Compliance officers wondering how their peers manage third-party risks and where they focus due diligence efforts these days will want to take a look at a new report on those practices.
Compliance officers responsible for emerging markets have long been hampered by poor access to corporate data, court records, and media reports in those regions. That has driven them to use technology for more comprehensive research on the third parties and individuals with whom they do business. “We really don’t see any sector as being able to avoid having to invest more in due diligence,” says Ed Long, head of research and report author for Arachnys, a British software firm that provides enhanced due diligence.
To get a better understanding of where in the world companies concentrate their due diligence efforts, Arachnys studied the volume and nature of its customers’ search efforts in the last year. Out of 206 countries where companies conducted due diligence searches, China was, by far, the most-searched country in the world—more than twice as much as Russia, the No. 2 country. Arachnys published that report this week and gave Compliance Week a sneak preview of the results.
Exposure to high levels of corruption in China and sanction violations in Russia probably explain why many companies focus their due diligence efforts on those two countries. “The number of international sanctions imposed has increased interest among compliance officers in checking out ownership structures of Russian companies, and checking out what their exposure is to these companies,” Long says.
As one risk adviser at a global accounting firm explained in the report, “It’s not the sanctions lists themselves that are causing my clients problems. It’s how to decipher whether third parties are or aren’t linked to the individuals or entities on the sanctioned list.”
Following China and Russia, the United States ranked third for due diligence research activity. One reason may be that significant practical barriers still exist in the United States to finding corporate information, particularly because many companies are registered at the state level, rather than at the federal. “Due diligence research is less than plain sailing, driving the need for improved tech solutions to catch the small details that can otherwise fall through the cracks,” the Arachnys report stated.
“What we see in the United States is competition to be the most opaque state,” Long says. Delaware, for example, stands out as the one of the least transparent states, where obtaining any information—particularly on beneficial ownership of companies—other than the name and registration number can be difficult, he says.
“We really don’t see any sector as being able to avoid having to invest more in due diligence.”
Ed Long, Head of Research, Arachnys
One senior vice president of an investment bank was quoted in the report saying that tracing ultimate beneficial ownership of a business in the United States can take just as much time and effort as he spends researching companies in North Africa. “The information is usually available online, but you often have to work hard to get it, jumping through different hoops.”
Other countries where companies commonly focused their due diligence searches include Brazil, Mexico, India, and Nigeria. “Compliance and risk professionals continue to focus on the BRIC nations to a far higher degree than their MINT (Mexico, Indonesia, Nigeria, and Turkey), counterparts,” the report stated. “[Arachnys] customers were four times more likely to run analysis on a BRIC nation than a MINT nation, for example, while over half of all searches in these countries were in China.”
Due diligence efforts also varied depending on industry, as well as country. The main driver is “how heavily regulated the industry is,” says David Buxton, founder of Arachnys—the more heavily regulated the sector, the greater need to perform due diligence. As a result, the financial services, pharmaceutical, and oil and gas sectors tend to perform high levels of due diligence.
Aside from regulatory pressures, geography still plays a strong role. “We see companies in what might otherwise be low-risk industries—retail, for example—that have very significant compliance exposure because of the markets in which they operate,” Buxton says.
The report also assessed the unique compliance obstacles that each country poses when performing a due diligence search. As one head of research at an investment bank explained in the report, two barriers arise in China: language differences—“especially when we need to undertake quick, reactive research;” and unraveling how a company is owned.
“We’ve had multiple experiences of companies being red-flagged only to find them months or years later simply operating under a new name,” the executive said in the report. “Understanding the data environment in China and knowing what information is out there relating to ultimate beneficial ownership is crucial.”
U.S., EU SANCTIONS
Below is a list of U.S. and EU sanctions in 2014 related to the Russia-Ukraine crisis.
Oct. 6, Sanctions Body – OFAC: Revision of General License 3 to include transactions involving Sberbank subsidiary DenizBank
Sept. 12, Sanctions Body – EC: Scope of sanctions extended on 5 restricted Russian banks; 6 companies in energy and defense sectors and 24 individuals also targeted
Sept. 12, Sanctions Body – OFAC: Specially Designated Nationals (SDN) list update adding a total of 17 entities, primarily targeting the oil and gas, financial services, and industrial sectors
July 31, Sanctions Body – OFAC: SDN list update adding 2 Ukrainian and 2 Russian officials
July 31, Sanctions Body – EC: Sector-wide sanctions imposed on 5 Russian banks, export restrictions to the Russian energy and defense sectors and new designations of 8 individuals and 3 corporate entities
July 30, Sanctions Body – EC: Extension of restrictions on trade and investment in transport, communications, or energy sectors in Eastern Ukraine
July 29, Sanctions Body – OFAC: SDN list update adding 1 industrial entity and 3 financial services entities
July 25, Sanctions Body – EC: Further designations of 15 individuals and 18 entities (9Crimean companies and 9 institutions)
July 16, Sanctions Body – OFAC: introduction of the new Sectoral Sanctions Identifications List; SDN lsit update to add 4 Russian officials, 1 Ukrainian official and 15 corporate entities, including 4 in the financial services sector
June 27, Sanctions Body – EC: Imposition of an import ban on goods from Crimea and Sevastopol
June 20, Sanctions Body – OFAC: SDN list update to add 1 Russian and 6 Ukrainian officials
May 12, Sanctions Body – EC: Sanctions imposed on 13 Russian and Ukrainian individuals; first EU asset freezes for 2 Ukrainian Energy companies
April 28, Sanctions Body – OFAC: SDN list update to add 7 Russian officials and 17 Russian corporate/financial entities
April 28, Sanctions Body – EC: 15 individuals added to designated persons list
April 11, Sanctions Body – OFAC: SDN list update to add 7 Crimean officials and one oil and gas company in Crimea
March 21, Sanctions Body – EC: Designations extended to include further 12 Crimean and Russian individuals
March 20, Sanctions Body – OFAC: SDN list update to add 20 Russian officials and one Russian bank
March 17, Sanctions Body – OFAC: First designations: 11 Ukrainian and Russian officials are added to the SDN list
March 17, Sanctions Body – EC: Asset freeze update to include 21 individual military and political figures from Crimea and Russia
March 6, Sanctions Body – OFAC: issuance of initial Ukraine-related Presidential Executive Order authorizing sanctions
March 6, Sanctions Body – EC: Asset freeze and travel ban on 18 senior officials of the ousted Ukrainian government
With the language barrier in particular, information on registered companies is only provided in Chinese; unless you have a team of local experts working on this research, “it can be very challenging for Western-based companies to do due diligence work on Chinese companies,” Long says. Furthermore, because registered companies in China are listed by province, “you really need to know where your company is registered to be able to find information on it,” he adds.
Another country that poses several due diligence reporting obstacles is Mexico, where the country’s federal structure, poor corporate transparency, and entrenched corruption makes research particularly difficult. According to the head of financial crime research at one multinational bank, “with other BRIC markets like Brazil, and even China, you see real progress in creating integrated, centralized, easy-to-use registries. That’s not yet the case in Mexico.”
“The key thing compliance officers should be doing is making sure they are going to the actual official sources of information,” Buxton says. He adds that companies shouldn’t always rely on third-party sources that “may not be up-to-date, or may or may not be accurate.” On a practical level, that requires having a deep understanding of each country’s unique compliance obstacles, and how to overcome them, he says.
A lot of companies simply don’t know what data is available, or how to access it in every country, Long says. At the same time, “the amount of direct sources available has grown exponentially,” he says; compliance officers have much more corporate disclosure data at their fingertips to research than ever before.
The good news is that by using a centralized system to conduct due diligence searches on corporate data, court records, and media reports, companies increasingly are simplifying and streamlining their due diligence efforts, while reducing their third-party risk exposure. Companies can expect that trend to continue as more countries continue to become more transparent.