Why local laws cannot be ignored by investors

At some point over the course of David Michaels’ tenure as administrator of the US Occupational Safety and Health Administration (OSHA) he came to the unfortunate conclusion that some Asian firms that had set up operations in the US – usually suppliers to automobile manufacturers – did not place much importance on worker safety or, for that matter, the regulatory requirements of the executive office he headed. “It was pretty bad,” he remembers. “The workers suffered amputations, basic safety procedures were not being followed.”

So Mr Michaels, now a professor at George Washington University in Washington, DC, decided to take his concerns to the very top. During a trip to Asia he requested appointments with top-level executives at the automobile manufacturers that these suppliers serviced.

“I explained we were seeing significant safety issues not in their assembly plants but in their tier-one suppliers’ plants. I said they have a responsibility to ensure that work was done safely. I told them if something terrible were to happen to one of the workers, it would bring shame to their companies,” he says.

Perhaps there was a translation error or perhaps the executives at the companies were not accustomed to taking responsibility for their suppliers’ workplaces. Either way, nothing changed.

The biggest challenge

Adhering to local regulations is a key element of direct investment. And while Mr Michaels’ experience is not necessarily typical – most companies want to comply, but trip up on the complexity of lower level regulations – it does illustrate the risks involved. There is the possibility of reputational damage, the unwelcome scrutiny of a regulator, a visit not just to your boss but your boss’ boss, and even fines, although these are usually the least of a company’s concerns.

In addition, it can be surprisingly easy to run afoul of local laws.

“Regulatory risk is one of the biggest if not the biggest challenge to FDI and that risk is more prevalent now than ever before,” says Rob Ginsburg, president of consultancy RBG Global.

That risk is perhaps best described as the forgotten side of FDI. Almost all such investment is driven by a strategic imperative: the market is good, the product is ripe for it, the local workforce is highly skilled, the customer base is lucrative, and so on.

Local customs, complex rules

Surprisingly few companies pay local regulations much attention when they make the decision to invest, says Henry Reynolds, accounting and tax portfolio director for global business services provider TMF Group.

Sometimes a company simply ends up in a foreign locale, he adds, saying: “You can find yourself in a foreign country via a merger or acquisition. Perhaps the acquired company had a legacy unit in, say, Turkey or Kazakhstan, and now you have to be familiar with those rules.”

Depending on the market, those rules could be numerous. Turkey, for example, is number one in TMF’s 2017 Financial Complexity Index, which ranks the world’s countries in order of the complexity of their accounting and tax regulations.

There is not one particular rule or regulation that took Turkey to the top. Rather, it was an accumulation of many smaller rules that as a whole can easily trip up a foreign company, according to Mr Reynolds.

There is the language and the complex tax environment, although Mr Reynolds notes that Turkey is in the process of making changes to its regime. Then there are the controls on foreign payments and capital. “On their own these are not cataclysmic rules, but they add up to a compliance minefield,” he says.

Help or hindrance?

Turkey is hardly alone with its strict requirements. In Bolivia, for example, transferring funds out of the country can be very expensive. “Any currency transfer they view as being 50% profit, so they levy a 25% tax on it,” says Mr Reynolds.

Sometimes it is not so much the regulations in place but the attitude of the regulators that make FDI difficult. In the UK, for example, a company can approach the tax authorities for guidance if it is not sure about something. Chile and Peru, by contrast, are examples of countries with tax authorities that are not typically open to offering guidance. At the far end of the spectrum are those countries that will investigate off the back of transactions, such as Thailand, which will inspect when a company requests a tax refund, Mr Reynolds says.

Sometimes a company makes a misstep due to a cultural misunderstanding. One example is a situation when it is appropriate to give a gift in one culture, which could be considered an attempt at bribery in another, according to Rick David, chief operating officer of UHY Advisors, a US professional services firm that has member companies in some 99 countries. “Proper training is key, of course,” he says.

When the environment changes

These missteps can be made worse when a country’s regulatory regime is undergoing a shift, as is happening in the US right now. President Donald Trump’s approach to business and safety regulations is drastically different from that of the previous Obama administration. At the same time, however, most Obama-era regulations are still in place.

“The tone is changing but these standards are still on books, so companies, especially foreign companies, are getting mixed messages about what they can and cannot do,” says Jordan Barab, a consultant and former deputy assistant secretary for OSHA. “It can take years to issue and repeal a standard. Enforcement is another matter though – it is fairly easy to effect change that way.”

After Mr Trump took office, OSHA stopped issuing press releases about the fines it was levying against companies for violations.

Frustrated when the information went dark, Mr Barab began publishing it himself – he knew how to find it in OSHA’s public records – as a private citizen on his blog. “That information is important,” he says. “It sends a message to US and foreign companies that these rules are still in place and need to be followed.”