Global Political Dangers

Martin Stone, a director in Aon’s “Counter-Terrorism & Political Risks” team, says that there is no such thing as a single “danger area” in the world anymore, thanks to the advent of global terrorism. Emerging market investors have much to be confident about this new year: the Dow Jones is back above 10,000 on a consistent basis and the UK’s equity market is up 35% on the past year, and some emerging stock markets are up by more than 100%. And, economic growth, albeit in a modest fashion, is widely anticipated in 2004.

Most economists expect the major western economies to grow slowly, however. Investing in the emerging markets might prove one of the few ways of making substantial returns. So far, so good.

But, if investors want to avoid the pitfalls of the last upswing, from 1993 to 1999, they need to be aware of the specific risks associated with investing in emerging markets, as the world of political risk is more complex and difficult than it was in the early 1990s. Some of the old certainties of a bipolar world have disappeared and terrorism has become global.

RISK FACTORS

Principally, investors should consider five classes of risk when looking at emerging markets. One of the most important is currency collapse, which is always closely associated with political instability. This can occur when political and social unrest cause global financial institutions to lose confidence in the economic viability of a market. This in turn leads to a run on that country’s currency. Currency collapse can cause investors to lose profits, business and, in the worst cases, invested capital.

Other risks commonly associated with emerging markets include political violence, conflict with other states, and terrorism. While expropriation (i.e., government seizure of an investor’s assets) is much less common than 20 years ago, governments still cause problems by delaying, canceling or restating licenses and permits.

In the early 1990s companies commonly understood terrorism risk as particular to one state or group of states. While the “FARC” in Colombia, or the “IRA” or “ETA” were acknowledged threats in specific countries, companies working in “safe” markets could be more or less sure that their operations would not be hit by terrorist activity. This picture has changed substantially since the terrorist attacks of 9/11. Most importantly, Al-Qaida targets companies for what they represent, rather than where they are located. For example, if it is possible to strike at a major U.K. financial institution (such as HSBC in Istanbul), they will do so – not because HSBC is in Istanbul, but because it is a western financial institution.

IDENTIFYING EXPOSURE

The change in the global political risk landscape means that companies need to look closely at their exposure to terrorist and political threats worldwide, and not just in those countries in which they might easily perceive themselves to be “at risk”. Considerations of political stability are still of crucial importance, though, given the relationship between political instability and terrorism. Terrorists can be most effective, and will find their activities less hindered by military action and law enforcement, in politically unstable states such as Afghanistan and Iraq. However, 9/11 shows us that the reach of these organizations is global, and no country is completely safe from threats.

As a result, companies looking to profit from the opportunities presented by emerging markets during an economic upturn must undertake a detailed assessment of the risks inherent in their investments. This should include an analysis of the threats facing the company, the risk to their business from those threats, the company’s capacity to manage these risks, and an assessment of any action the company can take to reduce their risk profile.

Next, companies should work with their advisors to develop their approach to managing these risks, including the level of risk they can retain and any appropriate risk transfer strategy. Perhaps most importantly, companies must continuously reevaluate their risk profile and act to make sure that they are anticipating political, economic and terrorist events wherever possible to minimize the impact of such events.

This will include assessing the financial and “reputational” impact of political and economic risks on their company’s activities, maintaining links with intelligence sources (governmental and non-governmental), and interpret this intelligence to work it into changes in risk management strategies.

GLOBAL HOTSPOTS

Aon recently published its “Political and Economic Risk Map 2004” (see Insight of CU’s March 2004 issue), showing both the interrelationship between terrorism and political risks and how investing organizations are moderating their behavior in respect of the changing risk environment.

In Latin America, we have observed improvements in the political and economic conditions for investors in Chile and Brazil, linked in part to the successful government of president Inacio Lula da Silva (Lula). Elsewhere in the world, the improvement in the climate for investors in the oil-rich states of the Gulf of Guinea is linked in part to the continued political insecurities following the war in Iraq.

In Europe, the added security of EU entry for central European states has led to an upgrade on our map for the political and economic situation for these states. Similarly, in central Asia, the booming Kazakh oil economy has made it the only CIS state now ranked, “medium high risk”, rather than “high risk”.

In conclusion, who you are, and what your company represents to terrorists as a “trophy target” is just as important in the new geopolitical climate as where your company chooses to do business, and how. Ethical policies, fair wages and attempts to understand local customs will be of little help to companies entering emerging markets: a robust assessment of the threats they face, and a solid risk management program to protect investments, are the only real answer to the challenges posed by the changing political and economic landscape of the coming upturn in the global economy.