Managing Geopolitical Risk In An Uncertain Market
Posted by Sjoerd-Jaap Westra
The role of the CFO has only become more complex over time. On top of managing a company's finances, the modern CFO faces an increasingly volatile operating environment in developing countries. The risk of terrorism, violent unrest or disruptions to the flow of key commodities can have a serious impact on a company's finances. This blog will help CFO's analyze and assess the most common forms of geopolitical risk and how to best protect the bottom line.
Security Is Paramount
One natural outcome of greater geopolitical instability in recent years has been the growing importance of securing firm assets overseas. Naturally, securing those assets has become a more expensive, specialized service. Security used to consist of the standard "gates, guards and guns" service for access control found at any corporate site. Today, companies partner with specialized security consulting firms that are typically staffed with former intelligence and military officials that can offer special insight into the world's hotspots. Some firms go a step further and hire people with those backgrounds to develop their own in-house security intelligence teams to provide custom analysis.
Using A Thorough Framework To Analyze Emerging Market Risks
In order to assess risks in emerging markets, it is best to group them by categories. The largest risk theme is political risk, which is the risk of disruption or financial loss due to local political changes or instability. However, political risk can be broken up into more specific concerns. Foreign exchange risk could result in local currency becoming inconvertible or heavily devalued due to local political developments or policy changes. Liquidity risk is similar; a firm may find that it cannot sell local assets after purchase. Other concerns include the risk of terrorism targeting foreign assets and general operating risks that could include corruption or bureaucratic hurdles. Every company has a different risk profile and needs to assess what is the threshold beneath which it can continue to operate normally. Knowing the risk factors and what the company can tolerate allows managers to operate in even the most volatile developing countries.
Hedging Key Commodities
Nowhere is geopolitical instability more immediately apparent than in the volatility of commodity prices. Prices for energy commodities such as oil and natural gas can now fluctuate 3-4 percent in a single day, roiling global stock markets. A single news article about sectarian fighting in Iraq or militant attacks in southern Nigeria can raise concerns about disruptions to the flow of oil that lead to an immediate spike in prices. As a result, firms that spend heavily on commodities must hedge against the risk of price increases. Many airlines, for example, hedge fuel prices years in advance to lock in prices and prevent the risk of a price spike that could erase margins.
Hiring Staff with A Global Perspective
Every firm is global. Even if a company is based in the U.S. and sells in the U.S., the raw inputs needed to sell goods typically come from overseas. Managing a global supply chain requires employees with deep knowledge of the markets in which the firm operate and the language skills to partner with local leaders. Managers with that background can best assess the local risk environment and devise preventative strategies long before protests shut down a factory. Companies such as Unit4 offer software that makes it easy for a global workforce to quickly share and access company data to make those critical decisions. A workforce with a global perspective helps ensure firms are nimble and able to quickly adapt to any incident.
The increasingly volatile geopolitical environment requires companies to develop effective resilience and business continuity plans. The average multinational has operations in over 100 countries and could face a wide range of possible disruptions. From protests to terrorism, even a limited work stoppage could significantly impact the bottom line. Managers need to devise redundancies in the supply chain to ensure that unrest in a single country or region doesn't threaten the firm's fiscal health. Managers also need to determine how they will respond to a localized disruption. Does the firm have contacts with local police or government offices? Can employees work remotely for an extended period of time? These questions need to be answered in advance. Perhaps most importantly, how will the firm recover and resume normal operations?
The types of risks that can impact a global economy, such as terrorism, civil unrest and possibly even a regional military conflict, can be financially ruinous. Firms may find that their capital-intensive assets are destroyed or otherwise inaccessible for an extended period of time. Fortunately, these types of risks have become common enough that companies can purchase highly specialized insurance. Major insurance providers now offer policies to protect against acts of terrorism, war or political risk. While costly, these types of insurance can provide firms with surety that they will be compensated if the worst should happen.
This article has covered some of the most common forms of geopolitical risk and should give CFO's an idea of the challenges they face operating in the developing world. While it's not possible to prepare for every contingency, a strong understanding of these risks and thorough planning can help limit the odds of business disruption. Ultimately, CFO's and the firm's they lead need to be nimble and able to quickly adapt to changing circumstances. That ability to thrive in developing markets where other firms stumble could prove a significant and lasting competitive advantage.