Financial executives typically consider a country’s sovereign risk when evaluating potential expansion into a market. This sovereign risk rating, as published by Moody’s, S&P or Fitch, primarily relates to a country’s credit rating, reflecting the sovereign government’s ability to meet its financial obligations.

While obviously important, sovereign risk is but one of several country-risk issues that can affect the business success of lessors and financiers in emerging markets. The following summarizes several more important factors to be considered:

Banking System Strength
Lessors must carefully evaluate a country’s banking system. In addition to concerns with payment system quality, regulatory oversight and the health of individual banks, the intrinsic strength of the system often acts as a barometer for the maturity of a country and its credit culture, which is critical to the interests of lessors.

For example, Mexico’s banking system is considered fairly good, which has helped companies there accept leasing as an effective strategy for acquiring equipment.

Conversely, despite having a stronger sovereign credit rating than Mexico, China has historically done a poorer job of regulating its banking system. The recent influence of western banks has helped China’s financial institutions make operational improvements. The fact is, however, China long fostered a lax credit culture that affects attitudes toward meeting financial obligations. Changing this mindset will take time.

Such banking-industry concerns are not preventing organizations from capitalizing on the vast Chinese market, as well as those in other emerging countries. They are, however, prompting finance companies to evaluate how much business they may want to conduct in China, as well as how fast they grow there.

Political Risk
Another key concern for lessors interested in expanding into new markets is political risk. Government stability — or lack thereof — can affect a lessor’s business operations through unexpected “rules changes” or changes in receptivity to non-local businesses.

Mexico has an acceptable credit rating, a relatively mature banking system and political stability. However, there may be fallout from the recently disputed presidential elections, with the left-wing loser Obrador threatening actions to undermine the newly elected administration of President Calderon.

Venezuela already has a culture of hostility toward Western economic interests that weighs heavily on business decisions made here and there. In Ecuador, a leftist candidate is about to take office and he plans to threaten a default of all foreign debt to force loan renegotiations.

Such hostility and threats undermine the degree of certainty/predictability of business and financing operations. By contrast, China — a “one-party” country — permits very limited political freedom, but is nonetheless considered quite stable and predictable, as well as increasingly receptive to long-term foreign involvement in the financing industry.

Transparency
From an operational standpoint, lessors must be concerned with transparency risk. This pertains to the availability and reliability of information on customers, as well as the openness of commercial transactions.

Transparency is improving in many growing economies around the world, especially among larger customers and prospects. Many challenges remain, however, when dealing with small- to mid-sized companies, and many financing businesses have been cautious moving “down market.”

Simply checking credit information can be problematic. A number of Latin American countries do have credit bureaus. But, in many cases, their laws require that written authorization is needed in advance to review such information. This can make the process very cumbersome.

The next area of focus concerns the accuracy and completeness of the information. There is no uniform standard to providing financial data in many countries located in Asia and Latin America. Organizations often present financial information to fit their needs, which can lead to deception. In such situations, one must have more than an acute eye for reading and understanding the data presented.

It can be extremely useful to have a local partner(s) with deep knowledge of the market and background on individuals and their organizations. Many lessees in emerging markets are privately owned or family-owned businesses, so public credit bureau information can be virtually impossible to secure. A local partner with close ties to the region and its business sector often knows exactly who owns and runs a business, its history and prospects for the future.

Corruption
Related to transparency risk is the level of corruption one may encounter in an emerging market. Transparency International — which can be found at www.transparency.org — provides companies with insight on what to expect in this regard when doing business in many countries.

China and many Latin American countries in particular are known for cronyism and corruption, although these certainly occur in other emerging markets and even to a certain extent in our own country. Therefore, lessors need to be very careful when determining with whom to work with. It may be imperative in certain cases to engage a trustworthy, reliable partner who will provide independent and accurate credit assessments of prospective customers.

Beware of side deals, however, struck to close a transaction. This practice does regularly occur in some markets. A lessor may have a signed lease contract in place but, nevertheless, an unwritten side agreement also is reached. Nobody likes surprises, but side deals often appear when the lessee wants to terminate a lease with no penalties or hassles, as well as other situations.

Some organizations choose to enter into more formal relationships with local companies, forming legal joint venture partnerships. While this approach has many benefits in terms of limiting or shielding the U.S. firm from certain risks, it has its own set of issues to consider. Among them are the potential partner’s reputation in the market, its risk appetite, competitive position, an ability to seamlessly handle customer handoffs, business control issues and regulatory compliance.

Legal System Risk
Despite a firm’s best efforts to evaluate creditworthiness, some level of bad loans is inevitable. The question for a lessor in an emerging market focuses on its ability to enforce legal contracts.

To address this concern, an organization has to evaluate the independence and reliability of a country’s legal system, as well as its timeliness in enforcing laws. This is another area where many emerging countries are making progress, although their legal channels are certainly not on par with those in the United States and other western countries.

Evaluating this risk requires developing a view of the independence of the court system, as well as its relative efficiency. Specific evidence regarding the question of judicial independence is typically anecdotal rather than systematic. However, the World Bank does attempt to measure the relative efficiency of various country court systems.

For example, when trying to collect a debt via legal action in Mexico, the World Bank reports legal fees equal to about 20% of the outstanding principal with no guarantees to collect. In the United States, this figure stands at 7-8% of the outstanding lease/debt value.

A related concern relates to securing equipment. That is, if a loan default occurs, the loan provider is protected by the fact that it can seize the equipment. In some emerging markets, including Mexico, the process for securing equipment loans properly is hampered by high costs and difficulty in enforcing claims.

Rewards Outweigh Risks
While this summary of risk elements may seem daunting, the fact is a number of U.S.-based lessors and finance companies are already successfully operating in many of the larger emerging markets across the globe.

The common thread among those organizations that are successful is their effort to look beyond the sovereign risk rating of a country, and designing a risk management program appropriate for their businesses.

Among the tools used to help manage these risks are business/credit policies clearly defining target customer sets; use of local, reputable partners; well-defined underwriting rules and delegation; use of alternative dispute resolution in cases where courts are unreliable; and limits on country and customer exposure.

These policies/tools are very company- and country-specific, but all sophisticated organizations know how important it is to have a comprehensive risk management plan in place before entering or expanding in an emerging market.

Many multi-national equipment leasing and asset finance companies employ a systematic approach to international business development. Their due diligence plays a key role in them flourishing in emerging markets — ripe for the full range of our industry’s services.

Joseph Boland is a principal of The Alta Group. His expertise includes credit risk management for large, multi-national enterprises and financing companies with multi-line, multi-country businesses. Prior to joining Alta, he was chief credit officer of IBM Corporation, responsible for optimizing the company’s credit risk position in 80+ countries.

Rafael Castillo-Triana is a principal of The Alta Group and an international attorney with expertise in international leasing law. His career in the leasing industry has included an executive position for a leasing company in South America, as well as founding two leasing companies in Colombia.