Peter Guy, Regulation Asia, September 19, 2016

Successfully conducting due diligence and mitigating risk is one of the most persistent and daunting challenges faced by financial services in Asia-Pacific. Its complicated nature and the manifest consequences of failure are evolving rapidly. This is at least partly linked to institutions’ growing exposure to multiple jurisdictions and different cultures, and the varied risks parties undertake, alongside aggressive enforcement by regulators and governments.

Legal counsel, risk and compliance managers face unprecedented pressure to efficiently decipher developments and update policies in order to conduct business effectively, while continuing to make profit.

Richard Dailly, managing director, Kroll, and the company’s senior adviser, David Twine, welcomed senior legal, compliance and risk managers from Australia’s financial services sector to candidly discuss experiences and attitudes to investment due diligence across Asia-Pacific.

As Dailly explained: “In opaque environments, clients wonder how they are supposed to gain comfort with the process, results and findings of due diligence. The realistic answer is that it's extremely difficult—there is no panacea.”

Challenges in Southeast Asia

Indonesia represents particular challenges in conducting a due diligence exercise.

Twine commented: “We might start by looking into someone’s relationship with the government. But, relationships with government ministers and military officers are often well hidden. Even though you can obtain corporate records, what do they actually tell you?

“And, often what is on their records is not actually true. The only way to resolve this is to get on the ground and ask questions in a discreet and covert way.”

Dailly further qualified due diligence methods. “It is important to have conversations with people who are part of the community and culture—those who know the answers to the questions being asked. Investors need to know who owns a business, associated businesses and, importantly, how they are connected,” he said.

An insurance compliance officer asked about the limits of due diligence and how it guides or restricts an investigator’s conduct and results.

Twine replied: “The real value is being able to access special groups within communities that few people can reach. Getting on the ground and talking to people helps you develop a compelling and convincing narrative, which fits in with the other parts of due diligence.”

A chief risk officer asked what some of the classic red flags or problems clients seem to miss are.

“Determining ownership of land is probably one of the biggest red flags, as it is based on verifying legitimacy of documents. In Asia, there can be multiple sets of documents laying claim to ownership,” Dailly pointed out.

Other business and legal problems can also arise from land ownership uncertainties or disputes, with Twine citing the resource and energy infrastructure sector in Indonesia as a typical example of where difficulties can occur.

“When an asset, like a mine becomes profitable—or as soon as the asset starts to work properly— some people appear and lay claim to the operation. There is nothing the victim can do about it,” he noted.

“It occurs as historically there is no black and white legal answer to who owns the land. Indonesia also presents unique problems as land title laws differ between the regency and Federal levels.”

A regional bank compliance executive asked: “What are the practical limits of due diligence investigation in Asia? Do you often reach people? What do you do when that happens?”

“Limits of investigation are reached. In other cases, gathering intelligence reveals certain government agents, ministers or military people.” noted Dailly.

New frontiers in due diligence

Today, there is a tightening focus on ethical supply chains in manufacturing and big retail, which involves and requires additional due diligence by financial institutions which serve these sectors. Key issues include human rights, labour abuses and human trafficking.

Dailly shared his experience in this complicated area: “Often, clients broadcast their inspection visit, so a subcontractor or factory is often ready for the inspectors. As a result, a client doesn’t capture possible infractions.”

“For those involved in banking, credit finance or investments, this is an issue where you can’t examine every possibility. Understanding how many steps you are removed from your clients’ core business is important because interlinked supply chains mean you might be potentially affected.”

“You have to ask: who are we lending to and for what purposes in the context of a complicated supply chain?” Dailly pointed out. “It is part of the holistic assessment of the customer to worry about the overall reputational risk of these activities. KYCC (know your customers’ customer) has been in use for some time and knowing your customers’ suppliers has grown in importance.”

An executive from a global bank asked about the issues involved with on-boarding and performing due diligence on an Iranian company in a post-sanctions environment.

“Iran will have to be dealt with in due course because there are Australian companies who are working there. Equally, Myanmar represents a similar problem due to connections with North Korea,” Twine concluded.

“More importantly, there is enormous pressure from front-line bankers to on-board clients from previously sanctioned countries—such as Iran—simply because the oil business is so lucrative.”


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