As firms foray into the emerging markets seeking growth opportunities, they need to be aware of the risks posed by cultural differences.
There are two ways of looking at the cultural aspects of operational risk: the cultural risks facing organisations operating across multiple locations and geographies, and the cultural differences. Judith Graham, Optial, COO looks at the ways workplace cultures differ across the globe, and how firms should adjust their operational risk practices to address this diversity.
This paper examines both of these aspects and the challenges they create for an organisation wishing to expand its operations into new markets, while maintaining control and visibility of its operational risk landscape.
With developed countries caught in the grip of the credit crisis, rising inflation and falling asset prices, the fast-growing markets of the developing world represent the most significant new opportunities for financial institutions. This includes not only the well-tested ground of the Bric countries (Brazil, Russia, India and China), but beyond them the next eleven – the so-called N11 countries – as well as the great crescent, the arc of oil, gas and resource-rich countries stretching across central Asia and through the Middle East.
But establishing a market presence in emerging economies can have a substantial downside: multinational operations in emerging markets might have very different business and social cultures to those of their respective home countries. This in turn inevitably increases an organisation’s exposure to operational risk.
Operational risk models based on, say, the New York, London or Frankfurt office could go badly awry when applied in countries with very different business and social cultures. As investment decisions become increasingly devolved to regional hubs, operational risk models and procedures must be flexible enough to accommodate local business sensibilities and practices.
The cultural risk peril
Although most operational risk can be expected – and occurs – on site, where financial institutions carry out most of their activities, the cultural risk of expanding into new geographies can entail an operational risk out of proportion to the level of economic activity involved. The risk is at least commensurate with developing new financial products.
The risks to financial institutions from multinational operations are manifold. Perhaps the most stark is fraud – either internal or external. Fraud is an exceptional risk for multinational financial operations because there is a big danger that operational controls will be weaker in new overseas operations than in their longer-established domestic counterparts. This is particularly so when the new offices might initially be understaffed, leading to breakdowns in basic tenets such as segregation of duties. The activities of Nick Leeson at Barings and Toshihide Iguchi at Daiwa are notable not only for the scale of losses – and of course the devastating impact on two well-established financial institutions – but also because their activities were so egregious it is difficult to believe they could have continued undetected for so long in a domestic operation.
While Iguchi and Leeson highlight the dangers of multinational operational fraud, there are many other categories of operational risk that pose a threat to multinational companies, not least the operational risk related to foreign exchange exposure management.
In many non-Western societies, although fraud will be as readily identified as in any Western organisation, different cultural and organisational sensibilities can create barriers to criticising workplace colleagues who might be making mistakes, and to reporting them, especially in line with imposed external or foreign corporate processes. The reluctance to criticise is not restricted to non-Western cultures; whistleblowers might end up pilloried by their own colleagues and management despite having exposed bad practices.
Localisation – where financial organisations create products specific to local business needs – also inevitably involves cultural risk. Without a good understanding of the purposes and background to the local business practices, the inherent risk profile of such products might be poorly understood.
As Investment decisions become increasingly devolved to regional hubs, op risk models and preocedures must be flexible enough to accomadate local business sensibilities and practices.
Cultural power distance
A key difference between a Western workplace and one set in South America, the Middle East or east Asia is what academics describe as cultural power distance. This is essentially the degree of hierarchy within an organisation or society. Low cultural power distance societies and organisations are more collegial, with value placed on social flow and less formality. High cultural power distance organisations are more formal, with far less social mixing between different levels of an organisation and higher value placed on respect.
Degrees of power distance also affect the rate at which problems get reported, concerns shared and colleagues work together to solve problems. In low power distance organisations, problems are shared and solved quickly, and there is typically little difficulty in communicating across disciplines or management levels. In high power distance organisations, on the other hand, problems tend not to be pushed into the spotlight, and there is often fear or reluctance about reporting issues to more senior management.
Power distance factors, of course, affect operational risk management. High levels of power distance make it more difficult for, say, risk officers, compliance, governance managers and auditors to discover risky procedures or poor operating processes. They can also make it much easier for a fraudulent senior member of staff to hide activities.
Cultural power distance is measured by an index compiled by Dutch sociologist Geert Hofstede (Culture’s consequences (2nd, fully revised edition, 2001)). In lower power distance countries, it is expected and accepted that power relations are more consultative or democratic, whereas in higher power distance countries the less powerful accept power relations that are more clearly hierarchical and structured.
Western countries with strong liberal and free market traditions tend to score low on the index. Denmark, Israel and Austria all score below 20. Switzerland, the UK and Germany all score 35, while the US scores 40. Latin countries tend to score higher, with Italy on 50, Spain on 57 and France on 68. Middle Eastern countries typically score around 80. Asian and South American countries score even higher, with China scoring 80, Philippines 94 and Malaysia 104.
Western operational risk procedures that naively assume an ‘out in the open’ workplace culture exists could come badly unstuck in a business culture such as the Middle East or Asia with distance scores double or more. Regardless of cultural background, no-one willingly embraces procedures they experience as disrespectful, disloyal or indiscreet. Instead, people find ways to communicate in a fashion they feel is socially comfortable, and it is this level of cultural understanding that operational risk managers must achieve if their programmes are to be successful globally.
A recent study by Wolfgang Stehle and Ronel Erwee of the University of Southern Queensland looked at some of these differences within the multinational operations of German companies operating in three Asian countries: Singapore, Thailand and Indonesia.
The study found German workplace practices tend to focus on achieving overarching goals and objectives. The Asian workplace, on the other hand, tends to adopt a nuanced approach, with a lower focus on team or business goals and a reluctance to suborn cultural and social norms to achieving corporate objectives.
Assumptions and evidence
Attitudes to uncertainty also differ markedly across business cultures. Western business culture tends to assume a high degree of uncertainty. This attitude was summed up memorably by former US defense secretary Donald Rumsfeld’s reference to the “unknown unknowns”, those “things we do not know we don’t know”. Or, as Socrates more eloquently put it “a man is wise if he can recognise how little he knows”.
Western thinkers such as Peter Drucker and Karl Popper have emphasised this tendency, and in doing so have had a strong influence on Western management practices. This has led to management procedures that constantly question assumptions and test evidence.
An assumption of uncertainty is also at the heart of operational risk management; effective management of operational risk requires a working culture that assumes a widespread presence of uncertainty. Put another way, operational risk management works best when an organisation’s work culture is open to question – and is empirical.
Stehle and Erwee found these Western attitudes to uncertainty were not widely shared in most Asian workplaces. Instead they found such attitudes were often rejected and criticised as being socially disruptive. Imposing an operational risk methodology, which will probably be rejected, constitutes in itself an enormous operational risk.
Even cultures that are seen by outsiders as being highly homogeneous can in practice be divergent, and require diversified approaches.
A separate study by the European Essec School of Management found wide differences across Scandinavian workplaces and management structures, despite common outsider assumptions that Scandinavian companies present a uniform model of consensus-based, liberal organisation. The study found that, while Scandinavian companies were frequently driven by conservative instincts with strong work ethics, within Scandinavia there were marked differences between Norwegian, Swedish and Danish companies. Danish companies typically employed looser, more liberal management styles compared with Swedish companies, which tended to be more conservative and structured. The study also found Finnish companies had little in common with other Scandinavian companies, whose structure and business practices were closer to American and UK companies.
Legal and regulatory landscapes
Another local issue that can affect op risk includes the foreign country’s legal and regulatory landscape. Lack of transparency in a country’s legal framework has already proved to be a decisive operational risk for a number of Western companies involved in developing economies, most notably Shell and BP in Russia, which have had legal and regulatory pressures applied to them to surrender their investments to state-owned companies.
On a smaller scale, even minor differences in regulatory or legal frameworks can create op risk for companies operating in countries such as China. Disparity in regulations relating to, for example, treasury management, inter-company loans, hedging and derivatives, or contract law can all incur increased risk.
Take for example the Chinese practice of sealing agreements with seals or company stamps – known as “chops” in the international business community – rather than with signatures and counter signatures. A company’s chops are registered with the local authors and become the legally binding method for sealing any contract. Consequently, people who advise on doing business in China typically warn of the potential risks surrounding signing contracts there.
Cultural shift – the goal posts move
Adapting operational risk procedures and systems to accommodate regional cultural risk is not enough. Multinational operations must also address the danger of what academics describe as ‘cultural shift’.
Divergences in global business are of course not static; they change over time. Until recently, consensus was that multi-national business cultures were largely converging. This perception was reinforced by Theodore Levitt’s influential 1983 Harvard Business Review article, “The globalisation of markets”, which popularised the term ‘globalisation’. Levitt argued that both culture and economics were flattening local differences and creating a more homogeneous globalised business culture.
Such a view appeared logical in a business world where the chief dynamo was provided by US multinationals and the dominant economic paradigm was Anglo-Saxon. That perception no longer appears so self-evident. There is gathering evidence that global cultural shift is not so much convergent as it is crossvergent or actively divergent. The rise of expansionary, well-funded and resource-rich multi-nationals from developing economies, especially the Bric nations, is promoting business models and cultures very different from the formerly dominant Anglo-Saxon model.
Moreover, the pace of emerging economy industrialisation, coupled with recent rapid growth in local media and the internet, is accelerating the speed of cultural shift. So what had once been a process of slowly modulated convergence is now becoming in many places an accelerating divergence.
Implications for operational risk
Such cultural risk and cultural shift factors have major implications for managing operational risk procedures and systems across multinational operations, especially in emerging market economies. They imply multinational operational risk systems should be flexible, agile and integrative. Multinational institutions must enforce the highest standards of operational risk management across all their operations, regardless of the location of their head office. To be effective, however, these operational risk frameworks need to adapt to the cultural risk factors of each location. That means software systems should be easily configurable and capable of accommodating local business rules and procedures without incurring major set-up costs or requiring special skills. People should be able to engage with operational risk management systems in their own language. Such systems also need to be modular, capable of running different localised configurations within overarching enterprise architecture, and ultimately able to enforce and control corporate-wide operational risk compliance.
Cultural shift – the increasing divergence of social and business cultures worldwide – means that such architectures also need to be agile, to incorporate and accommodate shifting patterns of culture risk, as well as new products and services, as they emerge.
Lastly, multinational operational risk systems should integrate easily across a wide range of other business systems. This includes other risk management systems, internal control systems and compliance systems. To reduce reliance on assumptions about workplace practices and communication flows, integration with front office and operational systems is required.
Cultural differences will undoubtedly always be with us and indeed, vive la différence. They are certainly likely to influence the multinational workplace for the foreseeable future. However the added operational risk arising from these cultural differences does not have to confound us. Recognising the nature of this risk, addressing it, and putting in place appropriate systems and technologies to manage it, will minimise the risk, and ultimately help open up new markets for financial institutions, with minimal downside.
Judith Graham is the chief operating officer at risk management solutions provider Optial
Article Published by OpRisk & Compliance in December 2008