Why Political Risk is a Leading Cause for Declining Confidence

Why Political Risk is a Leading Cause for Declining Confidence

According to the Financial Times, political risk is gaining executives’ votes as a top reason behind declining trade confidence. But it’s not just political violence you should be concerned about.

In the latest Financial Times / Economist Global Business Barometer survey, the percentage of executives who believe the global economic environment will worsen over the next six months nearly doubled to 18 per cent compared to a year ago. At the same time, the number of executives who cited political risk as one of the biggest threats to their business jumped to 43 per cent, the highest level since 2011, when the survey began.

Albert van Eeden, Director of Political Risk Insurance at Export Development Canada (EDC), is not surprised. “The news is increasingly filled with stories of civil unrest, contentious elections, war and terrorism. These events often occur in emerging markets, but even markets such as Russia, Brazil, China and Greece have presented significant challenges for investors.”

Van Eeden also points out that knowing where political upheavals will strike next is increasingly difficult, if not impossible, to predict. “I believe the 2012 Arab Spring was a big wake-up call for international businesses, because we saw how quickly unrest could escalate and spread across borders,” he says. “Today’s world has become a much more unstable place, and even places that appear stable today may pose new risks tomorrow.”

Not all political risk is violent

Albert van Eeden, EDC's Director of Public Risk Insurance

Albert van Eeden, EDC’s Director of Political Risk Insurance

Those risks, as companies are increasingly discovering, don’t just include people throwing rocks or setting buildings and equipment ablaze. With more pressure and demand on scarce natural resources, many governments in both emerging and developed markets are posturing a renewed resource nationalism.

“Some governments are feeling a need to better protect their interests in their country’s oil, gas, mineral and water resources, for example, and to take a harder look at foreign companies that have made investments within their borders,” says van Eeden. “They want to go back to the negotiating table and try to change contracts and resource agreements, so that creates a political risk for investors too.”

Other political risks can include:

  • Changes in laws or regulations that can make investments or exports less profitable
  • Import or export restrictions that disrupt a foreign affiliate’s operations
  • Foreign exchange restrictions, in which funds can’t be accessed or repatriated to Canada
  • Breach of contract by foreign governments
  • Expropriation
  • Failing to establish a “social license to operate”, or the local community’s willingness to support the company’s business operation.

Key signs of a pending political risk can include an expected change in government leadership; governments considering regulatory changes; a recession or worsening of the local socioeconomic environment; popular unrest or tensions between the country and its neighbour states.

“No matter what form it takes, political risk is unavoidable in the global marketplace,” van Eeden confirms. “The loss of a foreign-based asset or its productivity, or the loss of an export contract, can have an effect on cash flow, profitability, and even the overall viability of the company back in its domestic market.”

How to Manage Political Risk

Despite the heavy toll political risk can exact on a company, the majority of Canadian businesses do not manage political risk in any organized way. This is unfortunate, as actively monitoring and managing political situations not only helps a company avoid the risks, but can help it make strategic business decisions that take advantage of political change.

For example, some political events can have positive results such as a business boom. Companies that are good at monitoring political risk may see these changes coming before their competitors, and get a competitive edge.

Van Eeden recommends companies take an integrated approach to risk management, such as an Enterprise Risk Management (ERM) model. Typically, such a plan has four parts:

  1. Identify political risk exposure
  2. Measure its potential impacts
  3. Mitigate its effects
  4. Monitor over time

Some recommended measures companies can take to lessen their political risk exposure may include:

  • Diversify investments among different countries, and diversify buyers, suppliers and logistics routes.
  • Select local partners and buyers who are in good standing with the government, but not too closely associated in case of a change.
  • Develop a social license to operate using top-quality CSR practices.
  • Abide by all laws, regulations and contractual obligations.
  • Ensure benefits of concessions or licenses are not disproportionately favourable to the foreign affiliate over the host government.
  • Have contingency plans to move physical assets, such as equipment, rapidly out of harm’s way.
  • Set up an offshore account to receive payments, and regularly convert and transfer funds outside the country.
  • Purchase Political Risk Insurance.

For more information about political risk insurance, visit EDC’s website. Companies can also obtain help from many sources, such as the Canadian Trade Commissioner Service, the Canadian Commercial Corporation, industry associations, chambers of commerce and many others, as well as private-sector consulting and business intelligence agencies.

*The Business Barometer is based on a quarterly global survey of more than 1,500 business executives working in different regions and sectors, carried out by the Economist Intelligence Unit for the Financial Times and the Economist.

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