What Is Jurisdiction Risk?
Let me explain jurisdiction risk directly to you: it's the potential trouble you can run into when you're operating in a foreign country or jurisdiction. This can happen just from doing business there, or from lending or borrowing money across borders. The risks often come from legal, regulatory, or political differences in those places.
Lately, I've noticed that jurisdiction risk is getting a lot of attention in banking and finance circles, especially for institutions exposed to countries that are hot spots for money laundering or terrorism financing.
Key Takeaways
- Jurisdiction risk ties directly to operating in a foreign country or region.
- It can also hit when laws change unexpectedly in areas where you have investments.
- The U.S. government tells financial institutions to check FATF updates for risky jurisdictions weak on fighting money laundering and terrorist financing.
How Jurisdiction Risk Works
You need to understand that jurisdiction risk is any extra risk from borrowing, lending, or doing business abroad. It also covers situations where laws shift suddenly in a place where you've got exposure, which can spike price volatility. Because of that, you'll often see investors demanding higher returns to cover the increased risk.
Political risk is a key part of this—it's when your investment returns take a hit from political shifts or instability, like changes in government, legislation, foreign policy, or military actions.
Banks, investors, and companies deal with various jurisdiction risks, including legal hurdles, exchange rate issues, and geopolitical threats. As I mentioned, it's now heavily associated with countries prone to money laundering and terrorism, especially those labeled non-cooperative by the FATF or flagged by the U.S. Treasury for corruption concerns. To avoid massive fines, most organizations I know have strict processes to evaluate and reduce these risks.
Special Considerations
Here's what you should know about the FATF: they release two public documents three times a year since 2000, highlighting regions with weak controls against money laundering and terrorist financing. These are known as Non-Cooperative Countries or Territories (NCCTs).
As of June 2021, the FATF monitored 22 countries: Albania, Barbados, Botswana, Burkina Faso, Cambodia, Cayman Islands, Haiti, Jamaica, Malta, Mauritius, Morocco, Myanmar, Nicaragua, Pakistan, Panama, Philippines, Senegal, South Sudan, Syria, Uganda, Yemen, and Zimbabwe. These places have gaps in anti-money laundering and counter-terrorism financing, but they've pledged to fix them with FATF help.
The FATF has North Korea and Iran on its call-to-action list. North Korea is a major threat to global finance due to its lack of commitment, deficiencies, and even weapons proliferation. Iran promised action but hasn't followed through.
Examples of Jurisdiction Risk
You might encounter jurisdiction risk as foreign exchange risk, or currency risk, in international deals. Fluctuations in exchange rates can erode your investment's value. To handle this, I recommend hedging with options or forward contracts.
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