Political risk: what it is and how to deal with it

It’s reasonable to think that, with the ascendance of free market capitalism and growth in the number of democracies, political risks to cross-border business investments or exports would have abated.

Indeed, since the early 1990s, many governments – even the undesirable ones – have worked hard to attract international investment, pursue pro-growth policies and seek workable environments for businesses to operate within their borders.

But the reality is that firms of all sizes, whether exporting or setting up operations abroad, continue to face significant challenges from the political arenas they’re exposed to. Typically these ‘political risks’ fall into categories of expropriation (nationalisation), restricting the flow of profits or capital flows (transfer) or physical disturbance (war or political violence).

In fact, when looking broadly at the range of firms operating beyond borders, and the integrated complexity of global supply chains, the list of politically-inspired challenges seem endless. “Was the Mexican government’s failure to renew the license of a foreign owned landfill site a breach of contract?” asks political scientist Nathan Jensen. “Does a firm deserve compensation when rebels in Liberia eat the inventory of a U.S. pig farm? Who could have predicted that the Vietnamese government’s ban on foreign language advertising would also pertain to the logo on Pepsi beverage foundations, threatening Pepsi’s local beverage distribution network?”

Indeed, such questions raise complex and varying issues across a range of political landscapes. And these challenges are not just the domain of large multinationals with intricate in-country operations. Small exporters, for example, also face politically-inspired challenges from bribery and non-payment to currency fluctuations and opaque quarantine measures.

Clearly, for firms to navigate political risks they need to not only understand the political terrain of countries they deal with but combine the intimate knowledge of their business with the political factors that may cause disruption and reduce predictability. A British supermarket chain will know the width of its supermarket shelves in Pakistan, for example, but won’t necessarily know the threats from potential terror attacks to it’s plant or supply chain route.

Importantly, in scanning the political landscape, it’s useful for firms to avoid ‘white noise’ by drilling down and focusing on political risks that are specific, relevant and applicable. A great deal of recent political risk discussion, for example, has focused on the risks of nationalisation or ‘nativist policies’ in the wake of populist governments in Europe and the United States. While important, however, such wide analysis can apply little to a firm’s in-country operation. Liberian rebels eating away (literally) at foreign pig farm profits, as the above hypothetical cites, are not entirely motivated or touched by Brexit or the actions of Donald Trump.

And recourse methods for expropriation are not new in the world of business. A subsidiary of Australia’s Churchill Mining, as one recent case study shows, suffered losses of around $1 billion after the Indonesian government – citing licensing issues – expropriated the subsidiary’s cole mine in East Kutai. In February 2014, to the relief of investors, the International Centre for the Settlement of Investment Disputes ruled in favour of Churchill Mining.

Clear arbitration mechanisms are, of course, just one of a range of measures a firm can identify ‘up front’ to avoid catastrophic losses from the political risk of expropriation. Small exporters, for example, can seek local importers to sign irrevocable letters of credit while some firms can afford to take out political risk insurance through standard brokers or with institutions like the World Bank’s Multilateral Investment Guarantee Agency.

Investors and exporters alike, however, hope their operations never reach stages of intervention or loss. Sensible mitigation tactics can also be effective in dealing with unpredictable and harmful government action. These include diversifying supply chains, being transparent, building local goodwill through what is called a ‘social license to operate’ or conducting due diligence with (hopefully) reputable local partners. Clearly, duration is also important as the longer a firm is exposed to shaky political currents the harder mitigation becomes. At the same time, however, a firm’s mitigation tactics can also be given time to mature over a longer period.

As long as trade and international business exists so, too, will political risk. There are a range of well-established measures firms can take by undergoing a targeted form of due diligence. Doing so offers great risk but, as the saying goes, great reward.

To find out how I might be able to help you or your organisation navigate political risk further, please contact me here.

Image source: GRC Institute

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