Expertise
The Opacity Index
Although large-scale risks garner media attention, it is every day, small-scale risks associated with the lack of transparency in countries' legal, economic, regulatory and governance structures that can confound global investment and commerce.
The Opacity Index, first introduced in 2001, identifies the causes and measures the costs and effects of this phenomenon.
Over the years, businesses have evolved a number of innovative ways to manage the risks associated with being global. They have developed sophisticated ways to insure their infrastructures and their operations and to hedge their currencies. They have learned how to distribute information resources globally using highly resilient computer networks with geographically dispersed backups. They have put in place sophisticated new internal controls systems to monitor performance and tease out fraud on a global basis. They have developed intricate taxonomies to enable different parts of the company to rate and communicate their risks in a consistent manner around the world. They have created a new global role – the chief risk officer – to watch over the company as a whole. And many boards of directors have made risk management one of their top priorities. But despite these initiatives, gaps remain.
In our view, global companies face two distinct types of risks: : Large-scale, low-frequency risks and small-scale, high-frequency risks. Because they are so big and rare large-scale, low-frequency risks capture headlines. Earthquakes, wars, coup d’etats, and major acts of terrorism are front-page news.
And yet, the small-scale, high-frequency risks of operating globally present the real costs to business. These risks interfere with commerce, add to costs, slow growth and make the future even more difficult to predict. They also deter investment. “The key to any good investment relationship is clarity – the ability to see and even be in communication with what’s really going on. It’s the same whether it’s a company, a country or a region,” said Matt Feshbach, chief investment officer of MLF investments, a mid-sized hedge fund in Largo, Florida. “If the risk picture is unclear, capital is less likely to go where it’s needed.”
Since 2000, we have been studying the cost to businesses of these short term risks in a number of different countries in several different ways in the hopes of arriving at a stable methodology that allows us to do three things: 1. Project in which areas of a country’s economy the risks are greatest; Assess the costs of those risk; 3. Develop a method for comparing these risks on cost basis, country-by-country.
Our aim in doing this has been to create a tool for companies and countries. For companies the purpose of the tool would be to make better portfolio and direct investment decisions regarding where to develop markets, locate productive resources and find the best outsource partners. For governments, the aim has been to help them understand how to make their countries more attractive locations for investment and to measure their progress in improving conditions for inbound investment.
To assess the costs of small-scale, high-frequency business risks, we divided those risks into five broad categories: 1. Corruption in business and government; 2. The legal system -- its protection (or lack thereof) of critical rights and its ability to quickly settle disputes; 3. The government’s economic policy and its impact on business; 4. Accounting standards and governance rules; 5. The regulatory structure of the financial system, markets and business in general. We arrived at those five categories, which together form the acronym CLEAR, after talking with companies and financial and economic experts regarding their concerns.