Eastern Exposure

n 1986 on Sumbawa, a remote Indonesian island east of Bali, Newmont Mining Corp. undertook the biggest mining endeavor in its history. Financial executives knew that to mine rich gold and copper-ore deposits the Denver-based company would have to assess and manage many cultural and logistical risk factors. The project, called Batu Hijau, was vulnerable to unforeseen political, social and financial forces. But even knowledgeable risk specialists could not have predicted the confluence of circumstances—including the overthrow of the Indonesian government, riots in the capital, the worst copper prices in a decade and the lowest gold prices in 15 years—that would plague the company during the 13-year development of Batu Hijau.

With Southeast Asia in economic turmoil, American companies doing business there have had to upgrade their risk assessments. Many businesses, apparently afraid of endangering current or future holdings, declined to talk about their risk apparatus in Asia. However, key financial personnel at Newmont, Wang Global, Dana Corp. and PricewaterhouseCoopers explained how they deal with or advise people on Asia’s ongoing travail. Since CPAs frequently encounter risk-management issues in business—their own or clients’—these stories provide interesting insights into the challenge posed by Asian markets.  

A DIFFERENT WORLD

Although business practices in parts of Asia resemble those in the West, “some Asian countries are far removed from life in Europe,” says David Spence, who is in charge of risk management Asia/Pacific for PricewaterhouseCoopers. For example, financial reporting and auditing standards vary from country to country, he says, and in some places they may not be as rigorous as those of the United States.

Like their counterparts in the United States, Asian business people can be litigious. “The legal framework is completely different in Asia,” Spence says. “It’s best to avoid litigation in some countries, as the courts often favor the underdog.”

Corruption is a problem in Indonesia, where kickbacks and outright bribes are common, but its forms can be subtle. An Indonesian lawyer may request a “consulting fee” to get a contract for a U.S. company, for example. Spence warns companies that accepting such arrangements may put them in violation of the U.S. Foreign Corrupt Practices Act.

Another fact of life is mandatory risk coverage. “In certain Asian countries, you’re obligated to buy more insurance than you wish” because they have mandated minimum insurance levels, according to James Blinn, national director of the Ernst & Young Property/Casualty Risk Management Consulting practice. Overinsuring should be considered almost a cost of doing business.

Political problems are another issue. For instance, a company might need insurance against government expropriation in politically unstable locales. Other considerations include currency hedging, cultural differences, the Y2K computer issue and the importance of patience in a culture with very different rhythms from those of the West.

BATU HIJAU

For Newmont, the Batu Hijau mining project carried risk as well as opportunity. The project contains reserves of up to 12 million ounces of gold and 11 billion pounds of copper.

When production—scheduled for late 1999—begins, Batu Hijau is expected to produce an average of 270,000 tons of copper and 550,000 ounces of gold annually for more than 20 years. Copper is much in demand worldwide and is used in making everything from cars to computers. When Newmont started construction in 1996, it brought in three government agencies for political risk insurance (see “Mining for Dollars,” page 57, for more on financing). To further hedge risk, Newmont selected Sumitomo Corp. as a partner in Batu Hijau. “It’s a well-respected corporation with deep involvement in the copper business. It’s a good strategic fit,” says Thomas Mahoney, Newmont’s assistant treasurer. Besides partnering with Sumitomo, Newmont recruited several major international commercial banks to finance the project. “This spread the risk, and these financial institutions provided much-needed capital,” Mahoney says.

An Asian partner can provide contacts and knowledge about local business practices, but for some U.S. companies, that may mean teaming with an unknown entity that does not have the international reputation of a company such as Sumitomo. In those cases Spence recommends checking the potential partner’s track record. Examine the history and success of prior deals, and check all references as well as talk to your own local CPA and lawyer in the country about the potential partner’s reputation. If you are relying on financial statements to assess a potential partner’s or supplier’s financial status, Spence cautions, bear in mind that auditing standards in some foreign countries are different from those in the United States and judge how reliable the financial statements are in your decision-making process.

Although it seemed to be taking all the right risk-management steps, Newmont couldn’t foresee a trio of troubles ahead. The Asian economies cratered, starting in 1997. Copper and gold prices plunged. In the midst of economic turmoil, Suharto, who ruled Indonesia as president for 32 years, was ousted in May 1998 amid street rioting that took the lives of almost 1,200 people.

As its sole financial risk-management strategy, Newmont hedged gold using long-term forward pricing, but the company did not use the same strategy for copper. “The copper forward markets are not as developed as gold, where it’s possible to go five or six years or even longer. In copper, the longest you can go to hedge significant amounts is one or two years,” Mahoney says. That limits a company’s long-term risk-management options.  

TROUBLE IN PARADISE

There were some factors that helped Newmont. For example, the construction contracts at Batu Hijau were denominated in dollars deposited in offshore accounts. That helped when the value of Southeast Asian currencies plummeted.

For a while, the Indonesian government withheld Newmont’s construction permit, partly because of the Bre-X scandal, a business failure involving a Canadian mining company that caused huge losses for investors and repercussions that swept the Indonesian government. In response, the Indonesian government set up more restrictions that threatened investor returns, such as requiring full Indonesian management within six years for new mining operations. When Newmont contended its contract on Batu Hijau was exempt from these hurdles, the ministry of mines withheld the company’s permit for seven months, until Newmont threatened to abandon the project.

INTEGRATING RISK

Newmont is not alone in its struggle to protect its Asian investments. Dana Risk Management Services, Inc., faces similar concerns in its international operations. “We try to assess risk on a global basis,” says Dennis L. Bennice, president of the Toledo-based Dana Corp., an auto parts firm with Asian holdings. The company considers a variety of possibilities, including business interruption as well as equipment or machinery breakdowns.

Although Dana has a captive insurance company—a wholly owned subsidiary in Bermuda—Asian countries ban the use of such captive insurers, so Dana turns to the commercial insurance market when necessary.

“You can never do everything in risk management,” Bennice says. “We’re trying to find out our overall exposure and our appetite for risk and whether one exceeds the other. We decide the right level of risk to business so the smallest amount of dollars flows out from Dana. The question is how little to buy and how little to manage.”

In Thailand, where Dana has an operation, Bennice says, “I would consider risk insurance against damage to our buildings. I can’t guard against a disturbance, but I can try to stop it from impairing our balance sheet.” Besides obtaining insurance, Dana would make recommendations to local management about improving plant security at the Thai operation.

Such preventive measures against predictable risks can lower insurance costs. That’s important, because the increased dangers in Asia mean greater premiums, says Arthur Dubroff, executive vice-president and chief financial officer of Enhance Financial Services Group Inc.

USING DERIVATIVES

Derivatives are another risk-avoidance tool. According to its annual report, General Motors uses derivatives to manage exposure to fluctuations in interest rates and foreign exchange rates and to meet its customers’ financing needs. It uses mainly foreign-exchange forward contracts and options, interest-rate swaps and options and forward contracts to purchase or sell mortgages or mortgage-backed securities.

“GM uses derivatives to hedge underlying business exposures,” the report states. Since GM has operations in more than 50 countries, it is subject to foreign currency exposure in these countries when it buys, sells and finances in currencies other than the local currency. It primarily hedges cash flows such as debt, firm commitments and anticipated transactions involving vehicles, components, fixed assets and subsidiary dividends. It minimizes risk by limiting the amount of its exposure with any one bank or financial institution.  

HIGH-TECH HEADACHES

Computer service business Wang Global has a presence in the U.S., Japan, Australia, Hong Kong, China, Korea, Singapore, Indonesia, Thailand and the Philippines. “Our cost and revenues are in the same currency, so we’re naturally balanced,” says Frank Caine, who, until recently, was chief financial officer of the Billerica, Massachusetts, company.

The company avoids billing in dollars, which are now costly to the company’s customers when measured against the weakened Asian currencies. “Putting the risk on the customer leaves you at a competitive disadvantage. Our customers are affected by the faltering economy. We’re sensitive now to the business and economic climate in a number of Asian markets,” Caine says. Throughout the world, Wang Global puts its excess cash into dollars, its home currency. “This minimizes foreign-exchange exposures,” he says.

Although Asia exports technology, many local companies aren’t always up to speed technologically. “A lot of countries in Asia feel Y2K doesn’t apply to them,” says Spence of PricewaterhouseCoopers. “You could find your suppliers disappearing overnight due to computer problems. Only very recently are countries such as Japan and Korea becoming aware,” Spence says. The solution is to check the computer expertise of suppliers, partners and ancillary operators.  

MINING ASIA’S WEALTH

Despite the problems, everyone surveyed remains bullish on Asia. “At some point, Asia will return and be a good risk,” says William J. Wedlake, chief financial officer of Terra Nova Group.

Spence also feels the downturn in Asia is temporary and that recovery is only a question of time. Predictions range from two to five years. “The labor is cheap; the markets are free; the communications are good,” Spence says. “Asia is still one of the best places for business.”

That means companies must learn to live with the inherent risks. “Proper risk management for an international project must encompass a broad range of risk-management tools and strategies,” says Newmont’s Mahoney. “Many project sponsors may initially concentrate on the more traditional activities, such as obtaining commercial insurance coverage for property, casualty and business loss or evaluating interest rate hedging or other financial risk-management tools. However, proper risk management also extends to other avenues, such as political and long-term business risks. These are the areas where strategic partnerships, on both the equity and debt side, are extremely critical. I would advise companies considering major investment in lesser-developed countries to carefully consider these relationships early in the process.”

Accordingly, in Mahoney’s opinion, his company’s smartest risk-management step was its strategic partnership with Sumitomo. “Sumitomo has proven to be an excellent partner in the project. It brings a wealth of experience in the copper business and has taken the lead in the marketing effort for the copper concentrates that will be produced by the project. In addition, Sumitomo has a long history of investment in Indonesia, and that involvement has been a positive for Newmont. It also has an excellent relationship with the Export-Import Bank of Japan and has been instrumental in coordinating that agency’s involvement in lending to the project.”

Another important step was building credibility and good relationships. “For example, in developing our smaller Minahasa project, we adhered to strict environmental standards and paid great attention to community relations. This enabled us to establish a high degree of credibility with the Indonesian government and was critical to our subsequent development of Batu Hijau.

“As another example, when working in foreign countries, we endeavor to keep relations with the local government open and broad-based. Since the beginning of the Batu Hijau project, we have established aboveboard and proper relationships with individuals at all levels of the various governmental departments and agencies. As a result, despite the recent political disruptions and turmoil in Indonesia, we have been able to maintain appropriate business relationships with the government and its ministries, and have secured necessary permits on time so we could stay on schedule with our project construction. Responsible development translates into good business.”