Jurisdiction Definition of risk

What is the risk of jurisdiction?

Jurisdiction risk refers to the risks that may arise while operating in a foreign country or jurisdiction. These risks can arise simply by doing business, or by lending or borrowing money in another country. Risks could also arise from legal, regulatory or policy factors that exist in different countries or regions.

In recent times, jurisdiction risk has increasingly focused on banks and financial institutions which are exposed to volatility as some of the countries where they operate may be high risk areas for money laundering and the financing of terrorism.

Key points to remember

  • Jurisdiction risk is associated with operating in a foreign country or region.
  • Jurisdiction risk may also apply at times when an investor is exposed to unexpected changes in laws.
  • The US government publishes quarterly reports that identify potentially at-risk jurisdictions with weak measures to combat money laundering and terrorist financing.

How does jurisdictional risk work

Jurisdiction risk is any additional risk resulting from borrowing and lending or doing business in a foreign country. This risk can also refer to times when laws change unexpectedly in an area to which an investor is exposed. This type of jurisdiction risk can often lead to increased price volatility. As a result, the added risk of volatility means that investors will demand higher returns to offset the higher levels of risk they face.

Political risk is a form of jurisdiction risk where the returns on an investment could suffer due to political changes or instability in a country. Instability affecting investment returns could stem from a change in government, legislative bodies, other foreign policy makers, or military control.

Some of the risks associated with jurisdiction risk that banks, investors, and businesses may face include legal complications, exchange rate risks, and even geopolitical risks.

As mentioned above, jurisdiction risk has recently become synonymous with countries with high money laundering and terrorist activity. These activities are widely believed to be widespread in countries designated as uncooperative by the Financial Action Task Force (FATF) or are identified by the US Treasury as requiring special action due to concerns about money laundering or corruption. Due to the punitive fines and penalties that can be imposed on a financial institution involved, even inadvertently, in money laundering or terrorist financing, most organizations have specific processes in place to assess and mitigate jurisdictional risk.

Special considerations

The FATF has published two public documents three times a year since 2000. These reports identify regions of the world that the FATF claims to have weak efforts to combat both money laundering and terrorist financing. These countries are called non-cooperative countries or territories (PTNCs).

In October 2020, the FATF listed the following 15 countries as supervised jurisdictions: Albania, Barbados, Botswana, Cambodia, Ghana, Jamaica, Mauritius, Myanmar, Nicaragua, Pakistan, Panama, Syria, Uganda, Yemen and Zimbabwe. These PTNCs have shortcomings when it comes to putting in place anti-money laundering policies, as well as recognizing and combating the financing of terrorism. But they are all committed to working with the FATF to fill the gaps.

The FATF has placed the Democratic People’s Republic of Korea (i.e. North Korea) and Iran on its call to action list. According to the FATF, North Korea still poses a great risk to international finance due to its lack of engagement and its shortcomings in the areas mentioned. The FATF has also expressed concern over the proliferation of weapons of mass destruction in the country. The organization noted that Iran has stressed its commitment to the FATF but has not implemented its plan.

Examples of jurisdictional risks

Investors may be exposed to jurisdiction risk in the form of currency risk (also known as currency risk). Thus, an international financial transaction may be subject to currency fluctuations. This can cause the value of an investment to drop. Currency risks can be mitigated by using hedging strategies including options and futures.

Martin E. Berry

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