Businesses investing in new states face ‘collateral damage’

By Jeremy Woolfe

Date: 20/055/04

EU BUSINESSES investing in the new member states have been warned by one of Europe's leading accountants: doing business there could seriously harm your balance sheet.

That is the message from Paul Rutteman, secretary-general of the European Financial Reporting Advisory Group - an industry body that helps the European Commission vet accounting rules.

Rutteman, a former partner with Ernst&Young, told European Voice that listed companies in new member states are well up to speed when it comes to applying good quality accounting standards - meaning investors can be as sure as possible that no nasty surprises lurk in the books.

However, the Dutchman warns that the problems start to stack up when companies need to assert ownership of the collateral put up by their business partners in central Europe.

Collateral is often needed when the partner in the new country is required to share the investment risk. The surety represents a solid value 'caution' that can be called in by the major investor if things do not work out as planned. Generally, collateral consists either of buildings or shares.

But Rutteman said investors need to cast a dubious eye on both categories, adding that he has first-hand experience of problems in the Czech market.

A lack of experience in local courts can make it a nightmare for foreign investors to assert their ownership on property - often deemed a 'safe risk'.

A wait of two years plus for a court hearing - typical in many cases - makes it hard to solve disputes. Moreover, problems abound regarding the true value of property. Rutteman said the key problem regarding shares as collateral is a lack of liquid markets. That means there may not be a ready buyer for stocks - which makes it difficult to know their true value and, even harder, to cash them in.

"That is, what was the value of stock when the volume of transactions on the market turns out to be very low? Six months without trade was not uncommon for some stocks for some of these countries," he said.

Industrialists in western Europe and elsewhere have viewed EU enlargement as a chance to tap huge potential markets.

However, investment flows into the new countries via local banks can sometimes be a danger, he said.

"Dominant" local bank directors have been known to "divert funds", he warned, adding: "You don't have the same governance as you would elsewhere."

As a result of these factors, investment flows taking place are often via international blue-chip firms. An example is Hyundai's new car plant planned for Slovakia. Indirect investment tended to come from Austrian banks and from countries physically close to the market.

At the European Banking Federation, Elmars Kronbergs agrees that general collateral problems may "arise from time to time".

Ralf Rössing, a German development economist, said Romania, which hopes to join the Union in 2007, is one of the worst offenders. He said office buildings in Bucharest and shares in the best listed companies could now make for "satisfactory collateral", but industrial building in the regions would need a "super-cautious approach".

• Jeremy Woolfe is a Brussels-based freelance reporter.

Paul Rutteman, Secretary-General of the European Financial Reporting Advisory Group, has warned that a lack of experience in local courts can make life difficult for foreign investors to assert their ownership on property in new Member States.