How to be a Savvy Overseas Investor

After having been the top destination of inward foreign direct investment (FDI) for decades, China's investment orientation has become increasingly outward looking, and global. In 2014, China's outbound FDI surpassed inbound FDI for the first time. And between January and April 2016, China became number one in outward FDI globally. In the near term, China's overseas investments are expected to grow at 10 percent annually, and exceed US$2 trillion by 2020.

While Chinese companies are benefitting from taking advantage of emerging opportunities around the world, the rise in Chinese outbound FDI is occurring at a time of unprecedented risks - some of which are familiar and some of which are unknown. According to the China Global Investment Tracker, more than US$250 billion in Chinese investments abroad have failed since 2005. A lack of overseas investment experience, especially in risk management, has been one of the key impediments.

In our era of "man-made" risks, where climate change, cyber risk and terrorism are impacting the cross-border investment landscape with increasing frequency and severity, it is important for Chinese companies to adopt a more defensive posture. It used to be the case that operating successfully and achieving profitability on a sustained basis was simply a matter of being in the right place at the right time. That is no longer the case. The world has become a more complicated place. A Chinese company cannot simply appear and expect to achieve success internationally.

Today, what is required is "risk agility" - the ability to anticipate change and defend against unknown risks. How will climate change affect the physical platform for operating in a given country? Does your firm have sufficient protection against cyber risk? How well protected is it against terrorism? What happens when a government changes and a country can no longer pay its bills? How will your firm be able to continue to operate if a foreign currency shortage occurs? What tools, if any, does your company have to assess and manage such risks, and how well is your company prepared to address the realities of overseas investing?

To the extent that Chinese companies devote any resources at all to understanding cross-border trade and investment climates (and most do not), they may tend to over-rely on externally generated country risk analyses, which are more often than not produced generically and are not entirely appropriate for specific transactions. This is perhaps the most common mistake international businesses make. They believe that because they may have information about the general political and economic profile of a country, they have a true understanding of the real nature of the risks associated with doing business there.

They may neglect how important it is to truly understand the nature of legal and regulatory risk, the country's friendliness toward foreign trade and investment, and other companies' experience operating there. Too often, companies get caught in an "investment trap": they commit long-term resources to a country only to find that the bill of goods they were sold - or thought they understood - turned out to be something completely different.

There are plenty of stories about Chinese companies whose investments turned into disaster because the regulatory environment changed, a legal issue arose, international sanctions impacted their ability to operate, or they selected the wrong joint venture partner. After the investment has been made, it is often too late to pull out without incurring large losses, and experiencing reputational risk once the story hit the press.

Another common issue is that the lines of communication between risk management personnel, risk management and decision makers, or between decisions makers is either bypassed, convoluted, or just plain wrong. Here are a few examples:

• Risk management is given only cursory participation in the transaction approval process;
• Sales teams bypass risk management entirely, or ignore the risk management department's recommendation, because they fear a transaction will be canceled as a result of unacceptably high levels of risk;
• A CEO delivers a presentation to a board of directors that is false, but he believes it to be true, because the risk manager's staff said it was; or
• A board of directors has no idea what questions they should be asking of corporate decision makers.

A risk manager may have the right information, but based on a short-term assessment of the risks. The long-term view may be completely different, but in the absence of knowing what questions to ask and having clear lines of communicate on the right information, may not be taken into consideration.

The simple way to limit the possibility that unforeseen events will occur is to establish clear reporting lines and do your homework - really do your homework - and either hire one or more individuals in your company to focus full time on managing these risks, and/or hire an external firm to create a customized risk profile for each and every investment your company plans to make. The expense involved pays for itself many times over when a problem is uncovered and avoided, yet many companies are happy to invest millions of dollars to make cross-border investments without doing their homework.

Achieving risk agility in the 21st century is about respecting the speed with which things can fall apart as a result of unforeseen or unexpected events. Those Chinese firms that embrace risk agility will be able to quickly reinvent themselves and establish frameworks and a company culture that recognizes when the enterprise is imperiled by a particular internal course of action, or by external forces. This is the very destructive/creative cycle that drives the global economy. While embracing the ambitious "One Belt, One Road" initiative, now is the right time for Chinese companies to pursue and master risk agility as soon as possible.

Daniel Wagner is Managing Director of U.S.-based Risk Cooperative and co-author of the new book "Global Risk Agility and Decision Making".

Sun Xi is a China-born independent commentary writer based in Singapore who worked for the China Investment Promotion Agency under the Ministry of Commerce.

This article first appeared in the China Daily.