When all the swans turn black...

Apr 27th 2017 |

At the start of the year it was already clear that political risk would dominate 2017. Insurance broker Marsh, which produces an annual global risk map (https://www.marsh.com/uk/campaigns/political-risk-map-2017.html) pointed to the continuing reverberations from "the twin shocks of the UK’s vote to leave the European Union (EU) and Donald Trump’s victory in the US presidential election." It went on to predict that "political and economic risks for multinational businesses will increase in 2017, driven by rising nationalism, upcoming elections, succession concerns, and the threat of terrorism."

These predictions have come true far faster than Marsh can have expected. North Korea has threatened an imminent "thermo-nuclear war" and a "super-mighty pre-emptive strike" against the US; Russia-US relations have cooled as evidence of election interference mounts and as President Trump has intervened militarily in Syria in direct contradiction of his previously stated position. Far-left and far-right candidates look closer to power than ever before in France; the UK prime minister has called a snap election she had promised was unnecessary in an apparent quest for a mandate for a "hard Brexit".

In emerging markets, Turkey looks set for a period of prolonged instability after a narrow vote to overturn a century of secular democracy (itself prompted by an attempted coup that prompted a country-wide 'purge' of government opponents) ; Brazil's (relatively) new president has just had to deny that he hosted a meeting in which an illegal payment of $40 million to his political party was agreed and much of his cabinet is expected to resign in the wake of further corruption allegations; Venezuela is close to economic, political  and social collapse and the government has just illegally seized a GM plant; Malaysia and North Korea are locked in confrontation over the murder of the brother of Kim Jong-un; in Indonesia the charge of blasphemy against Jakarta’s Christian governor, who lost an election fraught with identity politics to Islamist hardliners, is the tip of a much larger movement that is being called, by opponents, a coup against the president. The list goes on and on.

While political instability is nothing new, what links many of these examples is that they were unexpected; either few people believed or even posited that they would happen or their severity or impact was unanticipated. In addition, a great many of them involve the polarisation of countries into binary groupings whose opposition to each other is more than "political". This raises the probability of social upheaval on a scale most of us are unused to in places where it has not been experienced for decades, if ever.

Why does this matter to treasurers? Well, first, and most obviously, if core developed markets, and some of the largest emerging markets, are experiencing extremes of political change, businesses' ability to predict risks and returns in them is greatly diminished. Also, such significant, mostly reactionary, political developments raise the possibility of sudden policy shifts - from nationalisation, to currency controls to punitive tax measures against foreign businesses – that may fundamentally alter the economics of MNCs' international networks and threaten their supply chains and financing. 

Worryingly too, because of the extreme nature of some of these events, even those that may seem to be irrelevant because they involve economically insignificant countries or resources (China's reef building in the South China Sea, for example) have the potential to cause significant instability regionally and globally.

Finally, the fact that long-tail events are more extreme in this environment means that all norms of volatility are likely to rise. Businesses (and consumers) have become accustomed to societies and politics operating within a set of accepted parameters. Events outside those parameters have been considered essentially impossible and therefore to be disregarded. Make those events possible and every development, every piece of news, is a move closer to or further from that extreme event. Its significance is enhanced by virtue of the fact that it could lead to an outcome far more serious than any that had previously been priced in. 

So what to do? Marsh is vague. "For multinational companies and local ones that do business with them, it is vital to understand where these risks are occurring and how they will impact your business. Only with such insights can companies truly begin to plan for possible scenarios as they develop risk management strategies to support investment decisions."

Many companies and many treasuries, are not equipped to do this. These types of extreme operational risk have generally been seen as "Black Swans" - very long-tail risks that one either ignores or avoids by not incurring them in the first place. But what happens when "black swan" risk becomes commonplace and therefore a threat to business continuity? Where in the business does that type of risk evaluation and management reside? Where can it be bought if it is not available internally? And given the apparent prevalence of extreme political events, what can treasury and finance do to manage the likely increases in financial volatility that may occur? What does it mean for funding and for holding cash abroad? 

These are questions EuroFinance will be investigating in detail in Barcelona on the 4th - 6th of October (click here for Agenda). International experts in political risks, financial risk managers and treasurers will try to untangle the scaremongering from the reality and to build a realistic framework that treasurers can use to manage this new and challenging environment.

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