25/09/2017 How to Manage Off-Balance Sheet Risk?

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How to Manage Off-Balance Sheet Risk?
Hong Kong Export
Credit Insurance There have been a string of recent and highly publicised scandals involving Chinese firms listed in the stock exchanges
Corporation
of Hong Kong, mainland China, Singapore and the US. These scandals have highlighted the unfortunate fact that a
Hong Kong Monetary
major risk in business comes from off-balance sheet issues. This issue is especially prevalent in the Mainland, where
Authority
reliable and accurate business, accounting and legal information is not often available and where, as a consequence,
Hong Kong Trustees'
Association there is a heavy reliance on personal relationships and consequently on personal integrity.

IBM Institute for To avoid major problems, it is vital to examine not only the companys financial statements and legal documents, but
Business Value
also to closely review the workforce and the organisation as well.
Knight Frank
Fung Business Most importantly, contingent liabilities, also referred to as off-balance sheet items, should be carefully analysed as part
Intelligence of the overall risk assessment. Potential off-balance sheet exposures include: understatement of tax payments, pending
Royal Institution of litigations, corporate guarantees, capital expenditures and financial commitments given to third or related parties.
Chartered Surveyors
(RICS) Due diligence should therefore be a critical part of the evaluation process before any merger and acquisition transaction.
Standard Chartered Essentially, the due diligence process helps identify issues that have not been disclosed and identify business, financial,
Bank
legal and human resources risks that are not immediately visible or obvious. Businesses should look closely at the
Global System for
entities and people (such as senior management) involved in any given transaction, examining their background,
Mobile
Communications reputation, track record and litigation history.
Association (GSMA)
Currently, there are many new entrepreneurs in mainland China, with excellent qualifications, skills and good
The Nielsen
Company connections. However, these cannot always be taken at face value and businesses need to verify and authenticate
PwC whether such qualifications and claims are in fact genuine.
Deloitte
Whether a potential target partner is a listed company, privately-held business or former state-owned enterprise,
KPMG focused reviews need to be conducted to gain a deeper insight into potential risks.
Baker McKenzie
Mayer Brown JSM
Companies require a level of comfort to support strategic and investment decisions. Issues such as the target partners
reputation, history, background, connection, network, business ethics and individual managements integrity and actual
Deacons
influence in its local environment can be the key to a successful deal.
Dezan Shira &
Associates
However, it is also necessary to identify potential problems, such as labour disputes, litigation history, undisclosed
EY
indebtedness, significant capital expenditures and operating commitment and contingent liabilities, and potential
regulatory or environmental breaches. Equally important are bribery-related considerations (e.g. employees taking kick-
Advertisement backs or rebates) or potential money laundering exposure.

Off-balance sheet risk can be manageable if company is willing to adopt a robust approach to due diligence.

Negative information acquired through due diligence can lead to more favourable negotiation terms for the acquirer, and
can ensure that deals are structured to reduce the identified risks.

Due diligence is particularly cost-effective when undertaken in the early stages of a transaction, because it allows
businesses to identify problematic issues quickly before committing considerable financial and management resources to
the deal. It can identify potentially serious disclosures failures which can lead to expensive delays, further negotiations,
cancellations or, most costly of all, damage to corporate reputation.

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