Uncertainty about global and domestic politics is greater today than it has been for some years. It is therefore inevitable that political risk will play a more prominent role in capital market investment decisions than it has done for many years.
Political risk is not a new phenomenon in markets. As early as 1294, the Ricciardi of Lucca, bankers to King Edward I, found themselves short of liquidity after an unanticipated Anglo-French war, which left them effectively bankrupted. Unforeseen political risk was their downfall.
We can see other examples from modern times. The assassination of Archduke Franz Ferdinand on 28 June 1914 caused barely a ripple in London’s markets, and it took the Austrian ultimatum to Serbia on 23 July to wake them up. Stock markets then fell and many were closed, liquidity dried up and there was a run to safety. As Gaspard Farrer, a partner in Baring Brothers, said, “The war came like a bolt from the blue and no one was prepared.”
It is the intrinsic uncertainty about the future that generates risk, and it is the job of business to manage that risk. That great philosopher and player of baseball, Yogi Berra, said all that needed to be said about risk in his aphorism “The future ain’t what it used to be.”
It is not always easy to disentangle the main components of what is loosely called economic and political business risk. A Marxist would argue that the dynamic of change is economic, driven by the struggle between the bourgeoisie and the proletariat for ownership of the means of production. So on that reading, all risk is essentially economic.
But consider the collapse in the oil market. Economists say this is down to falling demand, increased supply, and a commodity market reaction to the possibility of tighter monetary conditions in the USA. Political commentators point to an attempt by Sunni ruled Saudi Arabia to deal a blow at Shia ruled Iran, as well as an attempt by dominant Middle Eastern producers to cut some new oil and gas producers down to size through a price war.
Is it politics or economics that drives the oil price? You pays your money and you takes your choice.
There are two main drivers of political risk in the world today. The growing political tensions between the global power players – Russia, Japan, China, India, Saudi Arabia, the United States and the larger European countries – are driving political uncertainty, with a potential to spook global capital markets. Just consider the tensions in the China Sea and on the borders of the European Union, and the instability in parts of the Middle East, as well as the fractious debate within the Eurozone.
Political tensions within states can also drive uncertainty and political risk. Today, too many countries have found that the only way of maintaining employment and growth is by pumping up domestic demand. They do this by countenancing a build-up of government and consumer debt, often for housing. This has forced some governments to adopt “austerity policies”. In the worst cases, some governments have discovered that their financial systems, unable to sustain the debt burden, have collapsed, only to be bailed out by the creation of more government debt.
These tensions often exist in countries where income and wealth disparities have widened dramatically, and where the forces of globalisation and technical change have persuaded many citizens to distrust the established political order. These tensions can make it increasingly difficult to predict how governments will react five or ten years down the track. The result – greater political risk all around.
The UK banking industry is only too well acquainted with political risk. The one third increase in the UK bank levy announced in the Budget is a prime example. The UK bank levy has been increased time and time again in the last five years, and there are suggestions of a further increase after the election. Discriminatory Corporation Tax changes have targeted the banking sector too.
It is true that the banking sector has witnessed disgraceful behaviour over the past few years, and the age of contrition will never be over. However, this behaviour should be dealt with by better regulation and fines and penalties, not by a bank levy which makes no discrimination between responsible and irresponsible banking. Nor is there evidence to suggest that British banking is super profitable and justifies a special levy.
The levy will damage the UK banking sector, which brings significant economic benefit to this country in terms of good jobs, tax receipts, export earnings and finance for growth.
So if political risk is to play a greater weight in capital market investment decisions, what are the consequences? They are not good. Spreads, margins and the cost of capital will rise. Investment decisions will inevitably be skewed to the short term, where the perception will be that risks are more manageable. More short-termism is the last thing we need, and that’s why we should be concerned about the rise in political risk.
Sir Nigel Wicks is the chairman of the BBA but writes here in a personal capacity. This article draws on a lecture he gave to the International Capital Market Association (ICMA) earlier this week.
Sir Nigel Wicks