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The semantics of risk

Perhaps it’s to do with improving technology and easier and more immediate access to information, but it certainly seems that the number of hot spots brewing around the world are on the rise, making geopolitics and the evaluation of geopolitical risk an increasingly important component of any investor’s risk assessment strategy.

One tendency is to equate geopolitical risk with emerging markets. But is that justified or a misconception? To answer that question involves an exercise in semantics.


According to Investopedia, an emerging market economy is defined as an “economy that is progressing toward becoming advanced, as shown by some liquidity in local debt and equity markets and the existence of some form of market exchange and regulatory body”.

That then leads to the question ‘what is an advanced economy?’ But according to Investopedia, there is no one, agreed definition of an advanced or developed economy. It does, however, “typically refer to a country with a relatively high level of economic growth and security”.

So under which category would China, Brazil and Russia fall? All three countries are among the 10 largest economies in the world according to the latest figures released by the World Bank for 2013. But according to one source, “for us, Russia, China and Brazil are emerging markets”. That would indicate that economic size is not all that counts when determining the level of development. Perhaps more important is the second part included in the Investopedia definition – security.

Security encompasses a number of factors such as rule of law, political structure and transparency, as well as war, acts of terror and civil unrest. They are among the key criteria to be considered when assessing geopolitical risk. But does everyone have a set definition for the term?


“Geopolitical risk really, in my mind, is caused by tensions between different states and regional conflicts,” says Michael Wilkins, a managing director of the infrastructure finance ratings group of Standard & Poor’s. “That definitely is more of an issue in emerging markets,” he says, adding that institutions there tend to be characterised by a lack of independence, stability and transparency compared with those in developed countries.

“That’s a broad brush statement and you’ll find exceptions, but that tends to be the case,” Wilkins notes.

Douglas Doetsch, a partner at law firm Mayer Brown who heads the firm’s Latin America/Caribbean practice and co-heads its global banking and finance practice, tends to encounter a different term with his clients.

“In the deals I work on, people […] usually focus on sovereign risk which is the whole set of political and legal issues, monetary and financial issues that might exist in Argentina, Colombia or Indonesia,” he comments. “Sometimes sovereign risk is further broken down into convertibility risk or sovereign default risk if you’re talking about availability payments.”

While sovereign risk may be related to geopolitical risk, it is a narrower term.

For David Tafuri, a partner at law firm Dentons whose practice focuses on international business, international law and foreign investment, “geopolitical risk refers to the fact that events related to a country’s affairs and its relationships with other countries and non-state actors can impact the ability of investors to achieve their goals”.

A good example would be Turkey, which, according to one institutional investor, has geopolitical risk on a number of levels. First, there is Turkey’s ties to Russia given that the latter is Turkey’s largest supplier of gas. Then there are its neighbours, Syria and Iraq. What happens in those countries can have a ripple effect on Turkey.

But geopolitical risk should also take into account the country itself. “Look at the policies and actions taken by Turkey President Recep Tayyip Erdogan in recent years. Two years ago you would have said Turkey is a great country to invest in. Today, it’s a whole different situation,” this person remarks.


When making an assessment, one factor to consider is a country’s political structure. Another is the rule of law, as well as its enforceability.

“That’s a very important nuance because in many cases rule of law exists but if something goes wrong you might not be able to or might not want to take the government to court,” the investor says.

The type of investment will also determine which criteria will be used to assess risk. Infrastructure, where assets are usually very closely tied to or controlled by government, requires a different set of criteria than private equity or real estate.

Enforceability of the rule of law is crucial since, as the institutional investor points out, “investors can’t run away with a power plant or a toll road”. One way to evaluate enforceability is by looking at precedents.

“One of the questions that always comes up in deals we’re involved in in Latin America is not just what’s in the concession agreement but what is the record of that government or that country in actually complying with those provisions? And if there is a dispute, what is the mechanism for resolving it?” Doetsch says. “I can tell you that the lenders to a project and most sponsors going into a project would much prefer international arbitration rather than taking their case to local courts,” he concludes.

Especially when talking about infrastructure, which tends to be a long-term investment, being prepared for any contingencies that may arise over the next 10 to 15 years is vital.

“You don’t know which political party will come into power or whether there will be a coup d’etat or if the government will nationalise everything,” the institutional investor remarks. “But we negotiate things like that; oftentimes we negotiate under British law or New York law in order to protect our investment.”

Investors can protect themselves by getting to know the government of the country they’re investing in and by understanding the political situation, according to Tafuri. Forming relationships with not just the government but also key stakeholders is another measure Tafuri, whose clients invest in a variety of sectors in countries such as Iraq, Syria, Lebanon and Libya, recommends. Doing so will improve chances of investment obligations being honoured should there be a change in leadership.

While the consensus is that geopolitical risk is more of an issue in emerging markets, S&P’s Wilkins warns against discounting it completely in developed markets.

The investor who spoke to Infrastructure Investor agreed.

“The thing is that geopolitical risk is everywhere,” this person says. There’s direct and then there’s indirect risk. “Look at Europe, for example, and what happened with Russia taking over Crimea; that has affected everything,” the source comments, underscoring the link between politics and economics as Europe struggled with the decision to impose sanctions against Russia without hurting its own economic interests.

“You look at the price of oil today – how it’s affected some foreign currencies, what it’s done to oil companies. The impact is huge. I think it’s a matter of degree – it might be first degree, second degree and so forth, but geopolitical risk is everywhere.”