March 24, 2014 4:47 pm

When a haven harbours unseen risk

The British Budget illustrated how ‘safe’ countries are riskier for business than they look

If you had asked board directors at the beginning of last week which of two situations – the stand-off between Russia and Ukraine in Crimea, and the forthcoming British Budget – was politically riskier, they would have chosen the first. But for a few insurers involved in the lucrative business of offering annuities to pensioners, Britain turned out to be the more perilous place after George Osborne, the UK chancellor, astounded them by announcing reforms that could cut the size of that market by 90 per cent.

The Crimean crisis, for all its unpredictability, fits into the category of political risk that risk analysts love to analyse, risk managers to manage and insurers to insure against. If a capricious commander-in-chief orders men in fatigues in faraway places to do something that disrupts your supply chain or shuts down your factory, you may not like it, but the chances are you have braced yourselves for it. But if a minister in an industrialised country marches in and annexes your company’s profit forecasts overnight, it may come as a shock. It should not. “Safe” countries are riskier than they look.

Much recent economic growth has been concentrated in places where political and regulatory risk is high. Control Risks estimated the share of global output generated in riskier countries, coloured amber or red on its 2014 political RiskMap, had more than doubled to 35 per cent in the preceding decade. Multinationals have of necessity focused their investment and attention there. As a result, Richard Fenning, the consultancy’s chief executive, reckons boards now “fixate on political risk as what can be covered by a Lloyd’s of London insurance policy”.

Such an approach is understandable if you are Twitter, facing a ban in Turkey, Repsol, the Spanish company whose majority stake in Argentina’s YPF was nationalised in 2012, or Glencore, which has mining operations in volatile areas overseen by trigger-happy local authorities. Before listing in 2011, Glencore outlined potential geopolitical threats that included “terrorism, civil war, guerrilla activities, military repression, civil disorder, crime, workforce instability, change in government policy or the ruling party, economic or other sanctions imposed by other countries, extreme fluctuations in currency exchange rates or high inflation”.

“Risk factors” in companies’ share-listing documents are a bit like “may contain nuts” labels on food products – worthless to allergy-prone investors until their shares go into anaphylactic shock, at which point the company can say: “You can’t say we didn’t warn you”. But even so, it is significant that the political risk sections in the 2013 prospectuses of Partnership Assurance and Just Retirement – the two British annuity companies worst hit by last week’s Budget shockwave – consisted of virtually identical cut-and-paste legalese. The assumption was that the main threats to their business would be regulatory and incremental, not legislative and far-reaching.

G7 countries undoubtedly look like more stable places to do business than, say, Argentina, Turkey or Russia. But ask the directors of BP, HSBC and Standard Chartered – all of which have been flagellated by the American public and politicians following recent operational disasters – whether they assessed correctly the political risk of investing in and trading with the US.

Similarly, most executives would have listed Scottish independence or British withdrawal from the EU as outside chances until a few years ago. Now, even General Electric – a multinational that knows a lot about political risk – is giving warning about the potentially unpleasant consequences of Scotland breaking away or Britain quitting the EU. With a UK general election next spring, boards should be modelling the risks of potentially sweeping changes in energy and immigration policy, too.

Last week’s unexpected pension reform “probably has got a number of risk officers readjusting how they think about political risk”, one affected insurer’s head of risk ruefully admitted to me. But political risk equations should always multiply the scale of investment by the likelihood of a government springing a surprise. One salutary and important lesson is that even in supposedly safer countries – which, after all, still account for two-thirds of output – not every political risk is manageable, insurable or even predictable.
Twitter: @andrewtghill

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