Topics:   Risk Management,Strategy

Topics:   Risk Management,Strategy

June 22, 2022

Geopolitics Reasserts Itself as a Key Risk for Fortune 500 Committee Chairs

June 22, 2022

With Russia’s invasion of Ukraine, Ukraine’s unexpected resistance, Russia and China’s growing alliance, China’s desire to bring Taiwan back into its fold, and ongoing COVID-19–related lockdowns in China, geopolitics is affecting companies in ways they’ve never had to pay attention to before. In the spring of 2022, NACD, with Heidrick & Struggles, PwC, and Sidley Austin, brought together risk committee and nominating and governance committee chairs from Fortune 500 companies to hear how they can put these events into context and to discuss potential risks associated with these events and ways they can help their organizations mitigate the perils.

It’s a New World Order

The world is now in an era of hardening blocs, with Russia and China partnering, North Atlantic Treaty Organization (NATO) nations in another bloc, and the Global South caught in the middle, Michèle Flournoy, cofounder and managing partner at WestExec Advisors, told the group. This new world order is forcing change for companies both in the United States and abroad. The results are uncertain and how this plays out will take time, she said, so boards need to pay attention to the associated implications and risks since these will have a tangible effect on day-to-day operations.

What Are the Risks Related to Evolving Geopolitics?

We know that Russia’s economy is suffering from the sanctions that have been imposed. The longer they hold, the more isolated Russia will become. NATO’s presence—especially in countries bordering Russia—will strengthen, giving it a new sense of power. China’s economy is also slowing due to lockdowns from its zero-COVID policy. These factors, coupled with the aforementioned uncertainty, present challenges for companies that invest and do business in Russia and China and countries allied within this emerging bloc.

Risks boards should be aware of related to Russia’s invasion of Ukraine include:

Escalation. This conflict is far from over, according to Flournoy. Two scenarios concern her:

  1. Nuclear war: If Ukraine succeeds, will Vladimir Putin escalate with chemical or nuclear weapons? If the latter happens, the risk becomes more about world order and nuclear peace.
  2. Miscalculation and escalation: Air policing by NATO countries opens the risk of all-out war. So do Russian missiles accidentally hitting supply convoys on NATO soil. The risk of a military escalation, while perhaps small, is very real.

Cyber risk. While Russia has already hit Ukraine with cyberattacks, the United States and European Union remain largely untouched. However, as the war continues, expect this to change. Putin will likely target critical infrastructure, financial institutions, the electrical grid, and government functions, among other systems.

Sanctions. More stringent sanctions will affect the energy market, leading to potential energy shortages in Europe and price increases everywhere.

Industry shutdowns in Ukraine. Factories and farming remain at a standstill, which will have ripple effects on commodities markets and supply chains, as well as contribute to rising inflation.

Reputational risk. Companies that haven’t pulled operations from Russia are increasingly being called out and shamed on social media. This can negatively affect business and corporate or brand reputation, as recent examples have shown.

The risks boards should be aware of regarding China include:

Supply chain resilience. Lockdowns resulting from China’s zero-COVID policy have negatively affected supply chains as factories and shipping ports shut down for weeks or months at a time. Supply chains in the technology industry are especially sensitive since semiconductors and devices such as computers are manufactured there.

Reputational risk over views on Taiwan. Companies that invest in both China and Taiwan face a tricky situation. The day-to-day operations of an organization is less of a concern. The bigger concern is leadership in China increasingly demanding that companies doing business there demonstrate loyalty to China. This creates a difficult choice—does your organization view Taiwan as an independent state or as part of China? Boards need to discuss how to address this with their organizations.

How Can Organizations Mitigate the Risks?

While boards can’t stop the risks, they can make sure their organizations are prepared to address them. For example, organizations should consider how they would approach a crisis resulting from these emerging global issues. Participants at the spring meeting talked about conducting tabletop exercises to work through different scenarios.

Some risks regarding geopolitical issues aren’t new, such as cyberattacks; however, others are uncharted territory. Here’s how to approach these newer ones:

Reputation. If you’re still operating in Russia, consider leaving. “The [war in Ukraine] is likely to be a long affair,” Flournoy said. The longer companies stay in Russia, the harder it will be to leave and the public perception of failing to act will stick with these companies. For companies doing business in China, the reputation challenge is a little different. Maintaining a positive reputation with the Chinese government is critical while also communicating to Western stakeholders the company’s beliefs about Taiwan’s independence. This is a difficult balancing act, but critical at this point in time.

Reshoring. The United States can’t rely on one region for manufacturing. This means moving operations back to the United States or to other Asian nations, Mexico, or Canada, depending on the area or sector. It also does not mean that companies should pull operations out of China entirely. “I think we’ll see the US government defining key tech areas where we have to reshore that are central to economic and national security imperatives,” Flournoy said. This has already started with the CHIPS for America Act, enacted in 2021 to bring semiconductor manufacturing back home. Companies with a large presence in China will have to take stock of their supply chains and map out the risks on an ongoing basis.

Congress and the executive administration have no new clear guidelines on China, so Flournoy advised that organizations and their boards monitor closely for guidance. “Make sure someone on the team is watching like a hawk,” she said. The same advice applies to Russia; since we don’t know how Putin will escalate the war or how sanctions could affect Russia internally at a grassroots level, companies need to keep Russia on their radar screens.

Risks from North Korea and Iran Are a Distant Possibility

While risks related to North Korea and Iran are less imminent, directors and their organizations should still keep an eye on them. North Korea has intercontinental ballistic missile capabilities and will continue to test these. Iran has enough materials to make nuclear weapons. It also funds terrorism in the region.

We are now in a unique period of geopolitics in which companies are affected in a multitude of new ways. From disruptions of supply chains to the risk of a new world war, directors will need to get up to speed quickly on the evolving geopolitical landscape and the strategic, financial, operational, and human risks and opportunities to their firms.

Geopolitics Reasserts Itself as a Key Risk for Fortune 500 Committee Chairs

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