What are the risks and limitations of operating in a foreign environment?

Answer 1

Risks of conducting business internationally include currency fluctuation, compliance and regulatory risk, tax risk, and political risk. It is easiest to understand these risks with an example. Assume you have a financial consulting business is based in the U.S. You advise individuals on where you invest their retirement money. You decide to open expand globally, and look to open a branch in the United Kingdom. - Currency Risk: Your business's primary operations are in US Dollars, but in the UK you will be paid in British Pounds. The exchange rate between a US Dollar and British Pound fluctuates daily, meaning your earnings in Pounds once repatriated into dollars can vary substantially over time. As an example, currently 1 British Pound = 1.70 US Dollars. If the value of 1 British Pound fell to 0.85 US Dollars, your earnings (in Dollar terms) would be halved! Corporations frequently use foreign exchange contracts to hedge against currency fluctuations. - Compliance/Regulatory Risk: You must comply with the requirements of your host country. In the US, your financial firm complies with SEC and NASD rules, and laws like "The Patriot Act". When you open a London branch, you must comply with the FSA regulatory body and the laws of the UK that govern your business. All your employees must be compliant with the local laws as well. Your compliance with local laws and regulations makes you subject to fines, litigation, and reputational risk in both your host country and the U.S. - Tax Risk: You must comply with the tax laws of the local country. You are subject to changes in their tax code, which may adversely affect your business. You may be "double taxed" by both your host country and the country where your business is based. - Political Risk: The U.S. and U.K. have very stable governments with clearly defined rights and a strong judicial history. But let's say you decide to open a third branch in Latin America where a newly-elected socialist government decides that all financial firms should be state-owned. Your financial firm can be seized by the government with no recourse to you. Political risk is generally viewed to be a bigger problem in emerging markets than in first world countries.

Answer 2

There are three types of common risks associated with operating in a foreign environment: foreign exchange rate risk, interest rate risk and commodity price risk. As a result of these market risks, cash flow, future earnings and fair value of assets and liabilities are subject to a great deal of uncertainty. A business and financial plan are recommended, which should include actions (i.e. derivative instruments) to reduce the uncertainty and limit a business' exposure to risk. There are also different laws and political environments to take into consideration.