Jill Fenton Vigilant Due Diligence
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By Jill Fenton


Jill Fenton One could argue that today's global landscape hosts more risks to country, corporate and individual safety than ever before. Consider the war in Iraq, the volatile situation in the Middle East, global warming, organised crime, the growing threat of domestic and international terrorism, political regimes - for example in Zimbabwe - and military and nuclear weapon development by Russia, Iran and North Korea. These issues pose a threat not only to human lives but also to economic and business investment and development. But what kind of a threat?

Types of threat


As described in a recent Economist article, any shock to an economy will create waves. Output, prices, employment and inflation may all be affected. According to Nick Bloom of Stanford University, events that increase uncertainty, and therefore affect share prices, are actually fairly frequent. Extraordinary events like 9/11, the collapse of WorldCom and Enron and the Iraq war can have an even greater impact. Bloom describes how raised levels of uncertainty, brought on by a shock, tend to trigger a 'wait and see' attitude in companies: 'Firms that would otherwise have increased investment or taken on more workers postpone their plans.' An increase in uncertainty can, therefore, mean a drop in investment, employment and productivity in domestic and global economies.


In addition to threatening economics, a shock or threat, depending on its nature, can dramatically impact specific industries and businesses. The UK terror threats in 2006 were cited as a key contributor to revenue and profit losses experienced by the UK travel industry. MyTravel and BAA both reported losses in revenue. Other businesses, on the fringes of the industry, were also affected, like holiday product, electronic device and duty free retailers.

Direct financial threats may occur due to a specific event but they can also emerge from more generic avenues, for example foreign politics. President Robert Mugabe of Zimbabwe has announced that his government is preparing to seize majority shares in all of Zimbabwe's foreign-owned businesses and mines. Companies in the line of fire include Rio Tinto, Anglo American, Standard Chartered and Barclays. Not only could this move signal disaster for corporate business lines, it could also seriously hinder any future foreign investment in the country.

Although uncertainty can create losses it can also generate gains. Eurostar experienced a boost in business in summer 2006 as travellers sought alternative means of transport. BAE Systems, Britain's biggest defence company, posted a 21% increase in half-year turnover in 2006 due to sales of military equipment. Opportunities are likely to continue to grow for Britain's defence industry as international relationships, with Libya for example, develop.


The nature of some businesses and the geographic areas in which they operate mean that their exposure to factors that may threaten and influence their reputation is higher: corruption, organised crime, money laundering, environmental issues, social and human rights issues, political and personal connections, and corporate affiliations. In March 2006 Corporate Watch estimated that UK companies had won approximately 1.1bn GBP worth of contracts since the start of the Iraq war.

Very few Western companies, however, were keen to publicise their exact activities. Why? In the past, Nike and Gap have been accused of using overseas sweatshops. International energy companies, like Shell and BP, have found themselves in hot water over environmental issues, including the disposal of oil containers and rigs and intrusive exploration projects. How has this criticism affected the company's reputation, if at all? Would it influence a potential investor or partner? Would an association with these firms affect your reputation?

Some may suggest that in today's socially conscious environment, maintaining a sound and ethical corporate reputation is of upmost importance.

It's a risky business, but someone's got to do it

So, if there are so many risks involved in dealing with certain countries and companies, why would a business even consider entering a particular market or industry or investing in a relationship? Growth and development are key drivers.


BP, following in the footsteps of Royal Dutch Shell and ConocoPhillips, announced a 455m GBP gas exploration deal with Libya, the once vilified state. According to the Financial Times, UK and US energy companies have been keen to secure a share in the country's gas and oil reserves for some time, especially as it's the 14th largest in the world and includes the largest oilfield in Africa. Sanctions relating to Libya's arsenal of weapons of mass destruction and involvement with the Lockerbie bombing were lifted, allowing foreign multinationals to fully explore opportunities within the region. And, according to Business Week, if the political climate and cross-border relationships remain positive, North Africa could become home to one of the world's next economic booms. All sounds very positive for opportunity-seeking multinationals. But risks still remain. If Libya's economic policy fluctuates then multinationals could face an increase in taxes and royalties. As we approach the 40th anniversary of the Six Day War, the troubles in the Middle East seem far from over. Despite this, BG Group is apparently considering supplying Palestinian gas to Israel. This is a highly risky deal as Israel has previously vowed never to buy gas from its neighbour. The ongoing violence within the region may require BG Group to reconsider and renegotiate. Emerging Markets and Products.

We have all heard of the fantastic business and investment opportunities the 'Asian Tiger’ offers, but are there potential risks? HBR comments that in addition to intellectual property rights violations, corruption and potential political instability, CEOs should be aware of the huge environmental degradation in China, including soil erosion, water scarcity and pollution. These issues may not only affect the countries' GDP, and therefore economic stability, but could be a real risk to a multinational's operations and reputation if not dealt with sensitively. GE, for example, have taken this on board. In addition to their domestic operations, they are working with the Chinese government to help develop water and coal technologies.

As the world around us continues to change, so do behaviours. According to the FT, September 11th helped consolidate a global Islamic identity. Thanks to the rise in the number of Muslims seeking religiously sanctioned financial products and a boom in Middle East wealth, the Islamic finance market has rocketed. Standard & Poor's estimate that the sukuk market will grow from $70 billion to over $160 billion by the end of the decade. Western financial institutions have seized on this opportunity by offering innovative products to a growing sophisticated market. But risks still remain. In addition to confusion surrounding exactly which products comply with Islamic law, Mahomoud El-Gamal, chair of Islamic economics, finance and management at Rice University, Houston, makes the interesting point that '(Islamic finance) supports the development of a separatist and boastful Islamic identity.'

Reducing the risk

We have established that risks and threats to business investment and development exist through a multitude of external and associated factors. For a company to fully understand the risks involved in any new investment or venture effective due diligence research is essential.

Michele Bate of Archer Van Den Broeck Limited comments that without thorough due diligence a company can open itself up to risks to its reputation based on the companies (and people) with which it does business - suppliers, customers and joint venture partners.

A stark example of this is the case of the Global Relief Foundation. After the September 11th attacks, investigations brought to light the real nature of the charity, as the finance facility for Al Q'aeda. Any company or individual associated with the charity was, therefore, also under scrutiny.

Due diligence research can involve various investigative analysis techniques including economic and country forecasts, political policies and connections, corporate affiliations, personal and business associates, and legal or corporate misdemeanours.

Researching and reviewing material in the public domain such as press, Internet newsgroups, blogs, corporate records, litigation records, bankruptcy records, liens and judgments where available can highlight areas for further investigation.

Although it is difficult to predict every potential threat or risk associated with a country, industry or company, implementing an effective due diligence research process at the early stages of the investment process is vital to help reduce uncertainty and therefore losses. As Bate says: 'It's vital that you try to find out who you are dealing with, even though it is not always easy. Who is behind the company? How did they acquire their wealth? Who do they do business with? Otherwise you might find that other businesses don't want to do business with you!'

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