Jurisdiction Risk

Jurisdiction risk is the additional risk that arises from operating, investing, lending, or borrowing in a foreign country or legal jurisdiction. It encompasses legal, regulatory, political, and economic factors that can affect transactions or asset values when they fall under the laws or controls of another country.

Key takeaways

• Jurisdiction risk arises from exposure to foreign legal, regulatory, political, or economic conditions.
• Political changes, unstable governance, or sudden law changes can sharply affect investment returns.
• Financial institutions and investors monitor international lists (such as those from the Financial Action Task Force) to identify jurisdictions with weak anti–money laundering and counter‑terrorist financing controls.
• Common mitigations include compliance controls, monitoring risk lists, and financial hedging (for currency exposure).

How jurisdiction risk works

When a business or investor has exposure to another country, unexpected changes — for example, new regulations, nationalization, sanctions, or court rulings — can reduce asset values, restrict operations, or create legal liabilities. Increased uncertainty typically raises volatility; investors generally demand higher expected returns to compensate for that added risk.

Political risk is a major subset of jurisdiction risk. It refers to loss or underperformance caused by political events such as changes in government, legislative shifts, civil unrest, expropriation, or military actions.

Other common manifestations:
* Legal and contractual enforcement risks (difficulty enforcing contracts or obtaining remedy in local courts).
Currency and foreign exchange risk (value changes from exchange‑rate movements).
Geopolitical and sanction risks (trade restrictions, asset freezes).
* Compliance and reputational risk (involvement with jurisdictions linked to money laundering or corruption).

Special considerations: AML/CFT and high‑risk jurisdictions

Jurisdiction risk increasingly focuses on anti–money laundering (AML) and counter‑financing of terrorism (CFT) weaknesses. International bodies such as the Financial Action Task Force (FATF) publish lists and reports that identify jurisdictions with deficiencies in AML/CFT controls. Regulators and financial institutions use these lists to prioritize due diligence, apply enhanced monitoring, or impose restrictions.

The FATF also identifies a small number of jurisdictions that pose a heightened risk to the international financial system and, in extreme cases, places them on a “call for action” (e.g., past listings have included North Korea and Iran). Since jurisdictions and FATF assessments change over time, organizations should consult the latest FATF and national guidance when evaluating risk.

Examples and mitigation strategies

Examples:
* Currency exposure: An investment denominated in a foreign currency can lose value in domestic‑currency terms if the exchange rate moves unfavorably.
Regulatory change: A government may change tax, licensing, or foreign‑ownership rules affecting an existing investment.
AML/CFT exposure: Doing business in or through a jurisdiction with weak controls can expose institutions to fines and reputational damage.

Mitigation techniques:
* Conduct enhanced due diligence and ongoing monitoring for counterparties and jurisdictions identified as high risk.
Follow regulator and international‑body guidance (e.g., FATF advisories, national treasury or financial regulator notices).
Use financial hedges for currency risk (forward contracts, options).
Implement robust compliance programs, transaction monitoring, and sanctions screening.
Limit or avoid exposure in jurisdictions with unacceptable legal or political risk.

References

Organizations and sources commonly used for assessing jurisdiction risk:
* Financial Action Task Force (FATF) — high‑risk and monitored jurisdiction lists and guidance.
Financial Crimes Enforcement Network (FinCEN).
U.S. Department of the Treasury and other national financial regulators.