropriation, nationalisation
- War, civil disturbance (not terrorism)
- Breach of contract by legal counterparty
| Collateral | – Guarantees outside the risk country – Cash collateral (escrow, debt service reserve account)/ other collateral outside the risk country – Pledge over movable assets e.g. planes with re-possession insurance |
| Trade Finance Structures | – Controlled disbursement and repayment directly from off-takers / buyers outside the risk country – Bartering |
| Choice of Legal Counterparty | – Exposure to the government or government owned enterprises – Makes the country risk more pure by reducing commercial risk – Improves access to political risk insurance and credit derivatives |
| Co-lenders | – Entering into a joint finance package with supra national bodies such as IFC, EBRD etc may enhance influence in times of stress depending on the circumstances |
Other Cross Border Issues
| Jurisdiction | – Where there is more than one jurisdiction in a transaction (see below), you will need to get a strong legal opinion on the compatibility of the jurisdictions involved – Collateral is usually taken under the local laws, while the credit agreement will commonly be under Dutch, English or New York law – Less established legal systems can lead to the inability to take action and / or realise security. There is often uncertainty of outcome of legal action and long time delays |
| Regulation | – Consider the impact of different regulatory requirements and standards, especially in the banking sector |
| Withholding Tax | – You will need a grossing up clause for borrowers in countries where the authorities deduct tax from interest payments (Italy, India) |
