The Perfect Enemy | Geopolitics moves from the cocktail party to the boardroom - JD Supra
May 13, 2024

Geopolitics moves from the cocktail party to the boardroom – JD Supra

Geopolitics moves from the cocktail party to the boardroom  JD Supra

According to experts cited in this article from the WSJ, “[g]overnments are increasingly using ‘financial levers’ to advance national security goals,” a development that “has clear implications for businesses.” The war in Ukraine, with its related Russia sanctions, as well as the ongoing political tensions—and related tariffs and trade restrictions—with other countries to which we have deep economic ties have led risk experts to anticipate “more volatility ahead rather than less.” To be sure, war, political tensions and economic instability can affect companies’ current and prospective businesses. The Global Risks Perception Survey released this month by the World Economic Forum ranked “geoeconomic confrontation” as number three among the top ten identified risks over the next two years.  Accordingly, conversations about geopolitics that, say, ten years ago might have been reserved for cocktail parties are now taking place among managements and boards, leading some companies to recognize the need for a “geopolitical risk management function.” In this article, “Board Oversight of Geopolitical Risks and Opportunities,” two academics at the IMD Global Board Center offer a framework designed to help boards implement effective oversight of geopolitical risk.   To provide some insight into how boards are currently implementing oversight of geopolitical risk, Corporate Secretary has published the findings of a survey of governance professionals in a new report, “Geopolitical and economic risks: Board oversight in an evolving world.” 

IMD framework.  In this article, the authors at the IMD Global Board Center assert that the interruption in global supply chains and other disruptions that arose out of the COVID-19 pandemic led many boards “to rethink geopolitical risk oversight.”  In the authors’ view, geopolitical uncertainty “will remain and could potentially generate shocks that will have a negative impact on global business,” including potential consequences for business “from supply-chain disruptions to tariffs, to expropriation and even potentially to hot wars.” 

According to the article:

“At board level, the increased complexity and uncertainty pose governance challenges. Boards need to oversee geopolitical risk management more proactively than ever before. This means that they need to prepare their company well to manage the risks—limiting the downside and seizing the upside of disruption. To gain a competitive edge, board oversight of geopolitical risk would help a company to incorporate geopolitical risk management into its strategy setting, investment decisions, governance and broader risk management processes. The board should set the tone for actively managing geopolitical risk and confronting the challenge…. For the board, it is critical to understand its own oversight competency and readiness to engage management on these complex issues. By the same token, the board needs to make sure that management is well prepared for geopolitical risks and understands risk impacts—assumptions, identification, assessment and quantification of risk. Successful companies will be those that can take actions to manage and mitigate geopolitical risks. Board oversight also ensures that the proper actions, both tactical and in terms of strategic risk management, are taken. Finally, board oversight of actions would focus on how management turns risks into growth opportunities.”

The article provides a framework, consisting of three steps, to facilitate boards’ effective implementation of their geopolitical risk oversight responsibility. Each step is explained in detail in the article. The first step, Board Oversight Competency and Readiness, includes five components:

“First, the world is changing course [referring to a trade conflicts, hot wars and other factors that reflect a reversal of political and social forces that will reshape globalization in the long term] and directors need to accept this change with a mental shift. Second, to increase the board’s readiness to handle geopolitical risk oversight, assessment of board expertise is a crucial step. Third, companies can go further and recruit geopolitical experts or politically savvy directors to sit on the board. Fourth, continuing education can improve board competency and help directors to better understand geopolitical risks and opportunities. Finally, the board should be ‘governance ready,’ with the appropriate structure, processes and group dynamics for effective and efficient oversight.”

The authors’ second step in the oversight framework, Geopolitical Risk Preparedness Oversight, addresses better anticipation and preparedness, focusing the board on four components: “assumptions, identification, assessment and quantification. When geopolitics and regulations shift, the board should be aware that the previous assumptions of corporate strategy and risk management practices are likely to change accordingly. Therefore, the board needs to oversee the identification of relevant geopolitical factors, the assessment of their impact on reputation, sales, supply chain, finance, operations and stakeholders, and the quantification of their impact under various scenarios. Proactive risk management will reduce the negative impact and could even allow the company to benefit from the opportunities.”

The final step in the framework, Geopolitical Risk Action Oversight, involves potential actions after geopolitical risk has been analyzed.  For this step, the authors identify six components: prevention, exercising influence, diversification, insurance, hedging and seizing opportunities. The article advises that boards should develop, with management, “strategic options for acting on geopolitical risk and overseeing implementation in decision making,” and integrate geopolitical risk management into the company’s risk management system. According to the authors,

“[a]ll risks are linked to strategy; therefore, risk management should be dynamically incorporated into operations across the company’s entire ecosystem. Boards should oversee and support management to anticipate, assess, avoid, mitigate, eliminate, transfer or accept certain geopolitical risks. When geopolitical tensions evolve, a company needs to anticipate and assess the situation as early as possible. Companies must be proactive, rather than reactive, when it comes to handling geopolitical risks. In some situations, geopolitical disruptions can be prevented or proactively influenced; in other situations, geopolitical risks can be mitigated well in advance through diversification; and in still other situations, geopolitical disruptions and cost could be minimized through insurance and hedging. Furthermore, growth opportunities might exist alongside geopolitical risk. With board expertise, foresight and oversight of action, companies can be more resilient to geopolitical risks.”

Corporate Secretary survey. The survey from Corporate Secretary looked at risks encompassing war and economic instability, as well as some political and social matters. The survey examined which directors are responsible for overseeing geopolitical and economic risks, the frequency of discussion of these issues, what risks boards are analyzing, what risks investors are inquiring about and how these governance professionals rate board oversight in this context.

The survey was conducted between August and September 2022, and elicited responses from 229 governance professionals, comprising 23% general counsel and 30% corporate secretaries, as well as their teams and others. Respondents were largely in North America (69%).  Companies reflected a mix of mega-cap (13%), large cap (24%), mid-cap (31%) and small cap (24%).

According to Corporate Secretary, “[e]ffective oversight of geopolitical and economic risk entails committee assignments, main board-level discussions, identifying the key issues to address and keeping investors and others informed, where necessary.” In the survey, 54% of respondents said that the board as a whole has “primary oversight of relevant geopolitical risk issues,” with 17% identifying the risk committee and 15% the audit committee. Interestingly, large-cap companies tend to assign oversight responsibility to the main board more often than smaller companies:  67% of large-cap respondents and 65%  of mega-cap respondents indicated that primary oversight of geopolitical risk was the responsibility of the whole board, compared with only 47% of mid-caps and 46% of small caps, where relatively more audit committees are given that role. A similar pattern applied to oversight of economic risk, with a relatively larger proportion going to the audit committee.

Forty-six percent of respondents said that the primary overseer of geopolitical risk reports to the whole board on these issues at every meeting, with 16% indicating reporting was ad hoc. The same pattern largely applied among different size companies, except that 42% of respondents at small caps said that reporting was ad hoc or non-existent. With regard to economic risk, 56% of respondents indicated reporting occurred at every meeting.  

In the past 12 months, 42% of respondents indicated, the main board has discussed geopolitical risk issues at every board meeting, while 28% say those discussions occurred on an ad-hoc basis; only 6% reported that the board hadn’t discussed these issues. According to the survey, board discussions of geopolitical risks occur more regularly at larger companies. Economic risk issues were discussed at the board level more frequently, with 64% of respondents responding that their board discussed economic risk at each meeting. Over the last two years, the survey showed that the frequency of these board discussions of geopolitical risk has increased slightly (53%) or significantly (20%). The increase was slightly lower for discussions of economic issues.

According to the survey respondents, the most frequently mentioned economic/geopolitical topic discussed at board meetings in the past year were economic growth/recession (95%), inflation (93%), the war in Ukraine (84%), racial equality (46%) and gender pay gaps (43%).  Respondents at all mega caps and 97% of large caps reported that their boards had discussed the war in Ukraine.  Only 7% discussed reproductive rights over the past year (which the report found surprising given that some may face shareholder proposals on this topic this year). Overall, 24% of respondents reported board discussions of political spending and lobbying and 36% reported discussions of domestic elections.  At mega caps, 53% reported board discussions of political spending and 59% of domestic elections. In general, investors appeared to be concerned about the same issues.  According to the survey, in the last 12 months, investors inquired most often about economic growth/recession (64%), followed by inflation (60%), the war in Ukraine (45%), gender pay gaps (24%), racial equality (19%) and political lobbying and spending (14%). At mega-cap companies, 29% of respondents said that investors asked about domestic elections.

In general, 49% of respondents indicated that members of their boards never engaged with investors on relevant domestic or global political issues; however, there was enough involvement to result in an average score equal to “sometimes.” Among respondents at mega caps, 42% said that directors are “either frequently or always engaged with investors on relevant domestic or global political issues.” The level of engagement by directors is somewhat higher on economic issues, with 50% of respondents at mega caps reporting that directors are always or frequently engaged with investors on economic issues.

With regard to disclosure of geopolitical issues, 34% of respondents replied that primary oversight of company disclosures was the responsibility of the board, with 25% responding that the audit committee and 17% responding that management fills that role.

Twenty-six percent of respondents would like to see improvements in board oversight of economic or domestic/global political risks, including 32% at mid-cap companies, 31% at mega caps and only 21% at large caps.  Individually, respondents wanted to see more structure and formalization, more in-depth discussions of global political risks (including of the implications for the company’s operations), scenario planning and presentations by experts.

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