UUÂãÁÄÖ±²¥

The economic fallout from the ongoing Ukraine conflict and its subsequent effects on international markets has highlighted the need for UK boardrooms to consider how the threat posed by geopolitical risk is addressed in a world that looks to be becoming increasingly unstable. In this report, Market Tracker looks at the recent geopolitical struggles of FTSE 350 companies. In addition, it looks at how geopolitical risk is incorporated into some of their corporate governance and internal risk structures.

Living through volatile times

Over the past few years, global supply chains have taken a battering, as first the coronavirus (COVID-19) pandemic and now the Ukraine conflict have led to shortages, delays and in some cases, governments preventing the export of essential commodities to other countries for geopolitical reasons. The ensuing increase in costs for numerous industrial sectors is at least partially responsible for the recent surge in inflation worldwide. This in turn has led to a collapse in the share price of a number of FTSE 350 companies.  

For instance, grocery technology company Ocado plc (Ocado), which saw its share price amid the online shopping boom during the coronavirus pandemic, has since seen a 50.6% decline from 1,678.00 pence per share on 31 December 2021 to 829.40 pence per share as of 29 June 2022. Much of this fall is due to the waning of the tailwinds that the pandemic provided for the online retailer, as competitor supermarkets no longer languish under the temporary safety restrictions introduced to combat the virus. However, another reason is the current cost of living crisis, further exacerbated by the Ukraine conflict, which has Ocado to react to the ‘high cost inflation being experienced by food suppliers’ by increasing food prices for its customers:

'Since Ocado Retail’s Q1 trading update on the 17th of March, the trading environment has deteriorated, as has been widely reported in industry data, with the cost of living crisis compounding the impact of a return to more normal consumer behaviours as restrictions have ended and many people return to the office.

In the last few months, the grocery market has declined by 4-5% compared to last year when the country was experiencing peak COVID restrictions. Online grocery overall has declined by around 20% compared with last year, although the online market remains 60-70% higher compared with two years ago. Online share of grocery at 11-12% is almost double compared to pre-pandemic levels.’

Similarly, in Mitie Group plc’s recent Annual Report, disclosed on 27 June 2022, the strategic outsourcing and energy services company the following in its risk profile: 

‘Throughout FY22, Mitie has operated against a backdrop of continual uncertainty. The external landscape has changed rapidly due to the knock-on effects of COVID-19, Brexit, and the intensifying focus on climate change, while more recently this has been compounded by macroeconomic and geopolitical uncertainties.

The recovery of economic activity post COVID-19, has significantly increased inflation levels, increased global supply chain disruption, and in some circumstances resulted in significant legislative changes, all of which have the potential to impact the Group’s operations.’

The ramifications of the recent upheavals can also be seen for companies caught directly in the maelstrom of the Ukraine conflict. Whereas FTSE 350 miners with operations in Russia have suffered from and a collapse in their share price under the pressure of Western sanctions, Ferrexpo plc’s own mining operations continue in central Ukraine under the constraints of a supply chain in the middle of a warzone, including air strikes, rocket attacks, and economic blockade from the Black Sea (for more information, see FTSE 350 Q1 2022 reshuffle—Ukraine conflict sees board exodus at Evraz and Polymetal as share prices plummet and Ferrexpo’s board takes flak as operations continue amid Ukrainian conflict).

Friend-shoring and the management of geopolitical risk 

Faced with a world that seems to be lurching from crisis to crisis, some commentators in recent years, including the , have begun to question whether ‘friend-shoring’ represents a viable alternative to a globalised free-trade world. At the corporate level, friend-shoring envisions the possibility of businesses shifting their supply chains away from areas of geopolitical tension in favour of more neutral and/or stable countries that share the values and norms of the countries in which the companies are based. However, as the above examples demonstrate, it is often not as simple as that. The fortunes of many FTSE 350 companies are either very much dependent on the whims of international markets, are inextricably tied to a particular geographical area for their business operations, or require products made in politically unstable regions for their operations to function. This forces such companies to balance the threats posed by geopolitical risk against other factors, such as local expertise, cheaper production costs/wages or the need to enter new lucrative markets.

This is nevertheless a risky game to play. For instance, one of the largest gold producers in West Africa, Endeavour Mining plc (Endeavour Mining), narrowly avoided costs to its mining operations in Burkina Faso as a result of the military coup d'état against the country’s government on 23 January 2022, with the miner on 24 January 2022 ‘that its operations and supply chains in Burkina Faso have not been affected by the current political situation and its mines and projects continue to operate as usual’ (see: Investors continue to revolt in 2022 AGM season). However, operating in such a tumultuous region presents challenges on a regular basis. Just six months later, Endeavour Mining narrowly dodged a bullet when its former mine, which was to Néré Mining back in March 2022, came under attack by unidentified gunmen, the deaths of one soldier and one mine employee and forcing the mine to temporarily halt operations to concentrate on securing the site. Naturally, for Néré Mining, 90% of which is by a consortium led by local entrepreneur Élie Justin Ouédraogo and 10% by the Burkina Faso Government, friend-shoring is not an option. The question therefore remains, how can geopolitical risk be managed?

Geopolitical risk best practice and ESG2

On 24 February 2022, as Russian military units crossed the Ukrainian border, a blog post on geopolitics, corporate governance and ESG was published by The Risk Coalition. It the following:

‘Company boards and management teams often pay scant attention to geopolitical issues, at best drawing on occasional briefing or seeing geopolitics through the prism of a single impact such as supply chain or cyber disruption. But as geopolitical conditions become more uncertain, impacts are widening, undermining macroeconomic and investment conditions, and often generating second and third order strategic, financial, operational, legal and reputational risk impacts – even for firms not in geopolitically sensitive industry sectors.

How can company boards ensure their organisation remains resilient amidst increasingly turbulent geopolitical conditions?  Who in the organisation should have the leadership and oversight responsibilities in this area?  What internal capabilities do businesses need to anticipate the wider impacts of geopolitical instability, including on ESG deliberations, and how should these be deployed?’

In the aftermath of Russia’s invasion of Ukraine and increasing tensions in recent years between the US and China regarding Taiwan, many institutions have attempted to address the subject of geopolitical risk as an extra ‘G’ in the ESG acronym (namely ESG2), including The Risk Coalition, the and .

Under this ESG2 structure, The Risk Coalition believes that boards should that:

• ‘their oversight and challenge of management’s approach to principal and emerging risk issues have a geopolitical dimension – including focusing on second and third order impacts

• its members amongst them possess the necessary specialist skills to understand the geopolitical dynamics – or that they have access to these skills externally

• their organisation’s risk appetite is regularly reviewed and updated in the light of current or potential geopolitical dimensions

• they ensure their risk information they receive takes into account geopolitical matters of concern to the group 

• their risk function and risk management activities consider geopolitical matters and their impact on the business’

For many FTSE 350 companies, the entire board is responsible for looking at risk. For instance, car advertising company, Auto Trader Group plc, states that ‘the Board is collectively responsible for determining the nature and extent of the principal risks it is willing to take in achieving its strategic objectives’. In its , geopolitical risk is addressed in considerable detail (p. 67), with the company mentioning the coronavirus pandemic, supply shortages from the Suez Canal obstruction, Brexit, the military conflict in Ukraine, extreme weather events and the global semi-conductor shortage as some examples of external events that have adversely impacted its operations in recent times.

In contrast, for FirstGroup plc (FirstGroup), its ‘Executive Committee’, made up exclusively of members of executive management, ‘acts as Executive Risk Committee and reviews the Group’s risk management processes’, with the Audit Committee having ‘specific responsibility to review and validate the systems of risk management and internal control’. In its , FirstGroup addresses the subject of geopolitical risk at great length (p. 77), and sets out its level of risk relative to other factors in a graph:

Some FTSE 350 companies have even gone as far as to create a separate Risk Committee at the board level (for more information of Risk Committees see Practice Note: ) For example, the Risk Committee at Intermediate Capital Group plc is composed exclusively of the interim senior independent director and non-executive directors. In the private equity investment firm's geopolitical risks are incorporated under ‘External Environment Risks’ (p. 60), and are outlined as follows:

‘The risks and uncertainties arising from the immediate consequences of the Covid-19 pandemic are receding. However, macroeconomic uncertainty and geopolitical risks are increasing from other angles. Several macro challenges have developed, including increased inflation and interest rate concerns. At a Group level we are somewhat insulated from the direct impact of these risks, with our debt financing being fixed rate and with limited supply chain risk. We continue to work closely with the management of our funds’ portfolio companies to identify and mitigate these risks, where appropriate.

At the time of writing, the Russia-Ukraine conflict is bringing additional turbulence and uncertainty to the markets. ICG does not have any material financial or operational exposure at the Group level or within the funds we manage, directly or indirectly, to Russia or Ukraine.

Despite the uncertainty, these challenges are not new to the Group, and we are well positioned to navigate this investment environment in the long-term interests of our clients. This is evident for the period, where we have experienced very strong fundraising, raising significant third-party AUM, and deploying a substantial amount of capital across all our strategic asset classes.

We remain alert to the current macroeconomic and geopolitical uncertainty and continue to monitor the potential impact as regards our investment strategies, clients, and portfolio companies, as well as the broader markets. While the uncertainty remains elevated, we do not see an increased risk to our operations, strategy, or client demand as a result.’

The company even discloses the executive director responsible for each specific risk. In the case of External Environment Risks, this is its CEO and CIO Benoît Durteste.

The future of geopolitical risk

It is perhaps too early to see what the effects of an increasingly volatile world will have on the role of geopolitical risk and its place in UK corporate governance more broadly. However, following Russia’s invasion of Ukraine, there has been a renewed interest in the subject, with various institutions publishing articles, blogs and thought pieces. One unique example of this is State Street Global Asset Management’s decision in April 2022 to publish mid-AGM season on the topic for the companies in which it invests. It will be interesting to see if this increased awareness in geopolitical risk translates into a strengthening of internal risk systems among FTSE 350 companies, whether this takes the guise of the appointment of more directors with geopolitical risk expertise or the creation of more standalone Risk Committees.