Political risk…, a dramatically shifting perception surging through the corporate world!

Today's article turns the spotlight on political risk as THE rising star of corporate facing risks in today’s global trade environment, and looks at what businesses with an international footprint can do to navigate it.

by Evelyne Legaux on 14-09-2023

 

Truth is up until 2022, political risk was barely discussed in corporate boards meetings because considered a low-probability evil by many global businesses. The ongoing war in Ukraine however dramatically changed that perception, thus bringing political risk and its potentially devastating impact to business operations & finances to the fore.

 

Why such a sudden shift? And how broad is that shift?

Historically, political risk has been compared to that of natural disasters, that is a type of risk that is highly unlikely to materialise but severely damaging whenever it does happen. This is the reason why Credit insurance products used to typically treat political risk as a catastrophe risk in essence.

In 2022 however, the unexpected irruption of a military conflict in Europe triggered a powerful shock. The war suddenly became part of our advanced economies’ reality again & forced many businesses to cease operations & trade in Russia, Belarus and even Ukraine itself, either due to international sanctions, difficulty to generate Cash Flow or else new operational risks, thus resulting in a significantly negative financial impact.

But the shift caused by the war in Ukraine breaking out as the world was dealing with the aftermath of the global pandemic crisis, was actually much broader than just exiting a specific geography, whether voluntarily or not. Instead, the conflict triggered a cohort of other challenges for businesses including an exacerbated geostrategic competition between the US & China and unprecedented energy & food crisis mostly in Europe & Africa respectively, to name a few… Crucially, it also changed the way business leaders used to perceive the vital relationship between the world’s two largest economies.

As a direct consequence over the past year, a significant number of businesses were faced with an actual political risk loss – related to currency transfer, political violence, sanctions, sovereign default, etc… - &/or had to suddenly enhance their understanding of political risk and management capabilities thereof, which represented a significant change compared to previous years. Interestingly, those losses occurred not only in Russia, Belarus & the usual high-risk countries but also in China, the BRICs, the US & the UK… and across most sectors.

 

Looking ahead

The horizon unfortunately is not looking particularly rosy nor serein from a political risk perspective, with a geopolitical sky expected to darken instead. Businesses must therefore prepare to operate in an increasingly hostile world bringing more disruption, fast-changing trading conditions & the emergence of new risks.

To illustrate this, let’s have a look at what the near future has in store:

• the risk of escalation of the war in Ukraine, along with its cohort of international sanctions and impact on energy & food prices, remains a real worrying possibility 18 months into the conflict. In addition, domestic political instability in Russia is creating more uncertainty as to the likely trajectory of the war and its impact on global energy & food prices,
• deglobalization & decoupling from China has now become a priority for many, but equally a growing risk for other countries & businesses of being collateral damage in the trade war & geostrategic competition between the world’s two largest economies. Also worth mentioning is China’s economic slowdown driven by internal structural problems such as a shrinking workforce or a tense real estate market, not to forget the impact of US restrictions on the transfer of sensitive technologies to the country, that will have a damaging ripple effect across the whole world,
• shifting geopolitical alignments in emerging countries exacerbated by the conflict in Ukraine, and springing military coups in Africa,
• the risk of another regional military conflict breaking out in Taiwan, with a potentially devastating impact on global supply chains,
• state-sponsored cyber-attacks or industrial espionage as politically-motivated retaliation measures,
• state regulation of targeted markets to drive the creation of new global standards or manipulation of those markets, can force companies to globally comply with what are regional rules thus increasing operational costs,
• an elevated risk of collusion between national security interests & economic protectionism through state-imposed trade bans in specific sectors,
• climate change & the current El Nino cycle expected to trigger extreme weather events  causing droughts, floods, wildfires & landslides. Such events have the potential to disrupt business operations, supply chains & human resources, cause social unrest & trigger potentially detrimental public policy changes in affected geographies.
• last but not least, the realisation that advanced economies are no longer political risk free & report record public debt levels post-pandemic. Political uncertainty in the US combined with a loss of confidence in American institutions, and the rise of populism, anti-establishment movements or social unrest in Europe or elsewhere are only testimony to that.

The recent shift of geopolitical risk from emerging to advanced economies & the sudden realization that war has become our reality again, have fostered the need for businesses to put the management of political risk at the core of business strategy.

 

So, what can corporates do to mitigate political risk?

While this is a complex & volatile topic by nature, there is a range of actions that corporates can take to mitigate its impact.

• First, creating a culture of understanding & awareness of political risk throughout the business organization is a must to help employees identify & foresee newly emerging risks. Companies should share information internally & encourage regular cross-functional discussion groups around specific topics of concern.
• Such discussion forums should then lead to mapping the main operational & geographical risk areas and to conducting scenario-based analysis so as to prepare for what might happen in this most unpredictable world & how best to respond to it.
• An even better approach though would be for companies to proactively anticipate the materialisation of risks, prioritise those risks, adjust their operating model &/or business processes to mitigate their respective impact & possibly set up risk response teams.
• Going further, companies should consider adopting a policy of risk transfer by purchasing political risk insurance which also helps strengthen long term business resilience although at a cost, or else use financial hedging products where relevant.

Whatever course of action companies might take, it’s all about building adequate capabilities to identify & mitigate risk, bringing expertise in-house and placing political risk at the heart of Enterprise Risk Management strategy.

 

Are Credit insurance carriers helping?

As more & more companies now opt for political risk transfer solutions, key is for companies to understand where the insurance market is at in terms of risk appetite, coverage capacity & premium levels.

The good news is that, despite a significant rise in claims submissions & losses incurred by  insurers in 2022, insurance capacity appeared to have substantially increased, including for long tenors, as a combined result of bigger line sizes offered by existing players in the market & new ones entering it. This is testimony to the ongoing strength & resilience of the overall Credit insurance market.

Interestingly, in 2022 the demand for insurance cover appears to have been the strongest in advanced economies with the US & UK ranking on top, a trend that resonates with the rise of populism, political instability, social unrest & sovereign debt levels in the Western world. As far as industry, the public sector ranked second behind financial services and was closely followed by the energy & commodities sectors.

Although higher than in 2021, claims levels remained much lower than the previous 10 year average, partly thanks to the multitude of pandemic related governmental support schemes. This said, losses related to sovereign payment defaults represented a majority of losses incurred not only in certain African markets but increasingly in Russia or Belarus, a trend that is set to continue into 2023 & 2024…

 

Understanding & taking action to identify, prioritise & mitigate political risk is critical for internationally trading businesses to anticipate & minimize its potentially devastating impact. Whenever going for a risk transfer solution, companies should work with their broker to avail of insurance cover where still available.

 

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