As North American companies continue to explore growth opportunities abroad, particularly in emerging markets, compliance and integrity risks appear to be rising sharply, according to a recent report.

Regulation and compliance collectively remains the biggest risk to global businesses in 2011, according to Ernst & Young’s fifth annual Global Business Risk Report.

“Emerging markets clearly offer enormous potential for growth, particularly for resources based exporting economies and for many of the mature market economies, who are chasing an export-led recovery on the back of weaker currencies,” Andrew Embury, Ernst & Young EMEIA Advisory Leader, said.

Yet as North American companies continue to explore growth opportunities abroad, particularly in emerging markets, compliance and integrity risks appear to be rising sharply.

“While most executives are familiar with the categories of compliance risk — integrity and reputation, corruption, violation of economic and trade sanctions, and money laundering — expansion into the less-developed regions of Asia, Central/Eastern Europe and others is heightening the potential for those risks to become reality,” according to Deloitte Financial Advisory Services LLP and Forbes Insights‘ fourth annual Look Before You Leap report.

Based on a survey of 500 business professionals across a wide range of industries at companies in the United States, Canada and Mexico, the report found that the level of concern over the potential for compliance and integrity-related risks has increased substantially over the past three years, especially in the areas of integrity and reputation. In fact, 85 percent of respondents said such concerns had risen significantly (41 percent) or somewhat (44 percent).

Where are the danger zones? On the list of countries or regions ranked based on compliance and integrity concerns, China ranked highest (80 percent). Mexico and Central and South America ranked second, and Southeast Asia (Vietnam, Indonesia and the Philippines) was third.

“[I]n recent years, investment flows have shifted towards emerging markets, notably in Asia and Eastern Europe, as economic growth in these countries continues to outstrip growth in the developed world,” Look Before You Leap explains. “This changing pattern brings with it exceptional challenges in the area of compliance and integrity due diligence.”

Due to the heightened climate of risk, the overwhelming majority of companies surveyed said they always conduct compliance and integrity due diligence before entering into a foreign transaction. According to the Deloitte/Forbes report, more than 80 percent of respondents in the U.S. and Canada include due diligence as a core part of decision making throughout the deal process.

In cases where action needed to be taken as a result of due diligence revelations, a clear majority (61 percent) said they have pulled out of a business transaction as a result of information identified about the target company or its principals during compliance and integrity-related due diligence. Almost two-thirds (60 percent) said they have adjusted deal pricing to reflect compliance and integrity-related issues.

In the survey, 63 percent of respondents identified Foreign Corrupt Practices Act (FCPA) and anti-corruption issues that led to an aborted deal or a renegotiation over the past three years. Similarly, 62 percent of survey respondents pointed to issues related to potential violations of economic and trade sanctions as the cause for their companies to renegotiate or pull out of a deal over the past three years. One in five business professionals cited lack of transparency or unusual payment structures in contracts as reason for renegotiating or terminating deals, and 18 percent pointed to the use of agents, consultants, distributors or third parties to obtain or facilitate business.

Other actions further proved to be significant. For example, 60 percent of respondents said they required the target or partner to resolve and/or disclose to regulators a compliance and integrity issue prior to closing. The same proportion required an adjustment in the deal structure and/or non-price terms and conditions. Approximately 53 percent said they terminated certain vendor, client and/or distribution channel relationships after closing the deal.

“Respondents placed a great deal of importance on the strength of the integrity and reputation of potential business partners or acquisition targets, as well as the ramifications for their own organizations,” Wendy Schmidt, leader of Deloitte’s business intelligence services practice, said in an announcement of the findings. “In today’s environment where word travels quickly, maintaining one’s reputation, and engaging in business deals with upstanding organizations, is of utmost importance.”

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Resources

Look Before You Leap
Deloitte Financial Advisory Services LLP and Forbes Insights, February 2011

Nearly Two-Thirds Reported FCPA, Anti-Corruption or Economic Sanctions Issues Led to Renegotiated or Terminated Deals
Deloitte and Forbes Insights, Feb. 7, 2011

Cost Cutting and Pricing Pressures Fastest Growing Risks to Global Business in 2011
Ernst & Young, Dec. 17, 2010