Geopolitics, corporate governance and ESG

Derek Leatherdale and Hanif Barma from the Risk Coalition identify in this article the key things that any board or risk committee should consider in the context of the complex and volatile geopolitical environment in which business now operates.

Russia’s invasion of Ukraine has already led to untold tragedy as we have seen on news channels and social media.  The personal cost for the people of Ukraine is immense and this is clearly at the forefront of our minds.  There are also, though, ramifications for organisations and individuals much further afield.

Although these recent events have particularly brought the impact of geopolitics into much closer focus, corporate surveys have for some time been demonstrating that business leaders and board members have been well aware of increasing global geopolitical volatility.  These survey results are, however, not surprising.  Firms who globalised their market footprint and supply chains in the last three decades have found themselves now operating in a substantially more antagonistic geopolitical environment.

Deteriorating US-China relations has also been high on the risk list, with trade wars, sanctions and financial and geo-economic measures in key industry sectors like technology, financial services and strategic commodities.  Continued concerns about Hong Kong, and increasingly militarised disputes over Taiwan and maritime sovereignty in the South and East China Seas have been factors driving this.  In the Middle East, new tensions drive the kind of volatility long associated with the region.  The politics and fiscal arrangements of the Eurozone remain unsettled, while concern has risen in recent years about domestic politics in the US.  Emerging markets elsewhere in Asia, Africa and Latin America remain characterised by political and socio-economic challenges.

Geopolitical risk has therefore become a challenge across much of the global economy.  Conflict in  Ukraine and the pandemic’s long-term macroeconomic and fiscal impacts have accelerated and exacerbated these trends.

The same corporate surveys also show something else.  A majority of boards and management teams do not feel confident in their internal capabilities to interpret fast-moving geopolitical events or judge how these might impact their firms.  The absence of this capability makes it impossible to consider effective impact mitigation or to enable effective business preparedness and resilience.

Geopolitics increasingly cuts across the ESG landscape for corporates too.  For instance, analysts often suggest climate change is likely to drive scarcity of key transnational resources like water or generate destabilising migration flows.  As the absence of major nations at the COP26 summit also showed, geopolitical friction is undermining the multilateral public policy response needed from the world’s biggest CO2 emitters to restrain rising temperatures.

Other factors mean geopolitics also increasingly underpins ESG dynamics.  For instance, a US government report published in October 2021 concluded that… “Competition will grow to acquire and process minerals and resources used in key renewable energy technologies.  China is in a strong position to compete; it currently controls more than half the global processing capacity for many of these minerals… including rare earths for wind turbines and electric vehicle motors; polysilicon for solar panels; and cobalt, lithium, manganese, and graphite for electric vehicle batteries.”  Meanwhile, Ukraine has substantial natural resource reserves and is one of Europe’s major agricultural producers.  Russia meanwhile, of course, is major energy supplier to Europe.

So how does this complex and volatile backdrop affect business more broadly?  Observers tend to think primarily of geopolitics as either disrupting supply chains or exacerbating cyber risks.  While these are certainly pressure points for some firms, the impacts go much wider.

Political and economic sanctions aside, geopolitical volatility and the associated use of ‘business as usual’ geo-economic policy measures like tariffs and investment restrictions, degrade the macroeconomic conditions and industry sector performance on which corporate strategies are based.  This volatility can also disrupt key consumer or client segments for firms, while longer-term political uncertainty undermines investment strategies.  The increasingly complex crossover with corporate ESG agendas also creates additional reputational pressure on firms with key external stakeholders such as investors, regulators and NGOs.

Geopolitics therefore has consequences for organisations’ balance sheets and financial performance, as well as for operational and non-financial risk and control functions.  Some of these areas are new, but geopolitics is equally capable of exacerbating risks an organisation already recognises.  This means the geopolitical challenge for firms may be as much to optimise existing risk management frameworks and tools as it is to create entirely new capabilities.

In this context, how can boards of international and national companies – both inevitably are impacted by geopolitical developments – ensure their organisation remain resilient?  Who in the organisation should have the leadership and oversight responsibilities in this area?  What analytical capabilities do businesses need to anticipate geopolitical risks and their impacts, including on ESG deliberations, and how should these be deployed internally for maximum effect?

Recent guidance from the Risk Coalition and GRI Strategies, entitled The Extra G – ESG2, has been developed to support boards address the challenges posed by geopolitical risk.  It sets out how boards can make better use of their risk oversight committees and risk functions to improve oversight of geopolitical and related ESG risk, within a framework spanning accountability, risk culture, the integration and deployment of specialised analytical capabilities and expertise, and the interface with corporate strategy setting.  The guidance is supported by examples of emerging corporate practice in this area and a self-assessment tool, GABI-GEO which allows board members, management teams and heads of risk in firms to identify whether internal approaches reflect best practice and what practical actions could be taken to improve these.

In essence, there are a number of key things any board (or their risk oversight committee) should be doing, including ensuring that:

  • their oversight and challenge of management’s approaches to principal and emerging risk issues, as well as the building of organisational resilience, have a geopolitical dimension – including focusing on second and third order impacts
  • its members amongst them possess the necessary expertise and specialist skills to understand the geopolitical dynamics – or that they have access to these skills
  • their organisation’s risk appetite is regularly updated in the light of current or potential geopolitical developments
  • they ensure their risk information they receive takes into account geopolitical matters of concern to the business
  • their risk function and risk management activities regularly consider geopolitical matters and their impact on the business

As the geopolitical environment becomes more ‘competitive’ – the euphemism used by diplomats and political analysts to describe the trajectory of the geopolitical environment over the next two decades – business is increasingly affected.  This is not all downside – geopolitics can also generate commercial opportunities for agile firms.  The Risk Coalition’s ESG2 guidance gives boards and senior business leaders the guiderails needed to consider these issues systematically, develop resilience strategies and enhance decision-making to successfully navigate a more challenging macro environment.

 

Derek Leatherdale is founder of GRI Strategies and an Associate Director of the Risk Coalition.  Hanif Barma is Co-founder of the Risk Coalition and founder partner at board governance consultancy Board Alchemy.  More information about the Risk Coalition and ESG2 is available www.riskcoalition.org.uk.