Scanning the horizon for political risk

In the second of our series on managing geopolitical risk, Alasdair Ross considers where companies should start looking for potential risk events.
Alasdair Ross
May 02, 2018

Recent geopolitical events have thrown up renewed scope for business disruption. War, civil unrest or a sudden change of government can destroy demand for a company’s products, besmirch its reputation in the host or home market, disrupt logistics lifelines, and threaten the safety of staff. A single event can cascade through the organisation and manifest in different ways over time. Its impact can be direct or indirect, or dormant until it combines with other risks to produce further, unintended and unexpected consequences.

Furthermore, a geopolitical crisis can be capricious. It can devastate one market while leaving a neighbouring market unscathed. Even within the same market, an event may be perceived differently, depending on a company’s business model, sector, value chain or processes.

There is no single accepted taxonomy of political risk that companies (outside the financial sector) can adopt. This makes it particularly hard to identify the source of a threat, let alone calculate its impact on your company. But that shouldn’t deter companies from trying. As risk managers rightly warn: the costliest risk is often the one you hadn’t thought of.

‘As risk managers rightly warn: the costliest risk is often the one you hadn’t thought of.’

Nevertheless, a systematic assessment might begin by exploring the following categories of political risk that your company may face:

Governance: Investors depend on high-quality, stable government that can get things done. It helps if the administration’s policies are generally pro-business and responsive to investors’ concerns. But a ruling party’s stated policy aims—and its commitment to them—can easily change. Governments often struggle to implement policies because of weak coalitions or unreliable parliamentary majorities. An election might be looming with an opposition that wants radical change. There may be fierce resistance to reform, for example from trade unions, organised crime, or other embedded vested interests. Even in the best circumstances, transitions between one administration and the next can prolong uncertainty.

Ford Motor Company is among dozens of corporations that became the target of unexpected—and unwelcome—attention following Donald Trump’s 2016 US presidential election. Before even taking office he launched a Twitter attack citing Ford plans to move production of its Lincoln model from Kentucky to Mexico.  The US was ‘getting killed,’ he protested. When Ford announced that it would not transfer production (indeed, had never planned to) the company dodged a political bullet. But the incident made clear that there were new ‘rules of the game’.

For each market in which your company operates, start asking the following questions:

  • Is the government willing and able to create or maintain an attractive business environment?
  • Is a future administration likely to change the rules retrospectively or without warning?
  • Do government transitions follow clear and uncontested rules?

Regulation and public policy: All companies operate within a dense network of laws and regulations that set competition rules and protect citizens and consumers. Rules tend to be tougher in sectors such as finance, pharma and airlines where the danger to the public is potentially greater. However, the system may be ‘captured’ by vested interests. In some emerging markets, investors may believe that it’s easier to breach the rules and pay the fine than to seek official permission. But the consequences are not always limited to a fine.

German carmaker Volkswagen discovered this in 2015 when it was found to have cheated emissions tests. The company has since provisioned around $30bn against prospective fines and the cost of vehicle recalls and replacements, to say nothing of its reputation. Indeed, the scandal has harmed Germany’s automotive industry more generally.

Questions to ask:

  • Who is acting against our commercial interests, how and why?
  • Who are the key influencers of public policy, and can we speak to them?
  • What are the real costs of non-compliance?

Security: Some markets are particularly prone to theft, terrorism or violent crime. An unlucky company might find itself a direct target of protest as authorities appear powerless or unwilling to act. It may be because a brand has political or national symbolism.  In 2012, Chinese protestors, enraged over Japanese actions in the Senkaku islands (known as Diaoyu in China) over which both countries claim sovereignty, vandalised Japanese business assets across a swathe of provinces while the authorities stood by. Japanese-branded vehicles were torched where they stood. Honda, Toyota, Nissan and Mazda suspended production in plants around the country, as did Panasonic, Canon and Kobe Steel. In the auto industry alone, losses from suspended production reached $250m. Japanese goods exports to China slumped, as did China tourist arrivals in Japan.

A similar case arose with Southern Copper Corporation, a Mexican mining company, which had planned to break ground on its Tia Maria copper mining project in Peru in 2011. But the venture ran afoul of local farming communities who said it threatened their livelihoods. Six protestors died in clashes with police, and the project is still awaiting government permission. As well as a local cause celebre, Tia Maria has become a political football for successive national governments and a victim of Peru’s endemic political instability.

Questions to ask:

  • Are we vulnerable to discrimination through national association?
  • If we are subject to protests and disruption will the courts defend us?
  • Can we do more to win public support for our projects?

Infrastructure, logistics and supply chains: Political risks may not threaten a company directly, but can disrupt points along its value chain, especially those that rely on ‘just-in-time’ delivery. It is not just terrorist attacks such as 9/11 that companies need to worry about. Ports, roads, railways, airfreight, broadband, cloud-based services and computer processing capacity can all be affected by militants, street protests, mass migration, or a simple lack of public investment.

Tata Motors and its suppliers faced such disruption in Kolkata, India when local farmers, forcibly displaced to make way, took to the streets. Backed by a high-profile media campaign, they eventually forced Tata to dismantle the plant, and rebuild it in Gujarat at great costs.

Questions to ask:

  • Is there a history of civil unrest and government responses to consider?
  • Are fiscal constraints likely to lead to deterioration in the quality of infrastructure?
  • If a supplier fails, how quickly can we identify and secure a replacement?

Neither this list nor any other can be exhaustive, and political actions and decisions can affect businesses in almost limitless ways. But by viewing the political risk landscape systematically and asking the right questions companies can minimise the likelihood that they will confront a threat they have not considered.