Dealing with political risk: What FTSE-100 companies say

Financial Services

Political risk takes many forms and is not easily defined, but it is high and rising by just about any standard. Governments are under pressure or have been forced out of office in countries as far apart as Venezuela, Brazil, Turkey, South Africa, Malaysia and Thailand. Armed conflicts have becomes entrenched in the Ukraine, Syria and the Sahel. Geopolitical tensions are high in the South China Sea, between Iran and the Gulf countries, and between North Korea and neighbouring states. The number of terrorist incidents recorded in 2014, the last year for which data is currently available, was nine times as high as in 2000.

It is not just emerging and developing countries that are the sources of political risk. Populism is on the rise in Europe, with mainstream parties being squeezed in recent elections in Spain, Austria, and Germany. Migration has become a toxic political issue that is overriding and distorting other policy decisions by governments. The UK may soon choose to leave the EU, with uncertain consequences. In the US, the primaries for the presidential election have been more polarised than at any time in recent memory, with protectionism and populist policies moving to the centre of the political debate.

The prevalence of political risks, the varied forms they take, and their changing nature are complicating the business environment for many firms, particularly those with a large international presence. In this report we assess what FTSE-100 companies are saying about political risks in their annual reports. Our aim is to identify the most important sources of political risk, to see how this varies across sectors, and to establish the different ways in which companies are responding to these risks.

The analysis is intended to be useful for the companies themselves as they seek to improve their capability to identify, evaluate and mitigate political risks. It may also be helpful to investors who want to understand how their exposure to political risks is correlated across sectors and which companies appear best able to manage political risk. It also provides a resource for policymakers who want to reduce political risks.

Under the Companies Act (2006) annual reports must contain “a description of the principal risks and uncertainties facing the company”. This creates a legal obligation to report on political risks, if these are among the principal risks, although there is no obligation to identify which risks might be regarded as political, or indeed any established methodology for doing this.

In this report we make two methodological innovations. One is to look both at what we call hard and soft political risks. Hard risks are from security threats, political instability and geopolitical tensions. Soft risks are from significant changes to regulation, fiscal policies and the way legislation is enforced that at least in part reflect political pressures. We also look at a third category of risk – Europe risk – which has both hard and soft elements and is sui generis. The other innovation is to distinguish between generic descriptions of risk – sometimes in list form – and specific risks, which typically refer to a particular country, event or aspect of policy. As we show in the following sections these distinctions are critical to understanding who is exposed to political risk, where, and how they are responding.

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