Jurisdiction Risk

What Is Jurisdiction Risk?

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

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

How Jurisdiction Risk Works

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

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

As mentioned above, jurisdiction risk has recently become synonymous with countries where money laundering and terrorist activities are high. These activities are generally believed to be prevalent in countries that are designated as non-cooperative by the Financial Action Task Force (FATF) or are identified by the U.S. Treasury as requiring special measures due to concerns about money laundering or corruption. Because of the punitive fines and penalties that can be levied against a financial institution that is involved—even inadvertently—in money laundering or financing terrorism, most organizations have specific processes to assess and mitigate jurisdiction risk.

Special Considerations

The FATF publishes two documents publicly three times a year and has done so since 2000. These reports identify areas of the world that the FATF declares have weak efforts to combat both money laundering and terrorist financing. These countries are called Non-Cooperative Countries or Territories (NCCTs).

As of June 2021, the FATF listed the following 22 countries as monitored jurisdictions: 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 NCCTs have deficiencies when it comes to placing anti-money laundering policies, as well as recognizing and fighting terrorist financing. But they have all committed to working with the FATF to address the deficiencies.

The FATF placed both 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 because of its lack of commitment and deficiencies in the noted areas. The FATF also indicated its concern over the country's proliferation of weapons of mass destruction. The organization noted Iran outlined its commitment to the FATF but has failed to enact its plan.

Examples of Jurisdiction Risk

Investors may experience jurisdiction risk in the form of foreign exchange risk (also known as currency risk). So, an international financial transaction may be subject to fluctuations in currency exchange. This can lead to a drop in the value of an investment. Foreign exchange risks can be mitigated by using hedging strategies including options and forward contracts.