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Can Emerging Economies Afford a “Green” Recovery from COVID-19?

Can Emerging Economies Afford a “Green” Recovery from COVID-19?

The dramatic slowdown in industrial production, energy demand and transport activity in the first quarter of 2020 has led to significantly lower levels of air pollution, sparking debate over whether the coronavirus outbreak will lead to long-term shifts in consumer and industrial behaviours that could reorient economic policy towards sustainable development goals. 

However, rising public debt, combined with significant capital outflows and reduced exports, will make financing green investments a challenge for many emerging markets as their governments seek viable strategies for kick-starting their economies once the disruption from the pandemic subsides.

A report by the International Renewable Energy Agency (IRENA) projected that accelerating investment in renewable energy could underpin the global economy’s COVID-19 recovery by adding almost $100trn to GDP by 2050.

In addition to helping curb the rise in global temperatures, the IRENA report claims that ramping up investment in renewable energy would effectively pay for itself over the long term, by returning between $3 and $8 for every $1 invested, and quadrupling the number of jobs in the sector to 42m over the next three decades.

While welcoming direct spending on infrastructure as a tool for stimulating economic growth after the coronavirus crisis, Thura Ko, managing director of Myanmar-based YGA Capital, cautioned that green energy projects should still be vetted carefully to ensure they are well planned and cost-effective.

“This is particularly important if the government has had to resort to emergency sources of funding, such as borrowing, grants or even quantitative easing. Certainly, if a green energy initiative makes sense and is efficient, then the government should initiate investment there – but not all green energy initiatives are efficient,” Ko told OBG.

As governments consider the role that investment-linked to sustainable development goals could play in post-pandemic stimulus measures, recent polling data indicates that voters across emerging and developed economies are broadly supportive of a “green” economic recovery from COVID-19.

In a survey conducted by Ipsos across 14 countries in April, 65% of respondents said it was important for their government to prioritize climate change mitigation actions in their post-COVID-19 recovery strategies. The figure was as high as 81% in India and 80% in China and Mexico, and fell as low as 57% in the US, Germany and Australia.

Green commitments in the “yellow slice”

Almost all countries globally have ratified the 2015 Paris Agreement, committing them to reduce carbon emissions with the aim of ensuring that global temperatures do not rise more than 2°C above pre-industrial levels.

This includes all countries in the “yellow slice” of the global economic pie: those high-potential emerging markets that makeup Oxford Business Group’s portfolio.

The 10 countries of the ASEAN bloc are committed to collectively meeting 23% of their primary energy needs from renewable sources by 2025.

However, the transition towards renewables in South-east Asia is complicated to some extent by the region’s plentiful reserves of coal, which are viewed by some policymakers as a reliable and cost-effective option for quickly scaling up generation capacity to meet domestic power demand.

Prior to the outbreak of COVID-19, China and Japan were ready sources of finance for coal-powered energy projects in the region, but there are some indications that this is changing.

In April, two of Japan’s largest banks – Sumitomo Mitsui Banking Corporation (SMBC) and Mizuho – announced commitments to curb their financing of new coal power projects under renewed pressure from environmental groups.

Since January 2017 Mizuho, SMBC and fellow Japanese bank Mitsubishi UFJ Financial Group have accounted for 32% of direct lending to coal power plant developers, so Japanese banks’ decisions to rein in lending to the segment will create a significant gap in the financing ecosystem for such projects.

Elsewhere, GCC countries have made steady progress in adding to their renewable energy capacities, in tandem with efforts to diversify their economies away from dependence on hydrocarbons.

The UAE has been at the forefront of this transition and is now home to approximately 79% of installed solar photovoltaic capacity across the GCC’s six members. The country aims to generate 44% of its domestic power needs from renewable sources by 2050, the highest proportion in the region.

Meanwhile, 10 countries in Latin America and the Caribbean – led by Colombia – have set a regional goal of meeting at least 70% of electricity needs from renewable sources by 2030.

In Africa, where 600m people still do not have access to electricity, IRENA has proposed grid interconnections and the development of regional energy corridors as viable mechanisms for extending low-cost wind and solar energy to all countries, as well as enabling cross-border access to hydropower and geothermal energy.

Funding the transition

While climate change can be viewed as a systemic risk to the long-term development of emerging economies, it remains to be seen if governments in such countries will go beyond prior commitments to incorporate large-scale investments in green energy and infrastructure into their post-COVID-19 recovery strategies.

With business and household demand expected to remain depressed for some time after the worst health effects of the crisis subside, policymakers will be required to enact further policy measures to stimulate economic activity.

“If stimulus packages simply return countries to where they were before COVID-19, we will face the same problems tomorrow that we faced yesterday: low productivity, high pollution, and locked-in, carbon-intense economic structures,” Stéphane Hallegatte, lead economist of the World Bank’s Climate Change Group, told OBG.

“The most efficient stimulus packages will be the ones that are designed to create many jobs and support economic activity over the short term, but also get economies on track for rapid and sustainable growth post-COVID-19. Countries can use this spending to make them 21st century-ready by investing in developing the skills of their population, but also in a modern, zero-carbon infrastructure system and a healthy environment.”

If required investments can be catalyzed, green energy and infrastructure development can be particularly effective at addressing depressed demand because they can create a relatively high amount of jobs while also laying the foundations for sustainable long-term growth.

World Bank data indicates that mass transit projects, building retrofits to enhance energy efficiency and renewable energy plants are much more effective at job creation than fossil fuel projects. Looking further ahead, such projects should contribute to lower air pollution, which should simultaneously help to lower mortality rates and boost labor productivity.

Unlike the situation after the 2008-09 financial crisis, the cost of renewable energy generation is now competitive with fossil fuels, meaning fewer trade-offs between short-term pains and long-term gains when evaluating renewable energy investment decisions.

However, Hallegatte recognizes that many energy and public transport projects take a long time to prepare, and argues that they should be added to stimulus packages now – possibly by reviewing and updating existing plans – for the benefits to start being felt in six to 12 months.

He added that emerging economies could explore various avenues for financing such projects, including the state budget, offering attractive incentives to private firms and requesting support from multilateral finance institutions.

Looking further ahead, redirecting fossil fuel subsidies towards more productive and sustainable areas of the economy, as well as introducing energy or carbon taxes, could become part of the tool kit for channeling investment towards green infrastructure.

Private equity (PE) could also prove to be an effective alternative source of funding for green infrastructure projects, as many funds are now assessing new strategies for the recovery phase, but they are likely to become more discerning about where to allocate capital.

“PE funds will be even more selective and scrutinous than before. Underlying business prospects in a post-COVID-19 environment must be clear and visible. A link to sustainable development goals can add to the investment appeal – particularly in relation to an eventual exit – but this does not detract from the need for a business model to be robust and clear,” YGA Capital’s Ko told OBG.

For Ulrich Volz, director of the SOAS Centre for Sustainable Finance, emerging economies should also look at developing their domestic capital markets in order to become less reliant on foreign portfolio investment, which tends to migrate quickly towards developed market assets at the first hint of a crisis.

By doing so, they would be better placed to fund domestic investments through domestic savings, which in the past have predominantly been invested in advanced countries for relatively low returns.

“Some will claim that, in times of crisis, developing and emerging economies won’t be able to afford the ‘luxury’ of green or sustainable investments, but this is a very short-sighted view,” Volz told OBG.

“Growth that is not sustainable undermines long-term development. The COVID-19 crisis shows how risks that seem very far away and abstract can hit us with a vengeance. I would hope that sustainability risks will receive even more attention because of the current crisis.”

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This article originally appeared on oxfordbusinessgroup.com. Republished with permission.

global trade

Global Trade Talk: Reconfiguring US-China Supply Chains for a Post-Coronavirus World

Global Trade Talk is part of an ongoing series highlighting international business, trade, investment, and site location issues and opportunities. This article focuses on the conversation between Jack Perkowski, JFP Holdings Ltd., and Keith Rabin, KWR International, Inc.

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Hello Jack, how are you? It has been a long time since we last talked. Before we begin, can you tell us about your background and current activities?

After graduating from Harvard Business School, I went to work on Wall Street, joining Paine Webber, where I served for 20 years and ended up running the Investment Banking Department. I then decided to do something different for a second career and became interested in Asia. That led to a trip to Hong Kong in 1990 and my moving there in late 1991. I quickly decided within Asia, China was the key driver, and in 1992 made my first trip to the Mainland.

At that time, China’s auto market was small and fragmented. They were manufacturing about 500 thousand vehicles a year, but it was clear the country wanted to develop a large auto industry. However, foreign companies were slow to enter because volumes were too small, so to encourage investment, the government allowed foreigners to have majority ownership in automotive components companies. That is now allowed in most industries in China, but at the time, auto components were the only industry where this was permitted.

I decided to do a roll-up buying majority ownership in a dozen leading auto component companies; putting them under one umbrella; introducing new management and quality systems. To test whether this could work, I visited 100 factories in 40 cities, and concluded it was a viable strategy. I then went back to Wall Street and raised $150 million over the Christmas holidays in 1993 to fund the company. In February 1994, I founded ASIMCO Technologies, an automotive components company focused on China’s emerging auto market. A year later, we raised another $150 million. Over several years, we invested $300 million, which is a lot of money even today. In 1995, though, it was a very large sum.

ASIMCO evolved into a company with 12,000 employees, 17 factories and about a billion dollars in sales. In 2009, ASIMCO was sold to Bain Capital, and I started JFP Holdings, which helps foreign companies to determine whether there is a market in China for their product, service or technology. We also help Chinese companies to expand in overseas markets. We are very hands-on, undertaking research, and then helping our clients to effectively develop and implement their strategies and ongoing business operations.

Almost ten years ago we published an interview with you titled “Profiting from China’s Domestic Economy” concerning China’s rise over several decades to become the world’s second-largest economy. Can you talk about China’s emergence and the role it now plays in the world economy?

China’s growth has been very rapid and it became the world’s second-largest economy about the time we spoke in 2010. Its GDP was about $1.3 trillion in 2001 when it joined the World Trade Organization (WTO) – and over the past 20 years, it has grown by more than tenfold to about $14 trillion. In contrast, the US remains the world’s largest economy, at about $22 trillion.

Japan, which had been in second place, is now third, at about $5 trillion – so there is quite a drop from second to third place. Therefore, if you are a company looking for growth, China is very important. It is hard to see how in coming decades a company can maintain or build a global leadership position if it does not have a meaningful presence there. This is reflected in the Fortune 500 list, which now has as many Chinese firms included as from the US.

Per capita income in China has also risen to around $10 thousand a year. That, however, is a bit misleading, because it is an average. It includes an emerging middle and upper class of more than 500 million people, which is about 1.5 times the entire population of the US. These people largely live in major cities and are rapidly increasing their consumption. McKinsey, for example, estimated [1] last year that China delivered more than half of global growth in luxury spending between 2012 and 2018 and is expected to deliver 65% of additional spending into 2025.

This is important. US companies and policymakers need to think of China – not only in terms of manufacturing and sourcing – but also as an important driver of global growth. Therefore, while we need to address the dangers of being over-reliant on China in our supply chain, we also must remain aware of China’s growing global market share, so we can benefit and participate in a fair, constructive and competitive manner.

It is true that China’s economy is increasingly driven by consumer demand. It has also become an important source of R&D and innovation – trends that have risen dramatically since we last talked. Can you talk about this phenomenon, where China stands, and what it means to the US and companies and investors?

Unlike many who located factories in China as a way to reduce the costs of US production, I did not set up ASIMCO as an export company. Our emphasis was on becoming an important part of the local auto market. At the same time, we worked with foreign companies such as Bosch, Caterpillar, and others that sourced components in China, but viewed that as an extra revenue source and a way to ensure our factories could produce to international standards. Lowering labor costs was certainly a factor, but not the central element of our strategy, as I knew costs would rise as China developed. Toyota, for example, is a company that takes a similar view and doesn’t really embrace cost alone as a strategy. It has always wanted its suppliers to make components locally where possible so they can be close to where they are being used. That has been our approach as well.

Bottom line – to benefit from growth in China you need to be there. That is the only way to truly understand and participate. When we began, potential Chinese customers told us they would not take us seriously unless we had a factory there. That is important. The Chinese understand networks and supporting firms follow production. This leads to investment, infrastructure, and development of auxiliary industries and innovation within the supply chain. Academic institutions also respond and take steps to train engineers and others with the critical skills needed. This leads to advanced research and an ability to apply technologies and launch success stories. These make investors comfortable and provide additional benefits – which have value not only in China – but in other markets around the world.

With respect to innovation, few Americans realize how rapidly China is developing in areas including digital technologies, consumer payments, e-commerce, and services. In some areas, it is becoming more advanced than the US and we can learn from them. It is important to keep this in perspective and to balance the need to address trade issues and strengthen and safeguard our supply chain with the need to remain present and involved in this increasingly important market. This is the way we can sustain and advance growth and our global competitiveness.

At the same time, there is a legitimate concern in the US about Chinese technology. I spoke to a group of tech executives and investors in Jackson Hole last year. All they wanted to talk about was China’s development of 5G. While there are security implications if Chinese 5G equipment is installed in the US, you can’t blame China for taking steps to move up the value chain. The US also needs to upgrade our capacity and competitiveness – and our ability to develop the products, services, and supply chains that are needed moving forward.

China’s growth has heightened its political ambitions and in recent years we have seen growing tension in the South China Sea, the pursuit of the Belt and Road Initiative, control over rare earth metals, rising tariffs and trade disputes, blockage of Huawei and a generally more competitive posture than in the past. This has strained bilateral relations with the US and led to anxiety in Asia and other countries. What does this portend for China and US-China relations moving forward? Considering these developments and backlash over China with coronavirus what changes are we likely to see from China in respect to its trade and bilateral relations with other nations and multilateral institutions?

China joined the WTO in 2001 and there has since been a sharp uptick in every economic measure. Its economy has grown about ten times and the country has clearly benefitted from globalization. Meanwhile, the US and the rest of the world looked the other way as many Chinese policies and business practices during this period have been in violation of international trade practices. We have been like two ships passing in the night. No one, regardless of who was in the White House, wanted to address contentious trade, IPR, technology transfer, and other key issues.

Every year there was a state dinner or two and leaders of each country would shake hands, but important issues were never discussed in a direct, constructive way. President Trump has done this for the first time and the dynamics have changed. Up until the coronavirus, however, most of the world considered the Trade War as “Trump’s Trade War,” but the virus has caused trillions of dollars of damages throughout the world, and now many more countries will be concerned about China’s behavior. This will place more pressure on both Chinese companies and the government – and the country will have to adjust. At the same time, China’s leadership is going back to its more authoritarian roots, and no one likes that —least of all the Chinese people.

While many of China’s relationships with other countries are likely to be more confrontational going forward, I remain optimistic. At the beginning of the year, a phase one US-China trade agreement was signed. When it came out, many said the US did not get what it needed, and others said it was like the “unequal” treaties China entered with western powers in the 19th and early 20th centuries. I knew it could not be both and read through it.

Everyone has focused on the provision that says China will buy significant merchandise from the United States over the next two years, but the agreement also deals with IPR, currency manipulation, and other key issues. Most importantly, it includes an arbitration mechanism that provides for quarterly meetings between the US Trade Representative and China’s Deputy Prime Minister where issues of non-compliance are discussed and resolved. To me, this seems like a better approach than trying to take Chinese companies to court.

The real question is will the phase one deal be implemented? In my view, the economic devastation that has resulted from the coronavirus ensures that it will. The US and the Trump Administration want the purchases to go through and China wants tariffs to be lifted. So both sides are under pressure to comply. In a curious way, while our countries are at odds at the governmental level – there are real incentives to work through these important issues – which many in China also would like to see resolved. As a result, I believe the virus will help to build consensus and facilitate the implementation of the January 15th agreement.

The COVID-19 coronavirus is having a dramatic effect on global health as well as the global economy and China. What is the current situation in China? How has the virus affected its economy, and can we trust the data that is emerging? What lessons can we draw from the Chinese experience and what changes might result in respect to US-China and global economic relations and trade moving forward?

I don’t know the exact number of cases and deaths in China, and you can certainly fault their transparency and failure to alert the rest of the world. But, once China recognized the seriousness of the virus, the government imposed draconian measures within its borders that could not be applied here. For example, in the US you cannot rope off and restrict millions of people or undertake the kind of contact tracing and restrictions seen in China.

In this way, China was able to arrest the spread of the virus but nonetheless took a big hit in the first quarter. The second quarter will also not be great. China is, however, implementing stimulus measures – not the roads, bridges, and the infrastructure spending we saw after the 2008 financial crisis – but measures to increase the development of 5G and other technologies that were outlined as key industries in the country’s “Made in China 2025” plan.

As a result, China is likely to have a strong second half. The IMF predicts 1.3% annual growth in 2020. This is certainly down from the double-digit growth enjoyed over recent decades, but it is still positive. The bottom line is, while China is still practicing social distancing, imposing precautions, and incurring hardships, the country is largely back to work. We know that because we deal with businesses and factories all over China, including Hubei province where the virus originated. From what we see, the factories are close to full production. China was the first to take the hit, and it is now the first to recover. Beginning in the third quarter, we think growth will pick up and China is likely to see a V-shaped recovery.

For decades the US embraced China’s rise, and production moved there so companies could reduce costs, raise profitability, and access a new, large emerging market. That began to change with growing concerns over jobs, income inequality, and supply chain security. This sentiment accelerated as President Trump began to impose tariffs and even more now with the coronavirus. The result is more serious talk about bringing jobs and production back to the US. Is this possible and what would it mean for US companies, policymakers, and our economy?

It is definitely possible. A lot of production in the US moved to China in recent decades and the pendulum went way too far in that direction. Many jobs were lost; there was social dislocation, and the security of supply chains for a number of key products has been endangered. At the same time, while the US still possesses research and development advantages, foreign-based supply chains, industrial infrastructure, technical expertise, and networks place us at a disadvantage when it comes to implementation and development.

Much of the offshoring was motivated by the search for lower labor costs – but I think tax and regulatory issues in the US also played a role. So, while we need to address environmental concerns and keep to high standards, we must make the country more attractive if we are to bring companies back. This is particularly true in industries where there needs to be a US presence. That is something that has become even more apparent as trade and political disputes further aggravate this imbalance, and now with the coronavirus, logistics and transportation disruptions have caused inventories to run low.

We are also seeing and helping clients and companies to shift production out of China to Southeast Asia and other emerging markets. This is being done to optimize and diversify supply chains, maintain cost competitiveness, minimize tariff exposure, and to allow access to these growing markets. This is true not only for the US but also for Chinese, Japanese, Korean, European, and other firms. What considerations should companies consider as they reconfigure supply chains and their approach to international markets?

Every company needs to use this time to reexamine its supply chains to determine where they are vulnerable. If they don’t do that – they are simply not doing their job. Governments need to do that as well. If you don’t want the pharmaceutical and other critical industries and materials dependent on China or other nations, it is not enough to criticize foreign practices. You also have to provide real alternatives and incentives to bring production back here. This is true both from an inventory as well as an investor and national security standpoint.

Industries will not, however, come back to where they were in the 1970s and 1980s. The world has changed and we are now far more integrated than we were in the past, both in terms of supply and demand. While the need to address this issue has been clear for some time, US-China trade tensions and the coronavirus have accentuated the need to readjust. Until recently, companies were content to leave production in China as investments and this capacity was already in place – even though many factories were set up at an earlier time when labor costs in China were lower and conditions less developed.  Now, however, as it has become clear how dependent we are on foreign supply, there is more incentive to reevaluate. In many cases, customers, stakeholders, and investors will demand it.

Some of that production will come back to the US, but where cost remains a key determinant, much of it will go to other countries, such as those in Southeast Asia. A concern I have, however, is these countries are so much smaller than China there is a limit to how much production can be shifted there. There is also less opportunity to sell into the local market. Depending on the industry and location, infrastructure and services may also be lacking.

For example, in China, about 25 million vehicles are now manufactured annually, and there has been substantial investment into forging, casting, and other needed functions. These are expensive operations that are hard to replicate. At the same time, Southeast Asia is relatively close, and we are seeing interest from both foreign and Chinese companies to move at least part of their operations there. Because they offer an opportunity to diversify, countries like Vietnam are benefitting from the shift. Other Southeast Asian countries also provide benefits and need to be examined.

A major obstacle in moving jobs and production back to the US is the need to rebuild and upgrade infrastructure as well as our educational, immigration, and healthcare systems to provide the skills and environment needed to allow the transformation that must unfold. What steps need be taken by the US, state, and local governments if we are to rebuild our manufacturing capacity and to both repatriate production that moved offshore and new trade and investment back to the US?

We definitely have the ability to compete. We need to rebuild parts of our economy, but the cost and scope of a large national infrastructure program will be huge and complex, as is education, immigration, and healthcare reform. I believe, however, these goals will be achieved over time.

We also possess many advantages. For example, we are now an energy exporter and able to supply ourselves at low relative costs. Our universities and capital markets also provide strength.  The largest obstacle I see is the need to reduce regulation and institute favorable tax policies.  Addressing the devastating impact of the coronavirus on small businesses, which employ the vast majority of our population, is also now a major, if not our most important, priority. We need to get these people back to work ASAP.

Over the years, we have worked for many economic development agencies as well as private developers to facilitate their efforts to attract trade, investment, and business activity within a range of sectors. Drawing from your experience, what advice can you give to US companies and economic development agencies seeking to attract foreign trade and investment and business partners to enhance their businesses, local economies, and international competitiveness.

There are certain things economic development agencies can do tax-wise to provide incentives and create a welcoming business environment. At the same time, it is especially important to clearly and effectively position themselves to demonstrate competitive advantage and why their cities or states are attractive destinations, while also demonstrating their support for companies who relocate there.

When you travel around China, as we did when we arrived, local authorities roll out the red carpet. They make you feel wanted and have an interest in supporting your development. In contrast, I recently accompanied a Chinese manufacturer to a US Midwestern State as they contemplated setting up a facility there. One of their requests was to meet with local officials. The company we were working with was at first unsure who to meet with but eventually set up a meeting.

The officials were very nice, but it was clear this was unusual and they were not accustomed to meeting foreign companies. They were unsure of what they could contribute and did not seem to understand why they were there. In China, local governments are much more determined and willing to play an active role in wooing investment. In a sense, they try to be partners with businesses that base within their jurisdictions. That seems almost a foreign concept here.

As a result, US companies and economic development agencies should be more active and aggressive – to reduce barriers, provide incentives, and demonstrate an interest in attracting businesses that want to base in their city or state. They also need to demonstrate clear reasons as to the benefits of the location – so decisions are based more on value than on cost alone.

Thank you Jack for your time and attention. Look forward to following up soon.

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Keith Rabin serves as President at KWR International, Inc., a consulting firm specializing in international market entry, site location and trade, business, investment and economic development; as well as research and public relations/ public affairs services for a wide range of corporate and government clients.

[1] https://www.mckinsey.com/~/media/McKinsey/Featured%20Insights/China/How%20young%20Chinese%20consumers%20are%20reshaping%20global%20luxury/McKinsey-China-luxury-report-2019-How-young-Chinese-consumers-are-reshaping-global-luxury.ashx
baltic

The Silver Lining of the Baltic Banking Crisis

The continuing revelations as to the extent of money laundered through Baltic banking systems, most notably the dramatic accusations against Danske Bank (which are now pulling in Deutsche Bank as well) were an unfortunate blow to the Baltic states’ reputations as dynamic and safe markets for foreign investments in Europe. However, substantial media scrutiny and the public and private sector response may actually result in a safer financial environment for investments and business operations in Estonia, Latvia and Lithuania as well as an improved EU structure to deal with money-laundering.

A Series of Money-Laundering Failures brings Global Scrutiny to the Baltics

Danske Bank, the headlining financial institution at the heart of the massive $280 billion money-laundering investigation, has already pulled out of Russia and the Baltic States as a result of its misadventures in the region. Other banks, however, were also caught laundering funds from Russian, Ukrainian, Chinese and North Korean sources in the last few years, including Swedbank.  Although the majority of the scandal has been laid at the feet of Estonian and Latvian banks and financial oversight bodies, Lithuania has not survived unscathed and ongoing investigations will likely expose additional breaches in finance laws and EU and U.S. sanctions regimes.

While the scandal has put a dent into the business reputation of Estonia and Latvia, the resulting scrutiny and investigations are likely to improve transparency in the region and improve legal regimes and oversight structures for international business operations moving forward.  The heightened focus on anti-money laundering (AML) tools has also spurred tech innovation, leading to the creation of critical private-sector expertise to help consumers and businesses identify and fight money-laundering activities.

Exposing the Weakness in EU Mechanisms

The scandal exposed not just national-level problems, it highlighted an EU-wide gap in AML mechanisms. The decentralized nature of AML regulation and the lack of coordination amongst country regulators and oversight bodies across the EU provides opportunities for abuse. Lack of formal channels of communication, inter-agency / regulator dialogue and cooperation weakens the overall ability of any one country to effectively share information, pool resources and fight trans-national financial criminal activity.

Additionally, integral to the EU’s current challenges has been the deficiency in adoption vs. implementation. Larger EU states such as France and Germany traditionally maintain sufficient financial and human resources to not only transpose EU AML Directives into local legislation, but to ensure effective implementation. Scarcity of expertise, limited capacity and shortfalls in funding among smaller states such as Cyprus, the Baltic states and Malta, on the other hand, have hindered the effectiveness of resulting oversight processes and procedures to reduce money laundering. There is a growing recognition as to this weakness in the system, and a recent joint proposal from finance ministers of France, Germany, Italy, Latvia, the Netherlands, and Spain to create a centralized anti–money laundering (AML) supervisor with EU-wide authority may help to close this gap.

Finally, the anonymous nature of cryptocurrency and digital assets have made them attractive to illicit users interested in perpetrating money laundering and terrorism financing. Their use in recent cases has exposed the need throughout the EU for further innovations in their regulation and oversight to ensure transparency, accountability and legality of digital asset transactions.

In response to these challenges, the EU has adopted the 5th Anti-Money Laundering Directive which is required to be transposed into local law by Member States by January 2020. Although transposition into local law is required by January 2020, the key to determining the success of this legislation will be dependent upon the resources and ability to implement. Strong centralized technical support, human and financial resources should be provided – especially to smaller Member States – as they work to locally adopt and transform these concepts into practice.

The Revelations have Spurred Innovation

Concerns over money laundering have forced the government to take action (albeit rearguard in nature) but have also sparked concern from the business community, which is equally concerned about the stability of the national and regional financial system. Taavi Tamkivi, CEO of Salv, the Estonian AML-focused start-up funded by Transferwise and Skype employees, noted that although the incidence of such AML cases in Estonia is disappointing, the fact that they were brought to light speaks to the Estonian commitment to transparency, accountability, and responsibility. Recent scandals have brought into the open the weaknesses in the Estonian system and instead of hiding these scandals or shirking responsibility, the Estonian government, regulators and private sector have come together to learn from these investigations, strengthen their systems and develop world-class systems of AML. Tamkivi went on to note that Know Your Customer (KYC) efforts and risk profiling of new clients are important but must be coupled with monitoring the millions of transactions flowing through financial institutions every day for suspicious behavior.

Additionally, data sharing between and amongst banks and the government is needed to ensure comprehensive understanding and communication of suspected criminal activity. The only way to undertake such intensive oversight is through innovations in technology. Tamkivi noted that “Estonia is known for its e-residency and digital-centric culture, so I’m confident we can find smarter ways to share and use the data we all have; protecting individuals, but catching more criminals. With the right technology, we can really solve it.  Moving fast is the only way to keep up with the innovative organized criminals moving millions or billions around the world.”

Tamkivi went on to share an important aspect of the Baltic business environment which highlights the resiliency and affinity for innovation: “You can think of the Baltics nations, in many ways, as country-sized startups. We witnessed the mistakes and pitfalls of long-established nations from afar and, when we gained re-independence in the early 90s, we were able to start afresh. So, if you take a close look, you’ll find a dense web of fresh ideas and innovation woven into our structures. Sometimes, like Skype, TransferWise, and Bolt they do manage to kick off a profound change in the world.”

The Baltic Region Represents some of the Best Locations for Business Expansion in Europe

The innovative atmosphere that gave rise to tech companies such as Skype and Transferwise, vaulted Vilnius into the position of number one startup city for tech in the world, helped to launch the NATO Cooperative Cyber Defence Centre of Excellence and has all three countries listed in the top 20 for innovation globally by the World Bank Group is an astounding opportunity for foreign investors.  But the technology sector is not the only attraction to the Baltic economies.

According to the World Bank Group “Doing Business” assessment of jurisdictions, Lithuania, Estonia and Latvia rank 11th,  18th, and 19th respectively and all three rank highly on global lists for innovation, safety and quality of life.  The business-friendly nature of the Baltic countries coupled with their attractive cost of living provide a natural advantage in attracting a wide variety of global businesses. In 2018, Lithuania, Estonia and Latvia each outperformed the estimated EU hourly labor costs for the EU-28.

Closing the Gaps in the System

Estonia, Latvia, and Lithuania need to take quick and decisive action to prevent money-laundering in the future, as does the EU, which is facing similar problems in banking systems in Malta, Cyprus and other member states.  But while the Danske Bank scandal is a black mark on the region, a robust response to these concerns by governments and innovative private companies such as Salv and others will ensure that the thriving Baltic market becomes an even more attractive location for foreign investment projects by reducing investor exposure and political risk concerns.  As Taavi notes ‘…though many of the recent negative headlines came from Estonia, that may not necessarily be as bad as it first appears. Everyday Estonians are notorious for their commitment to transparency, and taking responsibility for mistakes. And, honestly, now that scandals are out in the open, we can all learn from the investigations. I wouldn’t even be surprised if, as a result, Estonia then grows some of the greatest AML experts in the region.”

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Gabriella Kusz, CPA is an international economic and financial sector development expert with experience in the areas of financial sector strengthening, governance, and regulation.  Ms. Kusz has held senior-level positions at the World Bank Group as well as with the International Federation of Accountants. 

Kirk Samson is the owner of Samson Atlantic LLC, a Chicago-based international business consulting company which offers market research, political risk assessment, and international negotiations assistance.  Mr. Samson is a former U.S. diplomat and international law advisor.