POLITICAL RISK: Eastern horizons

The Middle East has proven to be a politically volatile and unpredictable part of the world but remains a crucial region for many firms. Balancing risk and opportunity is as important now as ever, writes Martin Allen-Smith

By any standards, 2019 proved to be a turbulent year for doing business in the Middle East. Several countries were shaken by unrest and protests, there were increased and very significant risks to international shipping in the Strait of Hormuz, the Syrian civil war continued relentlessly, and, indeed the most worrying of all at the time, there was the very real threat of conflict between the US and Iran.

Against this backdrop of everchanging political landscapes, where are the key hotspots in the Middle East to have proved a particular challenge from a risk management perspective – and how can organisations best prepare for the often dramatically shifting sands in these areas? It is fair to say that the Middle East and North Africa has the full gamut of risk environments, like other regions – from low risk jurisdictions like Morocco and Jordan, to extremely high-risk countries like Yemen and Syria. Operators and underwriters with exposure in those facing political stability challenges like Iraq and Lebanon need higher risk thresholds than elsewhere, says Niamh McBurney, head of MENA at Maplecroft.

“Amid often fast-paced events, it’s important to clarify what is new in the situation and then assess how it relates to you. A change in government will not always bring an immediate change in regulations, and political instability or civil unrest doesn’t necessarily prompt business disruption,” she explains.

“For example, protests in Egypt in September 2019 were small, contained and did not disrupt business operations. Short-term exposure to an asset in Yemen might seem like a risky bet – unless you know that the asset’s location has not been materially affected by the civil war. Doing your due diligence and having a full understanding of your operating environment – the site, the country, the region – is key.”

She adds that Iraq offers rewards to those willing to take big bets on risk management and Egypt’s restructuring of its economy between 2016 and 2019 was challenging for those exposed to the banking sector – effectively all foreign operators, investors and underwriters.Organisations doing business in the region need to have a comprehensive mix of knowledge and flexibility if they are to ensure that they are in a position to act quickly should political tensions arise in a particular country or region.

If political tensions look like they could become disruptive, securing their assets – whether physical or financial – clearly comes first. But organisations need to know the local laws first to do that effectively. It is one thing to understand the past, and another to know the future, says McBurney. “Knowing the history of confiscation, expropriation, nationalisation and disruption (CEND) combined with a deep understanding of local political dynamics allows you to assess how risks to your assets will change. Take Lebanon’s recent sovereign bond default – its credit history would suggest it would successfully repay to foreign bond holders and their underwriters, but looking closer into the political dynamics right now, politicians were not willing to repay international lenders at the expense of the domestic banks, because it would hurt friends and family members of the political class.

“Geopolitical or regional events, political spats or pivots in alliances, most often lead to very subtle changes for those on the ground, but being aware of those changes can be the difference between an opportunity and a loss later on.”

The wider political risk landscape is becoming more precarious, according to the results of a survey by Willis Tower Watson. It asked 41 major corporations for their take on the global picture and the general view was that such risks had increased during 2019. Disruption of international trade was considered the most significant risk in the majority of regions. Fifty-eight per cent of respondents cited trade sanctions as a concern for their operations in Europe, 67 per cent in Asia-Pacific, while for Russia and The Commonwealth of Independent States, the figure was 77 per cent. Concerns about political violence were the highest in Africa (74 per cent) and the Middle East (71 per cent), with respondents reporting that new technologies such as drone strikes could exacerbate such risks.

2019 also saw an increase in the proportion of companies reporting that they had experienced political risk losses, according to the research. Fifty four per cent of respondents had experienced a loss due to political violence, compared with 48 per cent in 2018. Some 46 per cent reported losses due to trade sanctions or import or export embargoes in 2019, compared to 2018’s figure of 40 per cent. Almost a third of companies with revenues exceeding US$1 bilion reported previous experience of a catastrophic political risk loss of more than US$250 million.

“It is clear that political risk continues to increase, and that related financial losses are on the rise,” says Paul Davidson, chairman of financial solutions at Willis Towers Watson. “Corporations now face a strategic choice: to either maintain their global business models while accepting, mitigating or transferring the political risks associated with them, or attempting to realign themselves with the emerging shape of a new and apparently more nationalist global landscape.”

The majority of respondents (71 per cent) stated that emphasis on political risk management at their company had increased since 2018, and nearly 40 per cent felt that they were facing more pressure from investors regarding political risk management. The study included in-depth follow-up interviews with a panel of survey participants, whose top risks of concern included Middle East regional stability, alongside US/China strategic competition and the potential for an environmental/social/governance shock.

Of course, no region sits in isolation, and the situation in the Middle East often reflects the worldwide geopolitical risk landscape. So how have recent global shifts affected things, and where does the Middle East currently sit compared with other regions in terms of risk and complexity?

Certainly the ripples of domestic and foreign policies of the US, Russia and China all have an effect on the Middle East. Maplecroft’s McBurney believes that changing US policy towards the Middle East was one factor in Gulf states like the UAE and Saudi Arabia increasing the share of their oil exports to China and other major Asian consumers: “Combined with the boom in domestic tight oil production, the US now considers itself effectively energy independent – an extraordinary change from just a few years ago which robs the Gulf states of a market and reduces US exposure to the region. Robust governments without fully democratic systems provide more stability in some ways than in other regions like Latin America.”

There remains long-term concerns over some of the economic conditions that have made some gulf states such attractive propositions in the past. The International Monetary Fund warns that without widespread reforms, the region’s oil wealth could vanish by 2034 as global demand for oil slides. It suggests that some of these oil-rich countries will need to rationalise spending, reform their large civil service sectors, and reduce public wage bills – all of which could be delicate issues that risk having an adverse affect on citizens who are more accustomed to subsidies and low taxes.

But McBurney adds: “The underdeveloped regulatory environment and extensive presence of government-owned businesses in key sectors makes the region less dynamic – but this is starting to change. The region’s position in the energy supply chain and increasingly in the renewable energy sector means it will continue to be influential for the next several decades.”

Of course, no-one knows yet how any of the conventional norms will be transformed in a post-COVID-19 world, but it is likely that, despite the risks, the Middle East’s role as a pivotal business focal point for many global organisations will remain for a long time to come.

This article was published in the April 2020 issue of CIR Magazine.

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