Political risk Awareness at the heart of ERM strategy

Take a dive into geopolitical forces at play behind the scenes

by Evelyne Legaux on 12-12-2024

 

This article aims at emphasizing the profound underlying changes currently at play in the geopolitical sphere and the latest key developments, along with elevating the profile of political risk and related losses for international corporates.

 

From a geopolitical standpoint, the world as we know it today no longer resembles the world we took for granted over the past 75 years or so, and more specifically since the end of the Cold War. International institutions such as the UN, the WTO, the IMF or the World Bank – originally created as a mechanism to regulate global trade, protect peace and encourage democracy as THE political model to aspire to across the globe - are now being challenged with regards to their effectiveness, relevance & governance framework on the backdrop of military coups & conflicts or else rising populism & extremism.

 

Awakening to the prominence of Political risk
In such a global context, business leaders cannot just passively watch what’s unfolding around the planet like they would watch a fiction movie, thus ignoring its multifaceted impact. Instead, the current geopolitical developments must be understood for what they truly are, purposefully managed and embedded at the heart of Enterprise Risk Management strategy.
The good news is that, since 2023 and as the war in Ukraine escalates, political risk awareness has been making significant headways in the corporate world, a formerly distant problem now becoming a compelling concern. In fact, the number of internationally trading companies experiencing political risk losses has been soaring over that period, and this type of loss has now become a tangible corporate management reality.
In addition, awareness of the many different types of political risk losses such as political violence & social unrest, currency inconvertibility, expropriations, international sanctions, trade embargo and equally geostrategic competition, economic nationalism or populist policies, is also growing within business organisations.
Together with awareness, also comes the realisation by corporate leaders that political risk management skills & capabilities are more important today than ever before.

 

A Volatile geopolitical Landscape
Political risk today is not limited to Russia, the Middle-East, the Taiwan Strait or South-East Asia but has also spread over Europe & the US, with an ever-increasing volatility. 
Truth is the stable international rules-based order as we knew it is being constantly & deeply threatened from various directions, with new regimes sliding towards authoritarianism such as in Georgia, meddling into democratic countries elections such as in Romania, the return of extremist populism in the US, the rise of far-right movements across Western Europe, renewed threats to critical energy & other infrastructure or the opportunistic resurgence of civil war in Syria.

So, what next?

Ukraine conflict escalation
The war in Ukraine remains the #1 concern today, first because its wide ramifications into the energy market, core inflation & global supply chain disruptions have triggered the largest political risk losses for corporates, but also because recent political & military developments now risk destabilizing neighbouring countries and internationalizing the conflict, and represent no less than an existential threat to parts of the world. Let alone the growing tragic human cost involved, obviously…

Middle-East escalation
Recent developments in the region are increasingly concerning, with the Israel-Gaza conflict spreading to Lebanon, triggering direct attacks between Iran & Israel and on to shipping vessels in the Red Sea, Iran actively advancing its nuclear programme further and now the surprise resurgence of Syria’s civil war & lightning fall of the regime after several years of status quo. A mitigating aspect to the risks involved here though is that corporates have significantly less substantial economic interests in that region.
Given the present fluidity of the situation however, any further regional escalation would risk destabilizing the oil market and further disrupting global supply chains & shipping costs, ultimately severely impacting the global economy.

Rising tensions in Asia
The ongoing US-China tensions over Taiwan & the South China Sea along with the dormant conflict on the Korean Peninsula, the political instability in Pakistan & the geostrategic competition between China & India represent yet another ongoing threat to peace that could materialize in the blink of an eye, with devastating consequences not just for global trade & the economy, but most importantly for humanity as a whole.

Trump’s re-election in the US
With Donald Trump poised to return to the White House next month, economic nationalism & trade wars with China, Europe, bordering Canada & Mexico & other regions, a populist stance with respect to migration & minorities, a drastic overhaul of US economic, social & environmental policies, withdrawal from NATO & the Paris Agreement and uncertainty about any future support to Ukraine, are all widely anticipated, thus greatly straining US relations with other key regions/countries and causing further headaches for global corporate leaders. 

The ’in-between’ flourishing forms of political violence
A concerning new trend is indeed that of hostile political aggression that uses the space between peace & war to interfere, disrupt or influence a country’s internal affairs with destabilization as the ultimate purpose. This subtle type of political violence may manifest itself as interfering with another country’s national elections process, damaging their critical infrastructure, carrying out industrial espionage, influencing their political leaders to backslide from democracy & other Western values, fomenting protests, launching cyber-attacks, etc… Because covert in nature & usually conducted by non-state actors, such political violence has so far proven difficult to investigate and address effectively, while potentially causing significant damage to public institutions & businesses alike.

 

Growing geostrategic competition, or the advent of a new world order…
A key concern for many is the ongoing US-China power rivalry, with the US trying to retain its historical dominance and China becoming an increasingly credible alternative to the  international rules-based order that was overwhelmingly created & financed by the West post WWII. Any exacerbation of the competition between the two largest super-powers could have important repercussions on global companies with operations in / trading with China and conversely on the Chinese ones present on the US market, that would likely be caught up in a damaging tariffs / counter-tariffs cycle and face other restrictions.

Most worrying though is the fact that any vacuum arising from weakening international institutions & democratic backsliding in the West, will promptly be filled by other major geopolitical actors such as the BRICS countries with active support from others.

In actual facts, a major strategic rapprochement is already at play between Russia & Iran along the shores of the Caspian Sea, with an immediate goal to build a 162Km long railway line linking a large city in the north of Iran to the Azerbaijan/Iran border, that would ultimately give Russia a privileged & much shorter trade access to the Arabo-Persic Gulf & the Indian Ocean instead of having Russian ships sail along the Atlantic seaboard, cross the Mediterranean Sea then take the Suez Canal before eventually reaching the Red Sea. This project is part of a wider initiative aimed at linking Russia to India via Azerbaijan & the southern Iranian seaports, as Russian exports to the Gulf region, India & further afield in Asia critically soar. 

While this short railway line might seem anecdotal at first glance, this project is actually central to Russia’s strategic attempt to overcome the present flurry of Western sanctions. Most importantly though, it is at the heart of Russia’s efforts to create a new international order centred on the BRICS countries - joined by Egypt, the UAE, Ethiopia & Iran – and aiming to become the Global South alternative to the Western-dominated G7. Underlining the project’s strategic importance if needs be, Russia appears willing to finance the needed railway infrastructure works by way of a state-loan to economically-troubled Iran…

 

The compelling need to manage political risk
As Western values, democracy as a political model & the global rules-based order decline on the world scene, military coups multiply in Africa & Southeast Asia or else unexpected political turmoil in South-Korea, all combining to cause further instability, what will happen to the core principles of international peace, free trade, free democratic elections or human rights that used to be at the core of most countries’ institutions & regulatory systems?

While the governance of international institutions needs to be reformed to better reflect today’s global economic & political landscape and be more effective, if countries around the planet increasingly move away from those Western values & rules, what will the implications for corporates be? And how can such multiform & multidimensional political risk be best managed?

These are crucial questions for business leaders to strategically address on the eve of 2025…

• Global trade has already been challenged during the pandemic, and lead to increasingly protectionist policy-making across the planet and deglobalization of operations & supply chains. A key implication will therefore undoubtedly be the dynamic & potentially costly further re-design of those global supply chains, as the volatile geopolitical landscape keeps evolving.
• The need to relocate large scale operations from one country or part of the world to another will also continue to be on the corporate agenda, despite being more challenging.
• Investing in skills & capabilities to understand, manage & mitigate geopolitical risk is a definite MUST as an unstable geopolitical landscape & new types of losses become the norm.
• Appointing a Chief Risk Officer to lead a cross-functional team of risk-experts whose role would be to proactively identify new risks, monitor same and use scenario-planning methodologies to inform management decision-making, comes highly recommended.
• Putting political risk at the core of Enterprise Risk Management strategy has now become a necessity.
• Finally, keeping risk transfer techniques in mind through evolving insurance products & market players, may also add value to the overall approach to political risk.

 

While we do not have all the answers nor a crystal ball, the purpose of this article is to share some thoughts and help raise awareness of how deeply the world is changing. While the West experiences a shift to the political right and greater focus is placed by many countries on security, strategic autonomy & other matters of national interest, are we collectively experiencing the end of an era? 
Whatever the answer is, awareness, anticipation & intentional management are the keys for corporate leaders to successfully navigate the intricacies of political risk and minimize business impact.

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