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Geopolitical Risk

Smart companies seek best practices to counter geopolitical risk

Sept. 11, 2001, opened many executives’ eyes to geopolitical risk. While terrorism presents a high-impact, low-frequency risk to supply chains, other kinds of geopolitical risks are much more likely to disrupt business.

The term itself is a catch-all for exterior risks that aren’t caused by nature or by another company. Problems can run from the extreme of wars or coups to social unrest, expropriation or new parties ruling a government to embargoes, taxes, regulation and protectionism.

“Once a company’s operations cross borders and your processes are dependent on activities and persons outside your home country, you need to be more aware of geopolitical risk,” says Anne Marie Thurber, executive vice president and managing director for Zurich Insurance Group Ltd.’s credit and political risk business, based in Washington.

Geopolitical risks can arise quickly. The Arab Spring in 2011 swept from country to country, toppling some long-time leaders, like Hosni Mubarak of Egypt. Stability and economic progress were so notable in Egypt that it was one of the Civets (Colombia, Indonesia, Vietnam, Egypt, Turkey, South Africa), the fast-industrializing developing countries seen as the successors to the Brics. So, even countries that look as if they’re up and coming, with long-time stable governments, can still turn upside down almost overnight.

Export or import bans in the name of public safety also can arrive quickly, because authorities prefer to be wrong rather than sorry. In the space of two weeks in 2011, Spanish produce was nearly shut down as Germany banned Spanish cucumbers, which it blamed for a deadly E.coli outbreak. Other countries followed suit, some of them banning other vegetables as well. Russia banned all fresh vegetables from the entire European Union. The outbreak finally was traced to German bean sprouts.

The extended nature of supply chains can obscure the risks. You can have dealings with a supplier in one country, not realizing that your supplier has factories in a number of other countries, some of which might not have stable governments.

As with other supply chain risks, it’s essential to have a business continuity plan that considers these risks. You also need to know your suppliers, back to the raw materials if possible, and have second ssources for those in problematic countries. Here are some more best practices for geopolitical risk:

1. Stay informed

Large multinational companies have teams of people that deal with government relations, including geopolitical risks. “It’s important to have local expertise physically monitoring everyday things going on in that country or region that could affect your company,” especially new regulations, taxes or tariffs, says Celina Realuyo, assistant professor of national security affairs at the National Defense University in Washington.

It’s important to remain even-handed in dealings, too, even when a regime seems well entrenched. Companies shouldn’t just make ties to the ruling party because “something like the Arab Spring happens, and they find they don’t know anybody,” Dr. Realuyo says.

One of the classic responses when a new party comes to power is that “many of the contracts that were awarded by the previous government are scrutinized for corruption,” says Ms. Thurber. “It is important that you are always living within the spirit and requirements of host and home country laws.”

Much of the local expertise is devoted to financial matters such as taxes, Dr. Realuyo says. That’s important, but so are broader macroeconomic trends, shifts toward protectionism or moves toward free trade agreements.

Companies need to ask whether they have property rights over the pieces of the supply chain, she says. When choosing suppliers that are state-owned companies, contracts need to specify that they will last longer than a year or an administration. Companies also need to consider whether a political disruption—even one from a badly managed natural catastrophe rather than social upheaval—may result in goods not being able to enter or leave port.

2. Beware of death by a thousand cuts

Expropriation is generally illegal when governments don’t pay fair compensation. But armies rarely march in and take over foreign-owned factories these days—except in Venezuela and Bolivia. Instead, some governments favor a more subtle tactic, creeping expropriation, says Dan Riordan, chief executive officer, Zurich Global Corporate in North America. Using new rules and regulations that deprive investors of their rights or that make operations so costly as to eliminate any prospect for profitability, “it has the cumulative effect of being the same thing” as expropriation, he says.

When entering a country, it’s important to arrange in advance to have arbitration in a neutral venue to settle disputes. If the arbitration panel decides in favor of the company against the host country, whether it’s outright or creeping expropriation, and if the government doesn’t pay, then insurance may pay it, he says. Otherwise, “companies could be waiting a very long time to be paid.”

3. Know your vulnerabilities

If your second-tier supplier receives metals from a mine that is expropriated, it may be a year or more before the mine can get back to running, because of a lack of management expertise, Mr. Riordan says. Major companies try to build in redundancy among suppliers, but a multitude of sources simply doesn’t exist for some precious metals.

For example, China produces 97% of rare earth elements, which are increasingly used in high-tech products. And only a couple of companies are able to take the raw metals and process them to the purity that manufacturers need. South Africa produces 75% of the world’s platinum, Bolivia has about half the world’s lithium and the Democratic Republic of Congo produces 51% of the world’s cobalt.

In September 2010, China restricted exports of rare earth elements to Japan during a territorial dispute, reducing export quotas in the name of protecting the environment. That raised concerns because Japan is an important cluster for high-tech components.

“Sometimes you need to engage in R&D and consider and plan alternatives,” to avoid being too dependent on hard-to-get raw materials, says Amos Guiora, professor of law at the S.J. Quinney College of Law at the University of Utah in Salt Lake City. “If you say alternatives are way too expensive, and down the road something happens, it might not look so expensive. How much do you want to be dependent on problematic or at-risk regimes?”

4. Communicate quickly

If your company ends up in the middle of an uprising or even just a political firestorm, you need to get your message out quickly. Dr. Guiora described a company whose disaster plan included meeting an hour after a disaster to discuss a press release, with another two hours to write and approve the statement for release well ahead of the evening news. In an age of Twitter and social media, that’s way too slow.

“Time after time we see how poorly corporations do in the middle of an event,” he says. “CEOs need to prepare themselves for tough press conferences.” Delays only hurt the message.

With global supply chains and global financing, “it’s difficult to find shelter from many geopolitical risks,” says Robert Ritchie, professor of risk management at the University of Central Lancashire in the U.K. However, with risk comes opportunity. “There are certain areas where most companies fear to tread, but if you look, there are always some companies willing to go there, knowing the risk.”