The rapid speed in the rise of geopolitical risk will come as a surprise to some people. For others, it will be less of a surprise, although you might be asking whether your firm is adequately prepared to withstand the potential consequences of threats posed by elevated levels of geopolitical risk. And for most of us, the heightened state of geopolitical risk will bring back memories of January 2020, at the onset of the COVID-19 pandemic, when most of us knew life was about to change but had no idea to what degree.

Unlike the COVID-19 pandemic, the escalation of geopolitical risk has gradually increased in the past three decades. The use of sophisticated and focussed cyber-crime tactics by nation states to steal competitor state secrets and disrupt critical national infrastructure provided an early indicator of the escalating geopolitical risk profile. However, as the balance of power between the east and west escalates, new forms of geopolitical risk will evolve, such as acts of war, trade wars, market manipulation, physical threats and more. To understand what is behind the evolving geopolitical risk profile, we need to explore the drivers behind the rebalancing of global powers and influences.

The rise of China

Undoubtedly the most considerable influence in geopolitics is the rise of China. There are both defensive and offensive reasons for China’s rise as a global power. The Chinese government wants to make sure the country can never be invaded and colonized as it was one hundred years ago. At the same time, the Chinese government want to restore the country as a great power. Few people will dispute China’s progress on both fronts.

China’s elevation as a global economic and military power started in the 1980s, as China restructured internally to focus on becoming the world’s production base providing benefits to the west that underscored objectives of capitalism. The Chinese government initially sponsored the relocation of 300 million rural workers into cities to take positions in factories that often required working in inhumane conditions (occasionally referred to as “sweatshops”).

The Chinese government invested in building industrial hubs that have since led to China becoming a major global power across the buy and sell side channels of the global economy. Perhaps most significant is China’s position as the world’s supply chain hub. This position provides substantial cash inflows demonstrated through China’s trade surplus which reached $676 billion in 2021, up from $524 billion in 2020[1]. By comparison, the United States generated a trade deficit of $859 billion in 2021. China’s sustained and rapid growth has resulted in China becoming the second largest economy, with 2021 GDP of $16.9 trillion versus the United States at $22.9 trillion[2].

The Chinese government realised the importance of accessing technological capabilities that would allow the country to leapfrog conventional development cycles. A good example of China’s rapid technological advancement is demonstrated through the rollout of high-speed broadband. As opposed to connecting the country through the installation of conventional telephone lines, the government funded a nationwide installation of fibre optics. This decision encouraged, amongst other drivers, foreign firms to move into newly industrialised cities with access to stable, fast, and resilient broadband infrastructure. This helped create a competitive advantage for China as a place to do business compared against other developing nations. As firm’s entered China, they bought industrial, manufacturing, and technological capabilities with them. As the Chinese economy developed, western firms have been unable to ignore the growth potential presented by a country with 1.45 billion people.

The rise of China has led to China assuming a position of significant global influence. This position will allow China to further extend its global footprint whilst inserting its ideologies in areas of the world where it has gained a dominant position. Early signs of this can be seen in the way China has altered the rule of law in Hong Kong, and political assertions regarding the government’s willingness to use military action to regain control of Taiwan. China’s enhanced technological military capabilities were demonstrated once again in October 2021, following China’s test of a hypersonic missile with the ability to carry a nuclear warhead.

China’s multi-factored growth strategy provides a steppingstone for China to take a more assertive geopolitical stance, leading to greater levels of Chinese influence in setting of global standards and governance.

A new Middle East sheriff is in town

The second important trend influencing global geopolitics is the retreat by western nations from Middle East and Central Asian nations subjected to prolonged miliary campaigns. The 2011 Arab Springs offered a glimmer of hope for millions of people across the Middle East and North Africa, with aspirations of political order and a brighter economic future after decades of civil wars, economic stagnation, and political corruption. This hope had faded by mid-2012 following violent and deadly government reactions. The Arab Springs gave way to the “Arab Winter”, underscored by protracted civil wars across various Arab nations, such as Syria, Iraq, Yemen, and others.

The scale of poverty and destruction that has gripped some Middle Eastern nations in the past two decades coincides with progressive deterioration in appetite amongst western states to intervene. This was most recently demonstrated by the west’s rapid exit from Afghanistan which has since allowed the Taliban to take back control. Additionally, the decision by the US and UK governments in 2015 to limit intervention in Syria to focus on mitigating the Islamic State terrorist threat as opposed to protecting the rights of Syrian people after years of war between the Syrian government and terrorist factions, provided an earlier indicator of the declining appetite for war amongst western nations. This pattern has occurred at the same time as China and Russia have transformed their economic and military capabilities.

Russia and Syria have maintained close relations for over a century. In the late 1950s, Syria was the second state to purchase military hardware from the then powerful Soviet Union. Fast forward, and Russia played a pivotal role in attempting peace negotiations in Syria following the outbreak of civil war in 2011. Unlike the United States who excluded some rebel factions from negotiations, Russia successfully bought together rebel factions to sit next to the Syrian government in an attempt to negotiate a peace accord. The bond between Russia and Syria is long, distinguished and by no means insignificant. Syria provides Russia’s only Mediterranean naval base for its Black Sea Fleet.

To look at the situation through another lens, China’s involvement with Afghanistan has gained momentum in recent years and stands to benefit further from the west’s retreat from the country in late 2021. On one hand, China is rightly concerned about the potential rise of new terrorist factions. Any further escalation of civil unrest will add to existing migration pressures as people flee for safety. On the other hand, China’s involvement with Afghanistan could be seen as more sinister. China’s policy of asserting political influence through infrastructure investments, loans, and other state backed programmes is well versed. Few people can argue with China’s unparalleled capabilities in industry and infrastructure building. Afghanistan offers another platform for China to expand its political leverage by providing financial investment to a state in desperate need of financial aid. Added to this is the knowledge that Afghanistan could be sitting on $1 trillion of untapped lithium reserves. These reserves could become critical to China as it continues to balance its position as the world’s largest supply chain hub whilst creating its own industrial powerhouses able to challenge and compete with western peers.

As western nations retreat from years of military conflict across the Middle East and Central Asia, new opportunities for Russia and China to assert political and economic leverage will open across the region. And whilst Russia and China do not share the same ideals, which could become problematic in the future, recent public announcements demonstrate their support for their respective foreign policies and their willingness to work together to bring an end to perceived overassertiveness in western influences. In many respects, historical experiences have provided a rich source of learning for China and Russia. By working together, they are less likely to repeat the same mistakes.

What does this mean for firms in the future?

The geopolitical risk profile for firms across industries has become material, with potential conflict between Russia and Ukraine, China and Taiwan raising geopolitical risk to levels unseen since the Cold War era. Firms must prepare for heightened – and potentially further deteriorating – levels of geopolitical volatility in the coming years as global governments adjust to changes in the balance of power between the east and west. Firms should review current geopolitical risk management standards and processes to evaluate whether quantitative and qualitative risk assessments provide sufficient insights to the potential strategic, financial, operational, and reputational impacts of applied geopolitical risk scenarios. Firms should consider how the applied scenarios could influence other risks within their risk taxonomy, often referred to as “secondary risks”, such as:  

• Greater, more frequent, and broadening use of sanctions regimes requiring firms to be more prepared and adaptive to sudden changes in sanctions.
• Rising levels of social risk as social movements take aim at firms deemed to be cooperating, supporting, or appeasing Russian or Chinese political policies and/or state-backed firms.
• Increased sophistication cyber-crime with more frequent attacks on critical national infrastructure and other firms providing the opportunity to cause material harm to the public.
• Increased trade restrictions as western nations adopt policies designed to protect national security and the orderly functioning of markets.
• Sudden and prolonged disruption to critical supply chains.
• Higher security risk for board members and senior executives of significant firms who present potential political leverage.
  
  

Be prepared

Geopolitical risks are notoriously difficult to prepare for given the unpredictable nature of how circumstances can evolve. Scenario analysis provides a framework for firms to articulate and assess potential risks and impacts.

Given the heightened level of geopolitical risk presented by current affairs – namely the potential for military conflict between Russia and Ukraine, China and Taiwan – applying good practices of risk management will help firms prepare for what could be the next global crisis. The list below presents some suggestions.

• Establish a shortlist of geopolitical risk scenarios designed around current affairs with consideration given to both probable and extreme but plausible scenarios.
• Evaluate your firm’s risk appetite framework to determine whether expressions of risk-taking against established geopolitical risk scenarios are sufficiently articulated, with defined quantitative and qualitative risk measures, management and board-level reporting requirements and escalation thresholds.
• Undertake a structured risk assessment against each geopolitical risk scenario considering attributes such as risk likelihood, impact severity and importantly – the speed of onset (e.g., the speed at which the peak of a risk could surface). Reference your firm’s risk taxonomy to promote a comprehensive assessment of primary and secondary risks. The speed of onset is an important consideration given the lightning speed at which geopolitical risk events can unfold, such as supply restrictions, targeted cyber-attacks, disruption of critical national infrastructure, physical threats, etc.
• Given tendencies to overlook strategic risks, assess the business strategy and plan, including underlying assumptions and interdependencies, to identify strategic investments and initiatives most vulnerable against each geopolitical risk scenario.
• Segregate each risk into logical buckets, such as “prevent”, “reduce”, “transfer” or “monitor”. A similar activity could be undertaken for strategic investments and initiatives deemed vulnerable to change, such as “stop”, “pivot”, and “continue”.
• For the highest rated risks, identify, document, and evaluate current controls to determine the adequacy and effectiveness of the control environment to containing the impact of risks within stated thresholds of risk appetite and impact tolerances.
• Assess whether identified control gaps require capital investment and/or re-prioritisation of resources relative to the residual risk profile of each geopolitical risk scenario.
• Set requirements to monitor, adapt and report changes in the structure and risk profile of each geopolitical risk scenario. Be clear on defining processes to be applied when changes occur in any of the applied geopolitical risk scenarios and/or monitoring outcomes (e.g., where the likelihood of a scenario materialising exceeds a probability threshold).
• Evaluate the efficacy of data sharing and communication within and across your firm, including executive management and board members.
• Evaluate the effectiveness of your firm’s gold incident and/or crisis management response by running a scenario exercise to prepare board members, executives, and other key staff in responding to and recovering from a geopolitical incident. Scenario exercises should test the clarity of roles and responsibilities, situational awareness, organisational interdependencies, internal and external communications, information needs (including physical or virtual war room requirements), and pre-determined decisions such as travel bans, staff repatriation, activating contingency supply arrangements, capital preservation, and so on.
  
  

Proactive, open, and consistent engagement with executive management and the board is critical to promote awareness and the opportunity for challenge of applied geopolitical risk scenarios; an understanding of risk assessment outcomes; and management direction regarding the treatment of risks relative to your firm’s risk appetite and impact tolerances.

No regrets

The balance of power has escalated geopolitical risk as a leading risk. Firms across industries must adapt to the realities of a heightened and sustained state of geopolitical risk.

How prepared is your firm? Unlike the COVID-19 pandemic, you will not be able to say you did not see it coming.

[1] China Balance of Trade – January 2022 Data – 1981-2021 Historical – February Forecast (tradingeconomics.com)
[2] World GDP Ranking 2021 – StatisticsTimes.com