Why the political risk advisory industry is changing, and how firms need to adjust
By Matthew Shapiro
Political risk has always been a factor in market outcomes and corporate performance. However, it has rarely been more central in terms of its impact on an organization’s operations, investments, policies and people than it is today. The geopolitics of an investment can no longer be considered an isolated concern or a niche area with little influence on broader organizational tactics, strategy and planning – geopolitical factors will increasingly define either the field of play or the rules of the game (or both). The companies and investors that will find the most success will blend effective operational management with a more precise understanding of their geopolitical exposure, and the risks and opportunities presented by such exposures Managing this integration of political risk analysis into high-level strategic planning and day-to-day decision-making will be crucial, for corporations and institutional investors alike, to ensure companies are best placed to mitigate risks and take advantage of opportunities in a rapidly evolving global marketplace.
All this means that it is a great time to be in the political risk space. But how should we think about the evolving role of a political risk analyst and the kinds of information that will be essential for multinational companies, institutional investors and government agencies?
What does political risk mean today?
It is fair to say that geopolitical risk is now firmly entrenched in the lexicon of the business and investment communities around the world. A cursory Google search for mentions of political risk in the news surfaces a dozen or more links, all of which focus not only on the outcome of elections, the passage of legislation or the happenings at key international summits around the world, but critically on the intersection of traditional geopolitical forces and the implication for market participants.
However, while it may be the case that incorporating political risk analysis into decision making is now de rigueur for the Fortune 500 set, it is not as obvious that the term “political risk” in and of itself means anything practical. Investopedia.com, generally a solid and reliable resource for understanding the practical minutiae of financial markets, provides the following definition: “Political risk is the risk an investment's returns could suffer as a result of political changes or instability in a country.” This is both true and not very helpful. Being able to define what constitutes a political risk is a fundamental aspect of including geopolitical analysis as a regular component of any risk management or strategy exercise. Only if we can make the case convincing that something constitutes a political risk can the analyst offer real help to the decision maker.
To make that case, many of us tend to stress the complexity of events. The politics of a region, a country, or an industry can be difficult to unpack on the quietest days and are subject to frequent changes even during periods of relative calm. Highlighting how difficult it can be to understand this dynamism has the twin benefits of underlining our own importance as ‘people who know’ while giving us an excuse if things don’t unfold as we suggest they may. As a result, we are often tempted to make not only the issues we study but the way in which we study them appear more complex than they need to be. If we want to be appreciated, we must engage with our audience so that we are easy to understand.
To help impose the discipline of simplicity on myself and my writing, I have a working definition of political risk that sees geopolitics as containing five fundamental factors - political, economic, regulatory, reputational and security. In my view, everything that falls under the category of “political risk” can be neatly fitted into one or more of these categories. These are easy to grasp and can make analysis built on these platforms much more concrete and accessible for a client. Social unrest in Brazil? Certainly, it has political elements, and some obvious macroeconomic components as well. And depending on the size and location of the event there may very well be a security concern, alongside reputational risks for exposed companies. But take something less obvious like disruptive technology (think blockchain or AI), and there is a very real political component as governments come to grips with the far-reaching impacts of technological disruption of domestic society and the local business community.
There are equally obvious economic and regulatory realities to be covered as companies move to take advantage and those selfsame governments move to regulate. Looking at political risk in terms of these factors may take out some of the wonkiness that we share amongst ourselves, but it is immeasurably more practical from a business perspective. Political risk analysis that is based on a clearly understandable framework of assessment is much easier for busy clients to understand and import effectively into their own business concerns and interests. I won’t suggest that there is any single correct way to explain geopolitics (though I have an obvious bias for my intellectual five-ring circus), but a good analyst won’t leave a clear expression of value and impact up to the client. We will provide it for them.
What value does the political analyst bring to the table?
For many companies this is the multimillion-dollar question. In Oxford Analytica’s annual survey of how companies are grappling with political risk, we spoke with the senior leadership of more than 40 companies to get a better sense of how geopolitical factors impact their business and their decision making. We found that majority of companies with annual revenues of 1 billion dollars or more suffered a significant loss due to geopolitics (in excess of $100 million dollars), and that almost half the companies surveyed wound down some portion of operations due to concerns over local risk environments in 2018. In short, geopolitics matters in measurable ways, and political risk has real-world implications for policies, people, investments and operations.
For analysts this presents one very practical reality – political risk must be measurable too. It is no longer good enough to say, “things are getting worse” or “things seem to be improving”. In an information rich world, where traditional consumers and clients of geopolitical risk analysis are better and more quickly informed (and screaming for more data) analysts will need to provide a sharper edge, and in all likelihood that edge will be related to measurement.
And it is this expectation of data that separates the yesterday from today for political risk analysts. I acknowledge that data, and more specifically models, are not the traditional bailiwick of political risk experts, in the same way that context has not always been front of mind to the quantitatively inclined. Most country analysts couldn’t model their way into the ocean from a boat, and the algorithmically-oriented are more likely to debate the merits of Java vs. Python over the nuance of local election dynamics.
Yet data and technology are the future of the political risk space for both provider and consumer, and at this stage consumer demand is outstripping analytical supply. This is not to suggest that political risk analysts should be added to the list of professions soon to be replaced by our new robot overlords, at least not yet. However, it would be foolish to ignore the real demand for data-driven, quantifiable management solutions, as well as the wealth of data created by and exposed to geopolitical risk. Elections, immigration, poverty, supply chains, protest movements, terrorism, regulation – these are all things that produce, relate to, and are impacted by data points.
Increasingly, effective geopolitical analysis will incorporate a heavy dose of real-world numbers because, as our survey indicates, companies and investors deal with the implications of political risk in real world terms. Data should both impact an analyst’s view and be impacted by the changing dynamics in a country. In other words, if your analysis can’t point someone toward something practical in concrete terms it will become increasingly irrelevant, or worse yet, increasingly subjective. The challenge will no longer be constructing a narrative, but rather measuring the impact and accuracy of that narrative as it exists in the real world.
To reiterate the point made earlier, when thinking through the challenge of interpreting complex systems, simple is best. The good news is that political risk analysts have never been more central to the discussion for corporations and markets. The bad news is that those markets are better informed and moving a higher rate of travel than ever before, and no one pays someone else to create more complexity or more information density – they don’t have time for anything other than the bottom line presented in terms that make sense. Good analysis will deliver the same value proposition it always has and help clients understand, and ideally anticipate, the world around them. The best analysts will increasingly define a world that their clients can instantly engage with and will measure the practical impact of geopolitics on a set of outcomes that matter.
Matthew Shapiro is a Managing Director at Oxford Analytica.