Insights & Reports > Kroll Global Fraud Report

Until a few months ago, many considered emerging markets to be immune from what appeared to be a largely Western, and particularly American, financial crisis. Supporters of “decoupling” – a theory arguing that increasingly savvy and solvent, if not cash-rich, emerging states would not be dragged into the crisis with developed countries – were confident that there would be no repeat of the economic implosions of the 1990s. The prevalent feeling was that governments of emerging states had shored up their national balance sheets and built up significant reserves to weather the financial storm.

Developments in late 2008 showed the flaws in this argument. One after another, emerging countries have rushed to take extraordinary actions, clearly signaling the extent to which they have been hit by the “Western” financial crisis. South Korea pledged over $100 billion to bail-out its banks; Hungary and Pakistan sought assistance from the ECB and IMF respectively; and recent stellar performers such as India, Vietnam, Hungary, and Argentina have all been downgraded by rating agencies. Currencies have come under increasing pressure and equities have under-performed the Dow Jones index. Such developments, and the outlook for 2009, have spooked international investors and marked a shift in risk appetite away from emerging markets to the “safe” harbors of government bonds and commodities such as gold.

Yet a significant underlying difference apparently remains between Western and emerging economies: the prospect of recession. With the United States, Japan, and Western Europe already in recession, the extent of which still remains unclear, the general consensus seems to be that emerging countries will be able to avoid it. Forecasts for China, for example, still predict growth rates of from eight to nine percent for 2009.

The combination of economic growth and tumbling asset prices offers interesting opportunities to investors seeking higher returns than those of traditional refuge assets. As is always the case, the risks are also greater, making the adoption of a risk-conscious investment approach of paramount importance. In addition to the general macro-economic issues, such as liquidity and currency risks, critical investment-specific risks need to be taken into account when investing in emerging markets.

Such investments often present more dangers than those seen on the surface. Investors should look at a wide range of such issues, many country-specific, through an ad hoc process, focused on reaching beyond typical legal and accounting due diligence. The ultimate goal should be to understand the “undeclared” risks that are associated with higher returns on specific investments.

The possible impact of crime is particularly relevant. Regulatory risks, such as breach of anti-corruption legislation, do not materialize until a particular event – for example the alleged bribery of a public official – actually takes place. Yet the potential for, and consequently the risk of, an anti-corruption investigation may be detected well before a particular incident through a detailed due diligence process focusing on the nature of the target investment’s interaction with the public sector.

Likewise, the risk of an investment losing value through fraud is unlikely to be tangible prior to the detection of such a crime. However, detection and prevention mechanisms exist which can limit vulnerability. Investors should review anti-fraud policies as a pre-condition of their investment, and implement programs to combat fraud once the transaction has been executed.

Changes in market conditions do not eliminate fraud; they merely alter its shape. Emerging economies, with possibilities for real growth, may well provide highly attractive investment opportunities in the near term compared to those of the developed world. Without due diligence and sensible risk management, however, the dangers could outweigh the possible gains.

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Matteo Bigazzi is an associate managing director in Kroll’s Investigations Practice, specializing in all areas of internal fraud, currently based in London. Matteo joined Kroll in May 2001 and has worked on a wide variety of cases including fraud detection, investigation and prevention assignments. Prior to joining Kroll, Matteo collaborated with the University of Florence, where he held seminars in geopolitics and geo-economics.

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