Featured Image: Trucks at work in Chile (Photo: BizLatinHub.com)
What do I do...?
I work on quantification of jurisdiction risk under the broader guise of investment due diligence. I enjoy correlating managerial issues to mathematical challenges. Inchoate areas like ESG (Environmental, Social and Governance) and J (Jurisdiction, more commonly country or political) risks, not only need development but may also help solving many of the fundamental inconclusive problems in finance – how to value a stock, how to determine the prime capital structure of a firm, how to determine a suitable discount rate, how to solve the growth paradox, etc.
I have been publishing informative and actionable research under my own title – ESG+J Alpha, since late last year, although COVID acted as the bad charm and my publication has been somewhat on a hold since March 2020. I have had a very good response from the audience – I have been appreciated on providing a clear investment thesis for decision-makers. Essentially, I work on business cases around sustainability and I attempt to bridge the disconnect between intent and practice. My work extends beyond the mere exclusionary accounting, or negative aggregations, seen in many ESG related publications. Progressive sustainability policies and prescriptions are not antithetical to robust finance principles and I make it a point to reflect such principles in my work.
This year in PDAC 2020, just before all hell broke loose, I spoke on "Jurisdiction Risk and Discount Rates in the Latin American Context". This research is an advancement on political risk quantiﬁcation beyond sovereign and/or CDS (Credit Default Swap) spreads; I tested some of the initial assumptions of this model in the Latin American context and presented those findings at PDAC. I believe that extended versions of this project will highlight the shortcomings of prevailing dominant methods (which entail adding a risk premium to the discount rates). Some such gaps are potential double counting of global systematic and local macroeconomic risks and making eligible projects look less attractive by overestimating risk premiums.
To cut a long story short, I propose an alternate approach wherein the jurisdictionally caused risk is extracted from the holistic notion of country risk (that which has financial and economic determinants in addition to political and social ones) and then applied to the discount rate accordingly. I will be working on this project in the coming year and the results would be risk sensitized discount rates for Latin American and African jurisdictions, plus a template for other jurisdictional assessments. I believe that my results will have major implications on capital structure and insurance premiums for risky jurisdictions. Even though the demand for such insurance is considerable, little has been developed by non-life actuaries in terms of a methodological pricing approach for this niche – a gap which I am keen to fill.
I also like to link quantitative outputs to qualitative analysis. In my belief, one cannot do without the other. Once the broad indicators provide the necessary signaling, the challenge then lies in getting down to ground realities at the country, company and project level. I found this strongly manifested in my research on Latin America. Once the models showed that regulatory quality and rule of law had significant impacts on jurisdiction risk, I went back to some qualitative work around Latin America and discovered important determinants - (1) Legal studies on Latin America show that the key test in expropriation cases is to understand the legal framework and adapt the valuation approach accordingly. (2) Financial markets do not severely punish countries in which property rights (or rule of law) are respected and regulation is adequate, despite the low quality of governments.
There are also other plans in my work pipeline. This involves collaborating with experts who were brokers formerly and who will co-produce with me, some unique matter on managing ESG+J - through traditional financial risk - back-testing, hedging, VaR (Value at Risk - ensuring against large losses, determining adequacy requirements), options and setting P&L position limits.
I talk more later on my research tools – methods, designs and philosophy. The element of freshness that I try to get in my work is more by design than by default. Traditional research designs may not work - jurisdiction risk is not new but contextually it is becoming different, with risks becoming less volatile yet more sustained. This is a call to adapt with the changing times.