Top 10 op risks 2020: geopolitical risk

Nationalism, trade wars and epidemics make for a heady cocktail

Surveys of this type are always in danger of being rapidly overtaken by events. In the category of geopolitical risk, that can happen before the ink is even dry.

As February drew to a close, the coronavirus left markets reeling from their worst paper losses since the crisis, with governments scrambling to formulate a cohesive response. When the survey was conducted in early January, the virus drew scarcely a mention from respondents, a handful of whom, based in the Asia-Pacific region, flagged it as a blip on the radar.

Epidemic diseases are a standalone operational risk, forcing authorities to respond with quarantining measures and blanket restrictions on travel – all of which play havoc with international firms’ ability to do their jobs in a normal manner. However, the virus is here considered as a function of geopolitical risk.

10 Geopolitical risk

With the virus likely to contribute to a global economic slowdown, this will trigger wider operational risks – making loan fraud more likely as credit markets deteriorate, for example, or increasing cases of internal fraud as front-office staff struggle to hit targets.

At the time of writing, no end to the coronavirus outbreak was in sight. The number of new cases in China is reported to be slowing, but news is emerging of fresh outbreaks and quarantines in Iran, Italy, the Gulf and elsewhere. As the prospect of large-scale remote working grows, organisations will be reviewing business continuity plans.

Global health officials have not yet classified coronavirus as a pandemic, though. And companies will be aware that as fast as global viruses spread, they can just as rapidly recede.

Another form of virus worrying op risk managers is the threat of state-sponsored cyber attack – one of many ways in which modern geopolitical conflicts play out, as its use by Russia, North Korea and the US has shown in recent years.

Cyber warfare is prone to overspill. Cyber weapons, once deployed, can spread rapidly, and the billions of dollars of damage done by the NotPetya attack in 2017 shows the potential scale of the consequences – which, regulators fear, could rise to the level of a systemic liquidity crisis.

Cyber warfare is prone to overspill. Cyber weapons can spread rapidly, and the billions of dollars of damage done by the NotPetya attack in 2017 shows the potential scale of the consequences

Geopolitical risk manifests itself in other ways, too, such as regulatory uncertainty. Brexit, which also featured in the 2019 Top 10, continues to be an important concern for the financial sector. Almost four years after the UK voted to leave the European Union, there is still no EU-UK trade deal in place, meaning a lack of clarity on equivalence between UK and EU regulators, and on the ability of UK firms to trade in the EU after full separation at the end of 2020.

Many op risk managers regard the Brexit situation as more stable today than this time last year, with most financial institutions having established locally domiciled operations inside the EU.

Aside from whatever tariffs will eventually apply to a Brexited UK, the US government has imposed a raft of trade barriers on countries over the past three years. Survey respondents pointed out the increased compliance burden this involves, as well as the likelihood of sanctions-evading transactions. Fines for sanctions violations reached $19.9 billion between 2009 and 2019, stressing the need for effective know-your-customer procedures.

The link between geopolitical risk and financial impact, however, remains frustratingly indirect and uncertain. Nobel prize-winning economist Robert Engle, speaking at a Risk event in late 2019, pointed out that his ‘Geovol’ measure of geopolitical risk, derived from realised volatilities of multiple asset classes, rated the risk far lower than news-based measures like the Geopolitical Risk Index. Spikes in attention paid to geopolitical events are not always matched by market activity; in fact, 2017–19 was a period of abnormally low Geovol once the spike around the 2016 US election had subsided, Engle pointed out.

Another US election is due in November this year. The 2016 poll brought regulatory uncertainty as the two candidates differed significantly on financial regulation. And while Donald Trump is less of an unknown quantity this time around, November is likely again to present a choice between different regulatory and economic policies.

Climate change, leading the list of emerging global threats, does not appear on this year’s list of top operational risks, but has ascended to the level of a strategic risk for many institutions. Many survey respondents cited disruption from climate change protests and the credit and reputational risks of association with legacy fossil-fuel industry as concerns. The model risk involved in adapting to the new threats to lending and mortgage businesses posed by climate-related disasters such as floods and wildfires is also a worry for banks.

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