Australia: The impact of geo-political risk on business

John was asked to deliver the key note address at the General Counsel Summit held Tuesday 3 May to Wednesday 4 May 2016.

John spoke on the topic of "The impact of Geo-Political risk on Business".

Introduction

Why on earth am I speaking to you about this subject today?

It is well understood that strategy formation involves understanding how possible futures will affect present behaviors and actions.

Volatility and uncertainty are constant concerns for anyone thinking strategically about their operations and will increase now and in the future. How you participate in strategy formation is a challenge to all executives – including general counsel.

McKinsey & Co in its 2105 end of year survey of the key issues worrying the c-suite in relation to economic growth, identified geo political risk and its consequences as the number one concern.

When we talk about geo political risk what we really mean is why is the world behaving as it is and what does that mean for our future.

Increasingly GCS – because of your seniority and quality, are part of the executive teams of your organisations and are asked to participate in strategy formation.

Ceos are now increasingly asking you to help your organization to help 'see around corners' and bring an understanding of future directions to help your organisations manage and take advantage of risk.

So if your c-suites are worrying about geo political risk we, as advisers who claim to be client driven, must offer a perspective on geo political risk. Hence, my discussion today.

Friends, we live and work today in a complex, multi-player globalized world.

We are all affected by the complex economics and politics of the 21st century.

No nation, no company and no citizen is immune. Even businesses that are purely domestic are affected by the forces in play.

There can be no such thing as a by-stander.

Now - there is no doubt that globalization has brought many benefits, and these are well understood.

And putting it at its most positive: we live in a time of inter-connectedness that is exciting and full of opportunity.

But as it has evolved, globalization has also brought major downsides, increasing risks, and a surging need and demand for change.

For Australian-based companies and organisations and global companies represented here - like the ones we work for, advise, and represent, the complexity is only growing.

I believe the context in which we operate will continue to change to reflect the shifting circumstances we find ourselves in. Understanding that changing context is critical.

We need leaders who will be capable of understanding and managing the risks and challenges of this stage of globalization with foresight, wisdom and skill across governments, business and civil society.

So let me explain this changing context:

The post-war consensus

Following the great depression of the early 20th century, and the upheaval of world war 2, a studied and careful rebuilding of the world's economies through the "bretton woods consensus" and its like led to the creation of institutions (like the world bank) and economic programs that helped shattered economies get back on their feet. Essential to this project was a 'citizen bargain'. Citizens were brought into the post-war recovery project through widespread investment in education, social welfare and government assistance.

This proved to be the ideal way to ease fears of change and win support for the massive structural reforms necessary to rebuild the global economy.

The bargain began to break down in the 70's, 80's and 90's with the further opening and liberalisation of economies, that enabled what people are now calling globalisation 1.0.

The argument put to nations and citizens was that this further opening would not require the same safeguards as before. The trickle-down of wealth would help everyone rise in prosperity.

Globalisation 1.0 certainly did help the global economy grow. It saw China, India and the former USSR open up and billions of consumers enter the global economy and enabled the extraordinary technology revolution which helped change the way we work and live.

And yes, it took millions out of poverty and alleviated, on average, global inequality. But an unintended consequence was that it also allowed inequality to be exacerbated, particularly in first world developed economies. It led for example to the creation of the famous 'one percent.'

And there are consequences of that – many of which are unintentional and challenging and result in increased legal risk.

Citizens – of course - understand that inequality will always be with us but what citizens in developed economies resent and reject is inequality as a consequence of what they believe are rigged rules.

Populist politics are on the rise because there is a strong sense amongst citizens in developed economies that the rules are rigged in favour of a small elite. Citizens are evidencing an impulse to opt out of the global system – as in the push for brexit, or the trump call for America-first or calls to close borders and stop foreign investment.

Companies find themselves competing against free riders who are ruthlessly willing to avail themselves of tax evasion.

The system is seen by many to overweight investor rights against citizens rights. Bad governments have prospered. And the environment has been a major loser.

Meanwhile the will to find global solutions has become weaker or at least less effective. Last year the un world food programme (wfp) was forced to halve the value of food vouchers for the 6.5 million vulnerable Syrian refugees in southern Turkey, Lebanon and Jordan because of a severe lack of funding. Can we be surprised that so many are on the march and climbing on perilous boats?

Globalisation is not a static concept: it evolves.

This has led to what people now call globalisation 2.0. It is about fighting to maintain economic growth through behind the border reforms - despite a push to close those borders and the risk of economic nationalism and new forms of protectionism.

And achieving behind the border reforms are really subject to domestic political debates.

Arguably the very process that brought the world closer together – i.e. Globalisation - is now driving us apart. The lack of muscular institutional architecture to support contemporary globalisation was shown in the crisis of 2008 when the extraordinary inter-dependencies that underpinned globalisation 1.0 proved to be fragile and the global economy almost collapsed.

Three factors of globalisation

There are three factors relating to the evolution of globalization that are particularly worth noting here today – because they have forever changed the role of corporations in geo-political affairs, and brought corporations into the realm of far higher risk.

First, over the past few decades, industrial concentration has occurred in almost every sector, from cars to computers to beverages to luxury goods.

With globalization, the number of leading firms in most sectors has shrunk significantly. And it's not only the industrial sector. (we all know what's happening with law firms for example).

These top organisations sit at the summit of complex global supply and value chains, with companies all around the world competing to feed into those supply chains as producers and distributors.1

A failure at any point along the chain can affect the reputations and the fortunes of all its players – it might be a fire in a textile factory in Bangladesh, or an industrial accident in south America, or an animal cruelty video made in Indonesia, or the hacking of a law firm in panama.

Incidents that once might have been isolated in their impact, now ripple across global supply and value chains in dramatic and often unexpected ways. Enabled by the application of the digital platform that can make every citizen with a smart phone an activist.

Second, the value of the very largest companies is enormous, equivalent to the gdp of nation states. If apple were a nation, it would rank about number 55 in the world. Although this may have changed following its share price slump last week. And the slump followed a major investor's sell-down over concerns about china unilaterally limiting apple's access to its market. Which in turn has led to a broader market sell-off. Another example of the fragility of the times.

Meanwhile and third, corporations are now rightly regarded as pivotal and in some cases even central actors in our democracies.

For example in the 50's the financial service sector was described as the "hand maiden" to the real economy. It is now described as central to many economies with new responsibilities and challenging expectations as a consequence.

Governments are well aware that the fortunes of their large corporations – and those of their companies that depend upon access to global supply and value chains - will dictate their own broader economic and electoral outcomes.

A quick proof point – only last week the decision by one hedge fund owner to move his headquarters from new jersey to miami caused new jersey to write down its tax receipts and revise its budget.

Citizens, on the other hand - feeling disenfranchised from the benefits of globalization - are becoming deeply suspicious of "big" companies with their enormous influence.

'Big company/big end of town' are now forms of political invective.

Here in Australia we have strong governance systems and good regulatory agencies. Yet perceived serious or serial lapses in performance can trigger social and mass media outrage, big public protests, calls for stronger regulation, and even calls for royal commissions and senate inquiries.

All of these broad trends and developments form our current context and have important legal consequences for corporations. So you general counsel, more than most corporate executives, will play an important role in managing the nature, scale and impact of this new era of geo-political risk.

Indeed, we all need to be alert and informed if we are to navigate this era successfully.

New trade arrangements

Take, for example, the plethora of international trade and investment agreements that are currently in play.

At one level all these new arrangements might be seen as – and may well contribute to – paths towards enhanced global peace and prosperity.

But it's not hard to detect the long-term geo-political ambitions driving these economic deals – for dominance in central Asia, or across the Pacific, or in Europe. And the forces of counter-globalisation that could arise from them.

The USA, for example, is undoubtedly and legitimately pursuing its commercial and political interests via the trans-pacific partnership agreement that Australia recently signed. In addition it is now negotiating a trans-atlantic trade and investment partnership with the EU.

The counter globalisation groups are out in force claiming that these negotiations are being conducted in secret and driven by the interests of giant us global companies at the expense of europe's local communities, cultures and citizens.

China too is in the international trade and investment business advancing its political and economic interests. It has its 'one belt, one road' strategy, building infrastructure on the westward land route from china through central asia and on the maritime routes from china through southeast Asia and on to south Asia, Africa, and Europe.

Australia is a member of China's new asian infrastructure development bank (against the wishes of the USA). And China, along with its BRIC partners - Brazil, Russia and India – is leading the way on a new BRIC development bank.

Then there's the Shanghai Cooperation Organisation, founded by China, Russia, Kazakhstan, Kyrgyzstan, Tajikistan, and Uzbekistan. India and Pakistan are en route to full membership, with Iran and others to follow.

Meanwhile Russia is also the driving force behind the eurasian economic union, located primarily in northern Eurasia with Belarus, Kazakhstan and Armenia and Kyrgyzstan.

And while we can see how companies may win from the new arrangements, it's not hard to imagine that they might also find themselves either locked into legal obligations that are not of their choosing, or locked out of some markets altogether, as the world returns to its old model of spheres of power and influence. Reflecting on regional trading blocks - if history tells us anything – a great power conflict may lurk beneath.

And what might this conflict look like? And what are its risks for us?

Economic and technological tools

When governments want to attack, threaten or undermine other nations they no longer need to rely primarily on military intervention. They have a range of other arms-length mechanisms at their disposal.

Some examples of this:

  1. The term 'weaponization of finance' was coined by political scientist and risk expert Iian Bremmer. He's talking about nations using financial incentives (like access to capital markets), and financial penalties (such as various types of sanctions) as tools of geo-political power.

Take the United States, which has shown how ready it is to limit access to the us marketplace and to the us banking system in the interests of its foreign policy and security objectives.

It's not hard for companies to get caught in the cross-fire.

In 2014, BNP Paribas was fined billions of dollar for violations of us sanctions against Cuba, Sudan, and Iran. This in turn created tensions between the US and France.

  1. Last year the pentagon announced that it would update its cyber- strategy in order to combat perceived threats from countries like North Korea, which had used hackers to attack sony pictures entertainment. The US was quite clear that it would retaliate against cyber-attacks from anywhere using cyber and 'other means'

And the US security establishment is clear that there is no way China based cyber attacks on corporations can be stopped. They may be slowed but they cannot be eradicated. The fundamental nature of the Chinese state and the control of the party requires that all organizations and citizens including chinese lawyers support chinese national interests. Any organization that believes the opposite is putting it self at risk.

  1. And what about the prospective use of the us foreign & corrupt practices act as a trade weapon. How to establish a potential nexus with Australia based corporations is being examined to enable us department of justice led investigations to test compliance of Australian companies with the FCPA as a way of levelling the costs of us and other international US FCP compliant corporations against the perceived advantages of non US FCP compliant Australian corporations. Expect to see the extra territorial reach of the FCPA tested presently in Australia.
  2. Trade sanctions

Also last year, Turkish fighter jets shot down a Russian warplane near the Syrian border, claiming the Russians had violated Turkish airspace. Russia did not retaliate militarily. It didn't have to. Instead it punished the Turkish economy. Turkish farmers lost established markets in Russia, and the Russian tourism trade to Turkey evaporated.

  1. The manipulation of forced migration

Meanwhile Turkey, a relatively weak country, has developed disproportionate power over a nervous Europe because at any time it could throw open its borders to thousands and even millions of refugees and economic migrants eager for better lives in Europe.

Citizen activism

So far we've talked about high level alliances and partnerships; the force that can still be exerted by major powers, and even the capacity of relatively weak nation states to exert geo-political influence.

In addition we know all too well the power of non-state actors like al quaeda and ISIS to threaten and disrupt democratic life and economic stability across the globe.

But there's another force at work, too. Citizen activism. From the arab spring to the umbrella movement in Hong Kong, young, educated people with access to the internet are campaigning for freedom and rule of law.

The results have been mixed. In the middle east we've seen large-scale peaceful demonstrations followed by leadership and regime change, but we've also see those democratic gains lost, diluted or overwhelmed by long running civil wars.

But citizen activism can take many different forms. Consider the rise in so-called hacktivism and even 'leaktivism'. The panama papers are just the latest and most dramatic example of a trend that's been underway for some time. It's also happening here in Australia. And it's not just governments that are being targeted.

Companies and corporations are vulnerable and they are in the firing line.

The new citizen activism reflects, I think, a simmering back lash against globalization in general. And in particular a perception that there is too big a gap between what some companies and institutions publicly say about their ethical standards and their commitment to corporate social responsibility – and what they actually do. Expect more and better co-ordinated campaigns not just citizen led but also activist investor led.

What lies ahead

Putting this all together may sound like an unduly pessimistic analysis of our modern circumstances.

But we have cause for optimism. After the second world war an extraordinary global effort rebuilt the world economy. What we need to re-learn is the lesson that any institutional architecture that supports economic growth must include the broad community of citizens.

We also know that the global community still has great latent institutional capacity.

In 1997 the Asian financial crisis was managed effectively, and lessons learned.

In 2008 the G20 proved that it was still capable of cooperating and leading the world through the worst of the crisis.

Just last year all 190 country members of the UN signed on to the UN's 17 sustainable development goals.

But there is no doubt we need more and better leadership at all levels – from governments, private sector and civil society.

We need a revised global architecture that leads to a new global consensus, one that includes citizens in the process and ensures the benefits are more fairly distributed. By the way, the processes that lead to this outcome are never efficient. But they do create a mechanism like politics itself for grappling and managing issues too hard to simply resolve.

The role of general counsels

Which brings us to the question of how general counsel can best play their part in these complex times.

Here are five thoughts to spark consideration and debate, focusing on the short term imperatives.

  1. Don't get caught up in cowboy globalism. Obey the letter but also the spirit of the law. And not just here in Australia, but wherever you do business. A company caught transgressing in a foreign market will not only face the penalties of that particular system, but will also potentially confront moral pressure here in Australia that, at the very least, will cause serious brand damage and possibly provoke further penalties or inhibitions on organisations operating license, either formal or informal.
  2. Recognise the inherent instability of and compromise required in governments. We've seen an unprecedented turnover of global leaders in recent years. Even in Australia we've been rapid-cycling prime ministers since 2007. Across the world you could name a dozen leaders right now whose tenure is shaky at best. The prime minister of Iceland was recently brought down by the panama papers. The president of Brazil is under threat of impeachment. And the middle east is still in a state of turmoil. In an unstable environment, arrangements forged under one administration may not be welcome under new management. The quality and integrity of contracting could be critical – or on the other hand, it could be completely ignored by a new regime.
  3. Take risk seriously and prioritise it appropriately. Not all risks are the same. You, your risk officer, CIO, and board risk committee must be accorded full resources and support to do their jobs. Scenario planning and risk planning must be taken seriously and on the basis of good information. You may not be able to predict the exact nature of the next crisis, but you will be far better prepared to handle it if you can envisage a wide range of probabilities.
  4. Be aware of employee morale and employee perceptions. A corporation is like a mini-state. It relies upon the good will and faith of its people to survive and prosper. You can have all the in-house security and written confidentiality agreements you like, but it won't matter if your people lose faith in your business. In this new era, the flood of recent whistle-blowing suggests there is no place to hide from disaffection. And in a crisis, you will need your front-line people at the top of their game, because the reactions of the first responders can have a decisive effect on the playing out of the issue over the long term.
  5. Expect more of your external law firms. If they are really client driven then they need to be thinking about the issues i am discussing. They need to bring a perspective and help inform your world.

There are also high quality risk assessment outfits based in cities across the world. Make yourselves globally aware and alert.

A client driven law firm can help. Don't wait until you are in crisis mode to establish relationships with the people you need to know.

Conclusion

Let me conclude.

Clearly all the challenges i have outlined today have strong legal aspects and implications. The legal challenges may stretch from basic contractual savvy to extraction of personnel from foreign countries, to compensation claims against governments, and more.

But as we manage through the short term, we must keep our eye on long-term solutions. We all have a role to play. Our companies can only prosper within strong stable economies and societies.

Sound leadership is important; leadership that takes into account that we are societies before we are economies, and that globalization needs to work for all if it is to continue to drive the global agenda.

I believe general counsel will need to play a growing role in this area, and could, and arguably should, be well placed to take the lead in managing the entire question of geo-political risk in many companies.

Thank you and I'm happy to respond to any comments or questions.

Footnote

1Source: Is China Buying the World? Peter Nolan, 2012.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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