Today’s Trends: Geopolitical risk

Geopolitical risk-min

The world we know, be it in business or elsewhere, is shaped by delicate and multifaceted relationships between sovereign countries and alliances. In terms of business and finance, however, a stable status quo allows people to make decisions based on certain quantitative and qualitative factors that are either set or constrained.

But what happens when a shift in the political, economic, cultural or military relationships that countries have with each other alters this status quo? This is where companies encounter the concept of geopolitical risk: a commercial disruption that originates beyond business, in a sphere much more focused on governments and institutions.

The recent conflict between Russia and Ukraine highlights the concept of geopolitical risk: Russian businesses across the board have suffered the crippling effects of sanctions against the country for its aggression of Ukraine. They are, in fact, locked out of international trade by the SWIFT ban on Russia and can only accept payment in Russian Roubles. This makes trading with Russian importers costlier and more time-consuming. In Ukraine, where Russia´s advance has displaced people and destroyed infrastructure, the disruptions have also been detrimental to the economy, with entire industries either disrupted logistically or effectively shut down by Russian sieges.

Geopolitical risk can arise even from much less pronounced events than the Russia-Ukraine war, but have as great a financial impact. Already, the COVID-19 pandemic that began two years ago has forced businesses to take stock of their risk exposure to account for “greater-than-business” occurrences that materially affect their operations. Geopolitical risk differs from such black-swan events in that it is linked to diplomatic and international outcomes. It does, however, require an equally careful assessment of local political stability and international events, because in today’s interconnected world, geopolitical events can have ripple effects. For example, Russia’s effective isolation from international trade means that companies based in Russia cannot repay their debts to companies based in Europe and Asia, which could cause cash shortages on both continents. The debt of Russian companies amounts to over $100 billion for 2022 alone.

This ability of geopolitics to affect business extends beyond the financial markets via currency volatility and macroeconomics, to tangible operational concerns such as supply chain risk and business interruption risk. Economic sanctions can also lead to an increase in adverse events such as hacking and fraud: a recent report stated that North Korea stole $400 million worth of crypto-currencies in 2021 alone, further demonstrating the cyber security risk inherent in our ever more digital world.

While the above information paints a bleak picture of what geopolitical risk can potentially have on a company, the reality is that, like all external events, geopolitical risk can be integrated into a company’s risk management framework and be closely monitored. To mitigate its effects, companies need to develop business models and operations that are resilient to external events and hedge in simple ways to ensure the company’s long-term prospects despite geopolitical risks. Simple measures such as maintaining a balance sheet of both tangible and intangible assets or adopting a multinational approach can mitigate geopolitical risk. Corporate culture practices such as identifying as a global firm or board-level discussions on event-based actions can also contribute.

To sum up, geopolitical risk is an external event that therefore cannot be controlled. Still how companies manage this risk is very much an internal matter.