Investing in the BRICS

December 2011 | David Holley, Boston & Doug Frantz, Washington, DC Managing bribery and corruption risks through heightened due diligence should be a paramount focus when expanding into the BRIC markets -- Brazil, Russia, India, China -- and other emerging economies.

The fertile and fast-growing economies of the BRIC (Brazil, Russia, India, and China) countries are calling to international corporations, investment banks, and investors like the Sirens sang to Jason and his shipmates in Argonautica. The haste to take advantage of these burgeoning markets can lead to rushed decisions, shortcuts in diligence and potentially unmeasured business decisions. Whether a company is entering a new market, contemplating a joint venture with an overseas partner, investing in a foreign business or acquiring an overseas company, an appropriate level of due diligence on the foreign entity, its agents, business partners and intermediaries is required to avoid problems associated with current anti-bribery legislation. However, the results of Krolls 2011 Global Fraud Survey (click on link below to download full report) indicate that fewer than one in four respondents believe that their due diligence is sufficient to fully understand whether the acquisition target complies with either the United Kingdom Bribery Act (UKBA) or the United States Foreign Corrupt Practices Act (FCPA). In addition, nearly one out of two respondents consider their companies to be moderately to highly vulnerable to corruption, which is among the leading reasons why companies avoid investing in new regions or countries. The high level of concern uncovered in the survey may overestimate the true degree of compliance because companies often believe they are doing better in following the law than they are actually are. Even if we accept these self-reported estimates, however, there is cause for alarm over the exposure of many corporations to the criminal sanctions and costs imposed by the FCPA and UKBA, particularly in this era of aggressive enforcement by the Department of Justice (DOJ) and Britains Serious Fraud Office (SFO), respectively. The question then becomes what steps should be taken by a corporation determined to follow the spirit and letter of the law. Managing the anti-bribery risks through heightened due diligence should be a paramount focus when expanding into the BRIC markets and other emerging economies. There is little guidance in either law as to what constitutes sufficient due diligence. The FCPA makes no mention of the term. The DOJ in Opinion Procedure Release 08-01 has defined a reasonable due diligence file as containing the following: an independent investigative report by a reputable international investigative firm; guidance by a foreign business consultant to help navigate the due diligence in the foreign jurisdiction; reports from the US Commercial Service within the Department of Commerce; the results of various databases and watch lists, DNDB, etc.; meeting notes from

discussions with the US Embassy in the foreign jurisdiction; a report by outside counsel on the target; a report on the target company by an independent forensic accounting firm; and an opinion by a second outside counsel who reviewed the sufficiency of the entire due diligence process. While the UKBA and SFO provide some direction on due diligence, they also provide a defense for companies that have adequate procedures in place to prevent the type of conduct that would otherwise give rise to prosecution. The Ministry of Justice provides some guidance on adequate procedures indicating that due diligence should be conducted on parties performing services for, or on behalf of, a business and that it should be proportionate and risk-based. With relatively little guidance, it is no wonder that there is so much concern around the adequacy of due diligence undertaken in advance of a business transaction. Assuming that multinational corporations are doing some level of due diligence consistent with the guidance offered by American and British regulators, the question as to why the level of anxiety in respondents over the sufficiency of their due diligence remains high. When undertaking due diligence in contemplation of expansion into the BRIC and other emerging markets, consider the following recommendations: 1. The volume of publicly available information varies from country to country and is generally considerably less than what is available, for example, in the United States. In addition, the information is frequently not as well organized or as readily searchable as in many jurisdictions. This highlights the importance of feet on the ground and the ability to undertake discreet source inquiries to fully understand a due diligence subject. 2. The potential for encountering a Politically Exposed Person (PEP) is generally greater in Russia and China than in many other parts of the world. This requires more extensive due diligence on officers, directors, and shareholders than normal to steer clear of violations. An examination of a targets vendors and agents to ensure arms-length transactions with unrelated parties is also recommended. 3. Media searches may not be as thorough, complete, and reliable as in other jurisdictions, as the local media and press are generally less aggressive and less likely to present an in-depth examination of issues. For instance, in countries like China and Russia, both hotbeds of recent and future M&A activity by Western companies, the simple act of checking available media outlets for information about a potential partner is likely to yield incomplete results at best. This is particularly true in China, where the tradition of an open press is weak and corruption is generally regarded as high. 4. There continues to be an absence of strong anti-corruption laws and enforcement in BRIC countries compared to the United States, the United Kingdom, and other countries. This requires a company to engage in more extensive examinations of acquisition targets policies, procedures, and employee handbooks relating to corruption, anti-bribery, and gifts and entertainment expenditures. Understanding the requirements of thorough due diligence is an important step, but problems can also arise when issues turned up in a review are not managed effectively. This point was driven home by the March 2011 settlement involving Ball Corporation, a US manufacturer of metal packaging for food, beverages, and household products. In March 2006, Ball acquired an Argentine entity, Formametal S.A. The Securities and Exchange Commission (SEC) found that during the course of Balls preacquisition due diligence, information suggested that Formametal officials may have previously authorized questionable payments disguised within the companys books and records. Unfortunately,

Formametal executives did not do enough to prevent further improper payments to Argentine customs officials, giving rise to the SECs case. The SEC noted that Ball Corporation did not promptly terminate the responsible employees when company accountants learned about the improper payments in February 2007. Still, Balls fine was a relatively small $300,000 because of the companys other remedial efforts, voluntary disclosure of the misconduct, and cooperation in connection with a related investigation. The BRIC economies are enormously attractive investment opportunities. Estimates are that as much as 60 percent of the worlds GDP will come from them by 2030. Participating in the worlds fastestgrowing economies carries growing risks, too. American, British, and multinational corporations need to understand the potential corruption dangers in the BRIC and similar emerging economies and undertake effective due diligence to avoid running afoul of anti-corruption laws. Certainly the DOJ, SEC, and Britains Serious Fraud Office have recognized the risks and stepped up their scrutiny of activities in these countries as part of the overall trend in rising enforcement of anti-corruption laws globally. The Authors: David A. Holley ( dholley@kroll.com), a senior managing director and the head of Krolls Boston office, is a former member of the Environmental Enforcement Section of the US Department of Justice. Doug Frantz (dfrantz@kroll.com), a managing director in Krolls Washington, DC office, is a former Pulitzer Prize-winning investigative reporter and former deputy staff director and chief investigator of the U.S. Senate Foreign Relations Committee.

BRICS to set up joint bank, call for dialogue on Iran & Syria
NEW DELHI: Seeking to reinforce their growing economic heft with diplomatic clout, the BRICS grouping Thursday pitched for a bigger say in global governance institutions, including the UN and the IMF, and told the West that dialogue was the only way to resolve the Iranian nuclear issue and the Syria crisis. Brazil, Russia, India, China and South Africa, which comprise nearly half the world's population and a growing share of global GDP, signed two pacts to spur trade in their local currencies. They also agreed to set up a working group for a joint development bank to promote mutual investment in infrastructure. Prime Minister Manmohan Singh of India and Presidents Hu Jintao (China), Dmitry Medvedev(Russia), Dilma Rousseff (Brazil) and Jacob Zuma (South Africa) ended the fourth BRICS summit by renewing the pitch for reforming global governance institutions and closer coordination on global issues.

The five leaders stressed on the restructuring of the world order to accommodate emerging economies and developing countries and for promoting sustained and balanced global economic growth. "While some progress has been made in international financial institutions, there is lack of movement on the political side. BRICS should speak with one voice on important issues such as the reform of the UN Security Council," said Manmohan Singh, the summit host. "We are committed to stepping up exchanges with other countries on global economic governance reforms and increasing representation of developing countries," said Hu. The BRICS include Russia and China, two veto-wielding members of the UN Security Council, and three aspiring members for a permanent seat - India, Brazil and South Africa. The BRICS leaders also pitched for greater voting rights for developing countries in the IMF and voiced disappointment with the West over the slow pace of the quota reforms. In a fresh assertion, BRICS asked the West to implement the 2010 governance and quota reform before the 2012 IMF/World Bank annual meeting, as well as the comprehensive review of the quota formula to better reflect economic weights. They asked for enhancing the voice and representation of emerging market and developing countries by January 2013, followed by the completion of the next general quota review by January 2014. In a signature step, the BRICS decided to create their first institution in the form of a BRICS-led South South Development Bank that will mobilise "resources for infrastructure and sustainable development projects in BRICS and other emerging economies and developing countries", the BRICS' Delhi Declaration said. The leaders directed their finance ministers "to examine the feasibility and viability of such an initiative, set up a joint working group for further study, and report back by the next summit". The development banks of the five countries signed two pacts, including a master agreement on extending credit facility in local currency and BRICS multilateral letter of credit confirmation facility agreement, which could help scale up bilateral trade from $230 billion to $500 billion. Challenging the West's hegemony of the Bretton Woods institutions, the BRICS leaders welcomed the candidatures from the developing world for the position of the president of theWorld Bank and backed "an open and merit-based process" for selection of the heads of the World Bank and IMF.

Contesting the West's narrative, the five countries warned the West against allowing the Iransituation to escalate into a conflict and said dialogue was the only way to resolve the Iranian and Syria issues. "We agreed that a lasting solution in Syria and Iran can only be found through dialogue," Manmohan Singh said. "The situation concerning Iran cannot be allowed to escalate into conflict, the disastrous consequences of which will be in no one's interest," said the declaration, in a veiled allusion to the speculated plan by the US and Israel to target Iran's nuclear facilities. The declaration saw the leaders voicing "deep concern" over Syria as they called for "an immediate end to all violence and violations of human rights in that country", backing a Syrian-led inclusive political process. China and Russia had earlier voted against the US and Arab League-backed UN resolution on grounds that it amounted to a regime change, while India had supported the resolution

How to invest in the BRIC countries

The four BRIC countries are:

Brazil Russia India China

Each of the BRIC countries have big populations, an emerging middle class, and the countries should prosper in the 21st century.

Brazil
Brazil has won plaudits for the way its economy and government finances have been run in recent years. The Brazilian economy is booming thanks to large multinational corporations such as Petrobras as well as the growing wealth of the Brazilian middle class.

Russia
The Russian Federation covers a vast area reaching from its borders with Europe in the West to the sea of Japan in the East. It also shares strategic borders with another BRIC country - China. Russia has vast natural resources in the energy sector. It has an extensive oil and gas pipeline network that supplies energy to densely populated Western Europe. Like the other BRIC nations there is a growing middle class who are able to afford more consumer goods.

India
India has a massive population and while many live in abject poverty, there is a large and ever increasing middle class. During the 1990's many Western countries started to outsource call centre operations to India. Other skilled jobs followed and today India is one of the global heavyweights in the IT software and services sector. India is helped in the global economy by having a large English speaking population. As well as the Information Technlogy and services sector, India has a large agriculture sector and a huge global presence in heavy industrial industries such as steel making. Mobile telecommunications are also hugely important in India, as the fixed telephone line infrastructure is very basic in many areas of the country.

China
China has got rich by becoming the world's factory - many goods are now made there. Thanks to a vast population that has kept wages low, factories have prospered in China. But China is now much more than just a cheap place to make consumer goods. China is rapidly moving up the value chain into areas such as financial services, banking, telecommunications and commerce. Chinese companies are also moving into high value manufacturing areas such as aviation and vehicle production.

Investing in BRIC countries

For fans of Exchange Traded Funds, there are a number of ETFs that provide exposure to the stock markets of the BRIC nations. The iShares FTSE BRIC 50 (LSE stock ticker: BRIC) is an ETF that has holdings in the 50 largest BRIC companies. Holdings include the huge Russian energy giant Gazprom, Brazilian petroleum company Petrobras and Chinese companies China Mobile and Bank of China. Other BRIC ETFs include the Claymore BRIC ETF An alternative to an ETF is to invest in a unit trust or investment trust. Unit trusts with an investment mandate to invest in BRIC countries include the Allianz RCM BRIC Stars and the Schroder ISF BRIC fund. Investing in China can sometimes be difficult for Western investors. An alternative is to invest in the Hong Kong market. Alternatively it is possible to invest in countries heaviliy dependent on China. Australia for example derives a significant part of its wealth from selling raw materials like iron ore to China. An increasing number of Western countries have growing exposure to China - companies such as McDonalds and Yum Brands (Pizza Hut) have all opened many restaurants in China.