This post first appeared on Risk Management Magazine. Read the original article.
In March 2016, the Economist Intelligence Unit rated the possibility of a Donald Trump presidency as one of the top 10 risks facing the world—riskier even than the U.K. leaving the European Union, and just as unlikely. Judging impact and probability on a scale of one to 25, with 25 considered the most dangerous, the analysis rated the possibility of a Trump victory a 12—the same level of risk as “jihadi terrorism destabilizing the global economy” and slightly higher than Brexit and an armed clash in the South China Sea, both of which it gave an eight.
Now, of course, the U.K. is on track to exit the EU and President Trump is sitting in the White House, demonstrating just how unreliable political forecasting has become. Furthermore, the Brexit vote and Trump’s election show that monumental political change is not isolated to volatile developing countries where governments can change in the blink of an eye—it can happen in the world’s largest economies as well.
“While both of these events were on the horizon last year, no one predicted that they would turn out quite as they have,” said Keith Ricketts, vice president of marketing at software provider Sword Active Risk. “After the financial challenges of 2008 and the global recession, there was a feeling that many markets were getting back to a more even keel. This is a stark reminder that unexpected events beyond the control of companies can come out of the blue and have a dramatic impact.”
More political changes could be on the way this year. In Europe, while Article 50 has been invoked, plans for Brexit are still taking shape. France will elect a new president later this year, and Angela Merkel is up for re-election as German chancellor. In both countries, populist, right-wing, anti-immigration and anti-EU parties have gained unusual levels of support. There are also key general elections throughout South America, where a change of political party in office can often mean preparing for polar-opposite economic and business policies, while the Middle East continues to be as fractious and tense as ever with terrorism threats from ISIS and other extremists.
“If recent changes in the global political landscape have demonstrated anything, it is that black swans are everywhere and comfort zones don’t work,” said Ladd Muzzy, principal at Nasdaq BWise, a governance, risk and compliance management (GRC) software provider. “The task of risk management is to consider all scenarios. How many of us really considered the extremes? With major elections in Europe coming up this year and populism resetting the political parameters, nothing can be ruled out, and for risk managers, black swans have to be the new normal.”
Maintaining Perspective
Working through such a checklist will give risk managers and their organizations a better sense of how much change has actually occurred or is likely to occur. It will also help to maintain an objective perspective: Trump and Brexit are still very divisive, so looking dispassionately at what changes have actually been made will help prevent political bias.
Political risk analysts at the Eurasia Group predicted in January that 2017 would be the “most volatile” year for political risk since World War II. While international war or “the breakdown of major central government institutions” isn’t inevitable, the firm said, “such an outcome is now thinkable.” According to the Eurasia Group’s research, U.S. unilateralism and the country’s retreat from its leading role in world affairs and institutions like NATO is the key political risk for 2017, with China’s scheduled leadership transition coming in second. Lack of global economic reform to stimulate growth and potential political inference in central bank decision-making also pose serious risks.
While the world may seem a more uncertain place, experts believe it is important to maintain perspective. “Organizations must not panic—nothing is going to happen overnight,” said James Pothecary, risk analyst at political risk consultancy Allan & Associates. “It is important to keep a level head and not make any major business decisions quickly because of political change, such as relocating offices to another country, or pulling investment out of a country. Governments announce policy changes all the time, but they implement them a lot slower.”
He added, “There is no doubt that the nature of political risk has changed following Trump’s victory and the U.K.’s decision to Brexit, particularly as most commentators failed to predict the results. But it does not mean that the future is disastrous. The United Kingdom and United States are still highly prized markets to invest and locate in, and will remain so.”
As a way of assessing the impact of any political changes to their organizations, Pothecary advised companies to set a list of yes or no questions to help gauge their exposure to political shifts. For example, organizations could ask: Has the tax regime changed? Has there been a revolution or military coup? Have regulations and laws changed quickly? Are there restrictions on foreign travel? Are foreigners restricted from visiting or working in the country? Does rule of law still apply? Is there civil unrest? Are there restrictions on moving capital or making investments?
“Working through such a checklist will give risk managers and their organizations a better sense of how much change has actually occurred or is likely to occur,” Pothecary said. “It will also help to maintain an objective perspective: Trump and Brexit are still very divisive, so looking dispassionately at what changes have actually been made will help prevent political bias.”
Muhammad Chamaa, group compliance manager at financial services group Nest Investments, said that companies must remain composed in the face of serious political change. “A knee-jerk reaction is to start implementing crisis plans immediately. Don’t. Markets always balance themselves out and are by their very nature volatile,” he said. Indeed, while the pound plummeted after the Brexit vote, the FTSE 100 was up 16% in January from the eve of the election, and three days after the U.S. election, the Dow Jones Industrial Average actually appreciated by 2.81%.
Chamaa said that having access to the latest information to monitor developments is key. “Risk managers should ensure that they are constantly informed of what is going on and closely monitor developments within their areas of operation,” he said. It may be helpful to consult with specialists and analysts to help put systems in place to assess the business implications of unfolding events, as well as take advantage of new opportunities that might present themselves.
Chamaa also recommended that organizations look at areas of their foreign operations where risk exposures can be reduced, such as minimizing fixed investments and switching or diversifying suppliers. “Political risk is always related to the amount of capital at risk,” he said. “It is possible to mitigate risk by limiting costs—for instance, by leasing facilities instead of buying them, or using foreign suppliers that might not be affected by a sudden political change.”
Preparing for Any Scenario
The Brexit vote always had two outcomes to plan for, as did the U.S. election. The problem was that most companies ignored what they thought were “longshot” results, and many still do not believe changes will happen.
Despite the perception that many of these policy shifts are sudden or unexpected, it is usually possible to anticipate and plan for many political changes. For example, the Brexit vote always had two outcomes to plan for, as did the U.S. election. The problem was that most companies ignored what they thought were “longshot” results, and many still do not believe changes will happen.
John Holly, formerly a major general in the U.S. Army and now founder and managing director of risk management consultancy JH Associates, said that people should not be caught off guard when newly-elected governments actually try to implement the policies they championed as part of their campaign—no matter how controversial or impractical they may have seemed at the time. “President Trump is delivering on pre-election promises, so no one should be surprised, even if the roll-out of his policies is not being executed well,” he said.
Scenario planning is one of the best ways to assess the potential impact that changes in government, policy and the investment climate might have on a business, Holly said. He advises risk managers to monitor the geopolitical situation and determine how different scenarios—such as growing military tensions, an increase in terrorism, migration flow and so on—could affect the business. He warned, however, “risk continually changes, and organizations need to appreciate that fact. They also need to remember that monitoring risk is not the same as managing it.”
To understand what the actual changes will be, Holly recommended organizations rely on source material, such as government statements and regulatory announcements, rather than potentially-biased media reports. This also applies to using outside experts. “How can you be sure that the views of the people compiling the reports are in line with your own? Do they share the same values, goals and appetite for risk? What is their political bias? You can ask for expert assessments, but make sure the final decision is your own,” he said.
The Importance of Information
In a world that is driven by social media and other online information sources, businesses need to understand how societal changes are impacting the world around them, in real-time. Doing so is now as crucial to a business’s future as complying to specific regulations.
Experts agree that the best way to plan for political risks is to be better informed about them. Bodhi Ganguli, chief economist at credit data agency Dun & Bradstreet, said that it is increasingly important to have the right data in hand in order to make decisions. “It cannot be denied that the global political ecosystem is currently undergoing a significant shift, with Brexit one of the many reasons that businesses must now consider implementing a smart, logical approach that can best help mitigate risk,” he said.
The necessary information can be obtained from a range of diverse and immediate sources, including social media. Ganguli believes that the modern-day finance leader should be able to understand that data is central to truly understanding existing and emerging risks, and appreciate that a data-led approach can enable CFOs to drive an organization’s growth strategy. The only way to successfully achieve this is by taking the raw data available and turning it into tangible, usable insights, he said.
“Any significant political change—whether it stems from the intricacies of Brexit, the election of Trump, or other major agents of change—could bring with it regulatory changes, and with regulatory changes could come entirely new requirements for how businesses operate,” Ganguli said. “Implementing a data-led approach in the modern-day business world will be the only way for businesses to accurately understand and analyze changes, ensuring they keep up.”
Businesses must find the perfect blend between traditional and non-traditional data to control macro risks. “Traditional data and insight reports offer informed background checks on businesses, while non-traditional information from sources like social media provides real-time news,” he said. “A mix of the two can paint a clearer picture for organizations. In a world that is driven by social media and other online information sources, businesses need to understand how societal changes are impacting the world around them, in real-time. Doing so is now as crucial to a business’s future as complying to specific regulations.”
Industry Exposures
Although the actual identification of risk has not changed much, traditional methods of measuring it are now more challenging and investment in newer digital technologies to collect real-time data is important.
As with any risk, some aspects of a company’s operations are likely to be impacted more directly by change, and political risk is no different. For example, contracts signed with the previous government can be revoked or reworked, and dramatic turnarounds in policy or leadership can result in sudden currency fluctuations, which means that currency-hedging strategies can be impaired, especially if markets become volatile. More broadly, customer bases and supply chains can also be negatively impacted.
“The global risk map has changed immeasurably in the past year and geopolitical risk is now much higher up the corporate agenda,” said Dominic Tribe, senior consultant at supply chain strategy firm Vendigital. “The prospect of more shocks and extreme exchange rate fluctuations to come means multinationals and other businesses trading internationally need to change their approach to supply network design and management.”
Tribe recommended that risk managers start stress-testing their supply chains to identify areas of risk and put scenario-based plans in place to deal with those risks. “It is especially important to closely monitor suppliers in times of uncertainty so managers can make sure policies and procedures are being followed and potentially get early notice of any issues that could impact business continuity or productivity,” he said. “Businesses with well-established collaborative supply partnerships will have an advantage over less well-prepared competitors.”
Some industry sectors are also more exposed to political risk than others. The oil and gas, energy, and extractives sectors are usually prone to political turmoil (and occasionally direct government pressure and intervention), but the financial services sector is sensitive to changes in political direction as well.
Political risk is likely higher on banks’ agendas than it has been in decades, with the long-term impacts of Brexit and the U.S. election uncertain and potentially underestimated, according to Harpreet Singh, director at management and technology consultancy Brickendon. “The current political environment and interconnectedness of various risks mean banks require additional support to ensure they are correctly equipped to identify, measure and manage political risk in upcoming years,” he said.
“Although the actual identification of risk has not changed much, traditional methods of measuring it are now more challenging and investment in newer digital technologies to collect real-time data is important. In order to prepare, banks need increased support to better understand the correlation between different types of risk, as well as the public perception of these events,” Singh said.
Don’t Panic
Most of these things will play out over a long period of time—months and years, rather than hours and days. As such, political risks are often a distraction to risk management teams that are monitoring day-to-day risks that can actually impact the company at a moment’s notice.
Although political risks are at the top of many boardroom agendas, not everyone is convinced that they need to be. For some experts, political risk is just one risk of many, and not the most important by any stretch of the imagination.
French Caldwell, chief evangelist at GRC app provider MetricStream, warned against putting too much focus on political risks. “It’s the same as thinking about roadwork that is 100 miles away but not looking where you are driving now,” he said.
“The way political risks are reported in the media often makes them seem far more ominous for businesses in the short-term than they really are,” he said. “Whether it’s President Trump’s executive orders or Brexit, most of these things will play out over a long period of time—months and years, rather than hours and days. As such, political risks are often a distraction to risk management teams that are monitoring day-to-day risks that can actually impact the company at a moment’s notice.”
Companies should also be wary of investing too many resources in managing political risks. “While there will be long-term political risks that impact corporate planning and strategy, they only need to be monitored by one or two individuals,” Caldwell said. “These people can be responsible for monitoring for changes, carrying out impact analysis, and then informing decision-makers about the potential risks and opportunities. Investing too many resources in political risk management will simply lead to companies taking their eye off the ball.”