What is Political Risk?
Geopolitical risk, changing regulatory policies, domestic political instability, expropriation, corruption, ethical violations, and coups.
While I find it fascinating, when I tell people that I work in Political Risk, a lot of eyes glaze over, and most people simply change the subject. Occasionally, some asks “Well, what is Political Risk?”
What is Political Risk?
While it has many definitions, the definition that I use for Political Risk is as follows:
Political Risk is the potential harm to a business operation arising from political action.
I do want to highlight that I use the words “political action” and not “government action”. In the past, Political Risk was primarily viewed as the risk that government actions on decisions could have on a but the scope of political activities that affect business are happening almost everywhere—online, in the streets, in board rooms, in barracks, at neighbourhood bars and at global summits.
Why is Political Risk important?
Political risk is important because nowhere that companies operate are unaffected by the laws of the state and business operates in a framework set by political authority and social consensus. Regardless of where you are in the world, the political realm is pervasive. Over the past few months, the world has seen an insurrection in the United States, a military coup in Myanmar, a growing armed civil conflict in Ethiopia and increase in nationalization as countries compete to secure vaccinations for the COVID-19 virus.
There is a financial component to political risk. Regarding the impact of government and regulatory intervention on a company’s value, a McKinsey study found that 30 percent of a company’s business value be impacted for most sections, while other sectors such as the banking sector being as high as 50 percent. In addition, political risk can simply make things such as capital, labour or moving goods across borders cost more.
Political Risk will be especially important to understand as the highest growth opportunities are in emerging markets, yet political risk is highest in such regions - countries have greater political volatility, government institutions are less developed, and the rule of law is weaker.
Is Political Risk widely used?
It is not.
The problem is that Political Risk results from not from numbers but from decisions that people make. And people are hard to understand and to predict.
To understand people, we have to engagement with them, listen to them and understand them. And that is extremely hard to do.
When dealing with a specific government, their actions can be difficult to predict if there is a limited sample sizes of decisions or case studies when discussing an individual nation.
So, because people are hard to understand or not understanding how a government or organization may act in a particular case, quantifying political risk into a number difficult.
Which means decision makers often chose one of two routes when it comes to political risk: “Go with the Gut” or “Let’s just ignore it”.
In the book Fat Tail by Ian Bremmer and Preston Keat, they highlight a survey that finds that “political risk was considered the least likely of all risk categories to be managed well. Geopolitical risk was also perceived as least likely to impact a corporation—and thus least likely to be included in a company’s risk management planning.”
Do I need to pay attention to Political Risk?
If you are dealing with a supply chain that crosses borders, have clients in another country or are active in a country where the impact of government decisions has a greater impact on your operations or profits, then you should be investing some time and money into understanding political risk and its impact on your company.
Companies must also be concerned about the political risk of their business partners especially in developing regions where the rule of law is different from their own home country. A recent story of a Canada mining company in China accusing their state-owned business partner of teaming up with the local Chinese government to confiscate a mining operation highlights the danger of political risk.
If I were the CEO of tech company, I would be concerned about growing political risk as governments and other actors are only going to be increasing their overview and regulations of this sector. Be ready.
What can I do?
If you are concerned about Political Risk (and you should be), I would suggest three actions:
1.) Get Informed – Learn more about Political Risk. There is a wealth of information available on this issue. Books such as Fat Tail or Political Risk: How Businesses and Organizations Can Anticipate Global Insecurity are great places to start. Other options include signing up for newsletters from companies that deal in political risk, listening to a podcast and of course hiring a political risk company.
2.) Get ahead of risks – Identify those political risks that could impact your business, the likelihood of those risks happening and the impact that each risk would have on your business if it did happen. This can be done by an internal team but that political risk company that you hired in #1 can help with this as well.
3.) Develop risk mitigation plans – Now that you know what can affect your company, you need to take steps to mitigate the risks. From divestment to diversifying your supply chain, from political risk insurance to increasing your engagement with government officials or other political actors, there are numerous steps that can be taken to lessen your overall risk.