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Using the Opacity Index to Manage the Risks of Cross-Border Business

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Presentation on theme: "Using the Opacity Index to Manage the Risks of Cross-Border Business"— Presentation transcript:

1 Using the Opacity Index to Manage the Risks of Cross-Border Business
Joel Kurtzman Chairman, Kurtzman Group Senior Fellow, Milken Institute Global Edge: Using the Opacity Index to Manage the Risks of Cross-Border Business

2 Approach Today’s hypercompetition changes the old view of making countries successful Old view: countries compete on labor costs and raw material endowments New view: countries compete on a range of issues including: Access to capital Social systems and costs Stability Overall levels of risk Opacity

3 Markets and Countries Included in the Opacity Index
Austria Belgium Czech Rep. Denmark Finland France Germany Greece Hungary Ireland Italy Netherlands Norway Poland Portugal Russia Spain Sweden Switzerland Turkey United Kingdom China India Hong Kong Indonesia Japan Malaysia Pakistan Philippines Singapore South Korea Taiwan Thailand Canada United States Egypt Israel Kuwait Lebanon Nigeria Saudi Arabia Argentina Brazil Chile Colombia Ecuador Mexico Venezuela South Africa Australia

4 Two Types of Global Risks
Large-Scale, Low-Frequency Risk Large-scale risks (earthquakes, revolutions, nationalizations) are dramatic and rare but capture attention. Small-Scale, High-Frequency Risk Small-scale risks are everyday occurrences and are the real bane of business. For business, this is where the real costs lie.

5 The Impact of Small-Scale Risks Is Big
While all eyes focus on the large but rare risks, businesses must watch out for the real risks that cost money and time. Corruption Legal systems with limited protections Economic policies that hinder sustained growth Accounting and governance standards that make it difficult to see inside companies Regulatory systems that fail to protect investors These five (CLEAR) factors are sand in the gear of commerce. They are the “everyday risks” of being a global business.

6 We Call These Small-Scale Risks Opacity
What exactly is opacity? ”Opacity is the opposite of transparency. It is the lack of clear, accurate, easily discernible, and widely accepted practices governing the relationships among businesses, investors, and governments. Opacity acts as a brake on commerce, and its presence hampers the smooth operation of business transactions.” Joel Kurtzman and Glenn Yago MIT Sloan Management Review October 2004

7 The Costs of Small-Scale Risks Can Be Measured
Social scientists might call opacity “negative social capital.” Social capital includes institutions and “agreements” that keep a society functioning. It includes elements as diverse as laws, markets and educational institutions. Since opacity is a form of capital, it can be measured. Since opacity is a form of capital, its transformation from negative to positive can be noted and followed. Since opacity is a form of capital, its impact on business and growth can be plainly seen – if leaders want to look!

8 What Can We Do With Opacity?
Understand the link between opacity and growth Understand price risk Measure global portfolio risk and balance Create country-based strategies Create new types of portfolios (green, sustainable, peace etc.) Comply with pension fund “screens” Forecast challenges/opportunities Compute minimum-required rates of return

9 The Opacity Index Scores
Country Category Opacity Index C L E A R Finland 3 11 23 17 9 13 United Kingdom 20 25 33 19 Denmark 6 15 21 Sweden 8 24 Hong Kong 26 12 14 United States 28 27 10 Australia 16 Switzerland Austria 32 Belgium 30 Canada 37 Singapore 50 Netherlands 22 38

10 The Opacity Index Scores
Country Category Opacity Index C L E A R Germany 28 14 33 17 32 25 Ireland 19 29 38 9 26 Japan 24 31 22 Chile 41 30 20 27 Israel 44 Taiwan 47 40 34 South Africa 55 18 Spain 39 50 23 Malaysia 35 Thailand 72 21 Portugal 37 Hungary 51 36 France

11 The Opacity Index Scores
Country Category Opacity Index C L E A R South Korea 61 35 22 30 37 Brazil 47 48 32 40 Poland 63 19 41 Greece 58 36 50 Czech Republic 44 Ecuador 64 60 34 25 29 42 Colombia 57 45 21 43 Italy 52 24 Turkey 67 27 Mexico 65 33 Argentina Pakistan 75 49 Saudi Arabia 69 46

12 The Opacity Index Scores
Country Category Opacity Index C L E A R Russia 78 44 39 40 31 46 Egypt 71 37 51 48 India 74 49 30 Nigeria 80 65 50 China 56 43 Philippines 75 52 33 36 Venezuela 68 Lebanon 83 60 42 59 Indonesia 82 54 90 22

13 Behaviors Can Be Measured
Every Additional Point on an Opacity Score Yields: Lower average per capita income (-$986) Lower net foreign direct investment as a percent of GDP (-1 percent) Lower Capital Access Index Score (-0.06 points) Lower bank assets as a percent of GDP (-4 percent) Lower stock market capitalization as a percent of GDP (-0.9 percent) Lower stock market traded value as a percent of GDP (-0.9 percent) Increase average borrowing interest rate (57 basis points) Increase inflation rate (0.46 percent)

14 Complexity of Legal Systems
Procedural Complexity Index Number of filings Duration Cost Employment Laws Index Flexibility of Hiring Index Conditions of Employment Index Flexibility of Firing Index Aggregate Complexity Index Average of Procedural Complexity and Employment Laws Index Source: World Bank, Doing Business

15 Sources of Data (General)
Source Code Publication, Source WBRS Regulation and Supervision of Banking Around the World, World Bank SSBG Salomon Smith Barney Guide to World Equity Markets ISSA International Security Services Association Handbook IFAD International Forum on Accountancy Development, GAAP Convergence ICRG International Country Risk Guide, PRS Group TI Corruption Perceptions Index, Transparency International GCR Global Competitive Report, World Economic Forum WBDB Doing Business, World Bank AON Risk Management Updates WBCRS World Bank Survey on Public Credit Registry for Central Banks

16 Sources of Data (Economic and Regulatory)
Questions (E: Effectiveness of Economic Policy) Type of Data No of Countries for which data are available Source Average days of legal procedure from filing to enforcement Raw Data 48 WBDB Contract Enforcement Index: How inefficient (formalism) is contract enforcement? Index Business costs of terrorism (1-7, low is worse) 46 GCR Transparency of policy making 22 Organized crime costs on business Efficiency and transparency of tax system Extent of bureaucratic red tape Freedom of press Enforce contracts: cost (% GNI per capita) 47

17 Sources of Data (Economic and Regulatory)
Questions (R: Regulatory Regime) Type of Data No of Countries for which data are available Source Government stability Index 48 ICRG Capital Flows Restriction Index Heritage Foundation Government Involvement in Banking and Finance Index Regulatory Burden Index Start Business: number of Procedures Raw Data WBDB Start Business: duration (days) Start Business: cost (% GNI per capita) Start Business: min. capital (% GNI per capita)

18 Sources of Data (Economic and Regulatory)
Questions (R: Regulatory Regime) Type of Data No of Countries for which data are available Source Close Business: actual cost (% of estate) Raw Data 48 WBDB Close Business: goals of insolvency Index Index Can regulators engage in discretionary forbearance? Binary 46 WBRS Can the banking supervisor suspend a bank's directors' decision to distribute dividends, bonuses or management fees? 47 Is there a central securities and exchange regulator? 39 ISSA Can brokers set their own fees and commissions? 38 Is there self-regulation of brokers? 23 Have exchanges established listing requirements? 40 SSBG

19 Sources of Data (Economic and Regulatory)
Questions (R: Regulatory Regime) Type of Data No of Countries for which data are available Source Does the central bank or independent agent (other than the fiscal authority) handle the issuance and settlement of public debt? Binary 45 Country's regulator Is public debt distributed by auction? Is there a system of primary dealers? Is there a central clearinghouse for settlements? 44 Country's regulator Is debt held at a central depository? 34 Is there one or more consumer credit rating agency? 39 WBCRS Regulation of securities exchanges: transparency, effectiveness, role of government, industry intervention (1-7, low is worse) Index 46 GCR

20 U.S. GDP Growth Updated for GC 2007 Real GDP growth, quarterly
Source: International Financial Statistics

21 A Brief Period of U.S. Budget Surplus
Deficit Source: U.S. Department of the Treasury, Bureau of the Public Debt

22 Capital Access Index 2006 Gauging Entrepreneurial Access to Capital
Source: Milken Institute

23 Less access More access
Capital Access Index, 2006 Less access More access Sources: World Economic Outlook, Milken Institute

24 Factors Affecting Financial Market Development
Level of institutional development, including law and regulation (Boyd and Smith, 1996; Gurley and Shaw, 1955) Legal origin, shareholder rights and creditor rights (La Porta et al, 1998) Laws and regulations (Levine, 2002; World Bank, 2001) Demographics and human capital (Black, 2002)

25 Improved Capital Access Can Add Billions to Emerging Economies
Forgone GDP Growth % US$ Billions (2006) Mexico 2.63 22.09 Russia 2.50 24.48 Argentina 1.97 4.19 Pakistan 1.70 2.19 India 1.66 14.72 Institutional Risk indicators detail: What are real risks? Can they be prices? Where are they? When unenforceable property rights exist due to the absence of institutional infrastructure of laws and markets, wide differences in the marginal product of capital can exist. Since countries cannot borrow against their labor force (because labor cannot be used as collateral for loans), they cannot build sufficient physical capital stocks to prevent emigration. Source: Authors’ Calculation based upon Triphon Phumiwasana, (2003)

26 Representative Costs of Opacity Expressed in Percent
Finland: -1.83 UK: -0.44 Sweden: -0.31 U.S.: 0.00 Switzerland: 0.40 Belgium: 0.42 Germany: 0.86 Ireland: 1.03 Japan: 1.51 Brazil: 4.29 Czech Rep: 4.56 Turkey: 4.95 Mexico: 5.01 Saudi Arabia: 5.52 Russia: 5.64 China: 6.49 Venezuela: 6.56 Indonesia: 8.54

27 Opportunity Map Size of each bubble represents relative GDP Vertical (Y) location of the bubble indicates rate of growth Horizontal (X) location illustrates increasing procedural complexity Opportunity is defined here as a country’s legal and procedural complexity, relative to its overall market size and rate of growth Asia Europe North America Latin America Middle East Australia Africa GDP GROWTH RATE (%) Source: CIA World Factbook World Bank, Doing Business The Economist: World in Figures 2002

28 Forgone Finance, Forgone Growth
Recent empirical estimates suggest that… Doubling bank credit to the private sector as a percent of GDP in emerging markets could increase annual GDP growth by almost 3 percent. Doubling the trading volume of the stock market in an emerging market could increase annual GDP growth by almost 2 percent. T. Phumiwasana, 2002

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