7 January 2013

Ethiopia: Successful Extraction Effectively Mitigates Risks

Rising demand fuelled by emerging countries, most notoriously China and India, has led to increased competition for natural resources. Despite recurrent volatility in the markets, the trend is for a rise in prices, with oil being the prime example.

In this context, frontiers have disappeared, as have previously overlooked regions, includingEastern Africa.

With higher prices, massive investments needed to extract oil, gas and minerals, in often unstable and poorly accessible regions, become a profitable endeavour. In short, the risk to benefit equation has shifted.

This will not be news for anyone who has been working in the region. Yet, specific risks associated with those opportunities remain too often overlooked, by investors. Indeed, according to recent studies, fraud and corruption ranked only tenth in the risk survey for the mineral and metals industries. For the oil and gas industry, the threat was even lower, with fraud and corruption not even appearing on the radar.

As a reminder, 23 African countries remain in the bottom 30 of the World Bank's 2011 'Ease of Doing Business Index'. They include key extractive industry protagonists, such as;Angola,GabonandNiger. Corruption, meanwhile, remains pervasive. Needless to say, this is not exclusive to Africa, andBotswanais here to remind us that the so-called 'resource curse' is not always fatal for the development of good governance.

In these high-risk zones and highly competitive sectors, investors can be tempted to disregard good practices, in order to secure deals, reduce delays and improve their overall margins.

Examples of criminal actions can include; illicit payments, for example, bribery of a civil servant, in order to expedite administrative processes, indirectly financing criminal entities, human rights violations, such as forced labour or the violent relocation of local populations, and the violation of international sanctions. This has been particularly relevant for the diamond industry, since the establishment of the Kimberley Process, in 2000.

Investors can also be tempted to ignore illegal acts committed by their local joint-venture partners, often linked to, if not controlled by, politically exposed people. But ignorance is no legal protection. Such short-term tactics are dangerous and counter-productive.

Unscrupulous investors do not only face expensive legal sanctions, with possible jail terms, but also unmanageable public relations disasters. A company's reputation is a precious asset, which in the era of Twitter can be devastated in no time.

Rebuilding a positive, or at least neutral, image is a costly and time-consuming process. Make no mistake, anticorruption advocacies, such as Global Witness and Transparency International have acquired advanced investigative skills, and few would like to be one of their next targets.

Companies tend to be familiar with the 1977 United States Foreign Corrupt Practices Act (FCPA) and the more recent United Kingdom Bribery Act (2011), which provides strong extra-territorial legal incentives to prevent corruption. Meanwhile, the Extractive Industries Transparency Initiative (EITI) aims to reduce corruption, by making public the amounts of money transferred between extractive industry companies and governments.

Though the EITI is an important contribution, it still suffers from a fundamental weakness, in that it remains a voluntary scheme, which countries can simply choose to ignore.

Following tough negotiations, in August 2012, the United States Securities & Exchange Commission (SEC) adopted a decisive act on financial reform. They set new standards for the extractive industries.

One of the adopted sections requires companies listed in the United States to strengthen their supply-chain due diligence, in order to prove that the minerals they purchase do not fund armed groups. Companies now have two to four years, depending on their size, to put in place rigorous processes.

In effect, they will have to investigate the origin of the minerals they buy, the actors involved and any potential liability. This has the potential to change the manner in which business is done, in conflict-prone countries, and in doing so, cut funding for violent groups, existing within the 'conflict economy'.

The other section reinforces and complements the EITI, by requiring companies in the oil, gas and mining sectors to disclose payments made, on a project-by-project basis, to foreign governments. Since every company listed in the United States will have to respect this rule, countries will not be able to escape it.

Any discrepancy in the figures will then be easily identified, making it harder for corruption to go unpunished. The European Union will soon pass a similar law, which will also include timber companies. Investors can either conform or face severe sanctions.

In light of these factors, should companies stop investing in high-risk regions? The answer is no, but they do need to adopt effective risk-management policies.

On the one hand, they need to assess and monitor potential risks present in their sectors and geographical areas. Importantly; political, economic and social contexts vary greatly from country to country. Within countries themselves, we find great nuances, something particularly true for regional heavyweights. Ignoring them can cause costly mistakes.

On the other hand, they need to become familiar with new legal frameworks, as they directly affect their operations and strategy. In quickly changing environments, investors need to be proactive.

Furthermore, companies need to make decisions based upon reliable first-hand information. Thus, companies need to collect, through legal and ethical means, information about the products they buy and the partners they work with. In high-risk regions, companies need to conduct comprehensive due diligences and supply-chain mapping; this is crucial in assessing the integrity and reputation of anyone or anything that touches the company.

Lastly, companies need to strengthen and identify potential loopholes, in their internal procedures and structures, related to anti corruption.

Whilst risks are an inevitable part of business development, a successful investor will aim to mitigate them, whenever and wherever possible.

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