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Geopolitical risk: 2015's biggest concern

April 6, 2015

How can you lower your business risk when threats – like political unrest in other countries – are outside of your control?

barbed wire

Three of the top five global risks in terms of likelihood, identified by 900 top executives from business, academia and the public sector were in the geopolitical sphere: interstate conflict with regional consequences, failure of national governance and state collapse or crisis. We read about these risks almost every day on the front page of international newspapers, but do they actually mean anything for firms’ bottom lines? Let’s take a look.

Interstate conflict with regional consequences

With the fall of the Berlin Wall in 1989, some believed that dangerous conflict between major powers was over and the world would form a consensus around trade, development and international governance. We now know that seems to be a long way off, as countries increasingly turn to various forms of strategic competition, including war, to protect their interests. Nowhere is that more obvious than Ukraine, where Russian-backed militants and the Ukrainian army have been at war since early 2014.

This conflict has hit multinational firms directly in the form of rocket impact damage to facilities, looting and occupation of facilities by militant forces, and accordingly, insurers have seen the impact in political risk insurance claims activity. The consequences have reached far beyond eastern Ukraine to any firm investing, lending or being supplied from Russia, as western sanctions damage the Russian economy and yield Russian responses.

Political Risk in 2015: How World Conflict Can Affect Your BusinessFailure of national governance

This risk category includes the inability to govern due to corruption, illicit trade, organized crime and weak rule of law. We have long known that corruption levels are linked to economic development — all one has to do is look at Transparency International’s Corruption Perceptions Index to see that all the least corrupt countries have highly developed economies, while all the most corrupt are among the least developed.

It stands to reason that investors either avoid countries where they are not treated fairly or safely, or they demand higher return for investing in these areas.  Venezuela is an example where corruption, dubious rule of law and the weakness of property rights have been chronic problems, posing real and increasing risks to firms investing there.

State collapse or crisis

In many parts of the world, much of the population views governments as artificial constructs imposed by various combinations of outside powers and well-armed dictators. Under such circumstances, firms can find themselves passing from a situation of weak rules of the game to no rules. With the collapse of the Khadafi regime in Libya, many firms had to abandon their equipment in the country, leading to claims for Forced Abandonment on their political risk insurance policies.

Indonesia in 1997 was a case where economic stress led to state collapse, as a massive devaluation led to the collapse of the Suharto regime, resulting in the largest claim ever to the political risk insurance market to that point: million from CalEnergy’s geothermal power project.

Global leaders are more concerned about geopolitical risks than they have been over the last decade, but firms cannot afford to be paralyzed by such risks. Despite the risks presented by the emerging markets, they still represent the best prospects for growth. The key is recognizing that these risks to the firm exist, undertaking sound country risk analysis and finally building resiliency and risk mitigation into business plans.