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Business resilience in the face of financial adversity: Finding your geopolitical feet

Credit, Political Risk and Terrorism
Geopolitical Risk

July 14, 2021

Bringing insights from our geopolitical risk community into practical risk and resilience discussions.

Welcome to the second edition of ‘Finding your Geopolitical feet’. This October session focussed on the significance of the financial challenges relating to a global crisis and what could be learned from the experiences of a pandemic in securing the required levels of resource; what to consider when building business resilience in the face of financial adversity, steering through the interconnected challenges, the volatility and the uncertainties and how to make the most of the resultant reset.

Our community wanted to further explore from our first session in September the notion of regarding ‘resilience as an asset’. It has a cost, but a lack of resilience is likely to be a much greater cost. So how should Boards look to find and support this balance within their organisations and should there be more attention on financial ‘ring fencing’.

To address these interests and questions we were joined by three expert panellists who shared their personal views on the subject:

  • David Hoile, Senior Director, Global Head of Asset Research, Willis Towers Watson
  • Dr Tony Rooke, Director, Climate Transition Risk, Climate and Resilience Hub, Willis Towers Watson
  • Elisabeth Braw, Resident Fellow, American Enterprise Institute (AEI)

Andrew Hall
MBE Global Client Relationship Director
Geopolitical Risk practice


Table of content


The Panel

David Hoile
Senior Director, Global Head of Economics and Capital Markets Research, Willis Towers Watson

David Hoile has been the Global Head of Asset Research since 2006 – it is the economics and capital markets research department for Investments and Willis Towers Watson. His role and team cover a variety of responsibilities, including: research and forecasts for all major economies; asset market forecasts over short and long-term horizons, stress tests and appropriate financial portfolio strategy responses; and analysing the risks and opportunities from climate change and broader sustainability-related trends for economies, industries, and asset markets.


Director, Climate Transition Risk, Climate and Resilience Hub, Willis Towers Watson

Elisabeth Braw
Resident fellow at the American Enterprise Institute (AEI)

Elisabeth Braw is a resident fellow at the American Enterprise Institute (AEI), where she focuses on defense against emerging national security challenges, such as hybrid and grayzone threats. Concurrently, she is a columnist with Foreign Policy, where she writes on national security and the globalized economy, and a member of the National Preparedness Commission (UK).

Before joining AEI, Ms. Braw was a senior research fellow at the Royal United Services Institute for Defence and Security Studies in London, where she founded its modern deterrence project. She has also been an associate fellow at the European Leadership Network, a senior fellow at the Atlantic Council, and a senior consultant at Control Risks, a global risk consultancy.


The Panel

David Hoile

Starting a high level, globally, societies and economies have always shifted and adapted over time. However, for some time, we've been particularly emphasising that the pace, the complexity, and the scale of that change, has been increasing. What we're seeing now is that key, economic, social, and environmental systems have been transforming in a relatively short space of time; and for us, the drivers of that transformative change, show no real signs of slowing down.

The solution around resilience isn't about getting your predictions, right. It's about being flexible and agile to respond to the unpredictable.”

David Hoile | Senior Director, Global Head of Economics and Capital Markets Research, Willis Towers Watson

A critical implication of this is that if we base private and public investment decisions, primarily on historical observed relationships, then that's going to be unsatisfactory, because those relationships are unlikely to apply going forwards. This brings me back to some of the threads from the last session. Both Andrew [Hall] and Lord Arbuthnot have noted that the importance of making your business resilient. And in that context, resilience means an ability to survive, or to prosper in the face of various things that can be thrown at you. The solution around resilience isn't about getting your predictions, right. It's about being flexible and agile enough to respond to the unpredictable things, which is not a straightforward undertaking in practice.

If you're looking at the impact of pandemics, or cyber-attacks, climate change, trade conflicts, financial crisis – in terms of their effects on returns on capital, to draw credible conclusions, and support meaningful action – this is a difficult thing to do. There's really no choice but to think in detail about the economic, the value chain, and the capital implications of those risk trends and their interactions, with an eye on trying to extract the most likely and important implications for your business and for your business resiliency.

A framework for business resilience

Keeping these thoughts in mind, what would a framework for business resilience look like? In recent years, viewing the economy, the firms of which it's made up and the financial system, as a set of ecosystems has been gaining popularity. This concept makes sense in a world where economies, financial markets and businesses have become increasingly interconnected. These changes require a corresponding shift in perspective for leaders away from considering how an individual firm might compete, to a broader view of explicitly considering its place in the system as a whole. Ultimately, that approach, we think, allows a better assessment and management of risks faced by individual businesses, but also broader systemic risks.

So how do we turn that notion of systems thinking and apply it in practice? There are three important principles that I wanted to highlight:

  1. The first is the critical importance of using a bottom up approach. Businesses are the primary domain through which regulatory, social, physical, technologies are all going to be adopted and which will in turn drive change. It will be essential to use that business-by-business or microeconomic approach, as maintaining a top down approach will be too high level to cope with the uncertainties;
  2. Second, we can deal with decision making under uncertainty using scenarios. Looking at cost benefit analysis at a business or microeconomic level, we can identify and estimate where possible what the material shifts or risks are in your business or in broader society;
  3. And then, third, is the need to focus on the practical and material outcomes. Part of that process is identifying the barriers which may prevent a scenario from being realized and incorporating this stress testing of thinking into our risk registers. What gets measured well gets managed well, so building a practical understanding will increase confidence and risk maturity.
Practical application

If we accept this broad notion of a framework focused on risk and resiliency, the benefit of scenario based framing, cost benefit analysis, and the critical barriers, how do we apply it in practice? And what are the benefits?

If we can have a better understanding of the risk and potential repricing of assets based on catastrophic risks, that gives important signals that can be used to improve investment decisions by both corporates and financial markets to avoid catastrophic risks in areas where the economic financial benefits aren't compensated for against those risks. Embracing these metrics will encourage business strategies to reduce the impact of catastrophic risks. These signals can also help to develop other market led solutions around hedging or insurance, and that can help to diversify or socialise catastrophic risks.

An example in practice: considering transition risk to a lower carbon economy

To give a practical example that is climate related, if we took an archetypal European construction or concessions firm, there are many different types of exposures through its lines of business; construction, power, energy, efficiency, transport, etc. These in turn lead to multiple different exposures to different transition pathways – climate- related pressures associated with concrete-based emissions, construction-based emissions, power generation, its airport operations, etc. Each of those areas, the volume implications, the margin implications and the capex exposures can be modelled and estimated, and then aggregated back up to get a real world sense of the value of risk that the firm faces under carbon transition related risks.

This kind of process could be applied to any risk. I’d like to finish by emphasising that we are not so much interested in the most likely impact, what we're trying to do is sensitivity test against the range of potential shifts that could occur, in this case, under a climate transformation.

Tony Rooke

One of the things I wanted to share in this forum is the view that climate is one of the waves of drivers that's going to be washing all over us. We are very much entrenched in COVID-19 at the moment and the recession that's bringing on, but climate change represents a much bigger systemic problem for the economy, for society and for business as a whole, and even behind that, the problem of potential by diversity collapse. It is also an important breaking point, because history is not going to be a basis of how we predict the future – we have to look forwards to where we want to be. The freedom to think forwards unhindered by the past is an opportunity, and being a director of transition risk, I always characterise transition as being the human response to climate change.

The Green Swan: foreseen and predictable

In many ways, we've probably heard in risk circles about Black Swans and Grey Swans, well, this is a predictable Green Swan1. In many of the industries, we know how to transition to low carbon economies. Some of them are interim solutions whilst we develop and scale up more long-term solutions, but we know many of the solutions that we need to put in place. This will involve a lot of investment.

For example, it's been estimated by Lord Nicholas Stern and his new climate economy group that we'll need about $90 trillion worth of capital to be invested by 20302. We've got the European Commission estimating in that block alone, somewhere between €175-290bn per annum to meet their targets by the 20503. At first glance these sounds like really, really nasty, big numbers, but actually, I look at it the other way. This means there's investment that's going to take place and the resilient firm that is going to be able to ride that investment, is going to be able to get a surfboard out and get on top of those waves, rather than waiting for those waves to crash on top of them.

What gets measured gets managed

Globally we're seeing more and more companies, and more and more countries and regions setting targets. The EU set a target for 55% emission reduction by 20304 and China surprised us all at a couple of weeks ago by setting a net zero target by 20605 (and if history is a lesson there, they always achieved their targets years earlier).

Organisations have weighed up the risks and opportunities and have committed themselves to transition to a low carbon economy.”

Tony Rooke | Director, Climate Transition Risk, Climate and Resilience Hub, Willis Towers Watson

There has been huge flurry of activity happen in the last few months, we've had a plethora of companies set targets for Net Zero, and over 1,000 companies have set science-based targets6. These organisations have weighed up the risks and opportunities and have committed themselves to transition to a low carbon economy, and in line with a better than 2 degree target or even a 1.5 degree target. We've seen the likes of Google and Microsoft say they're not just going to go stop at net zero, they're going to wipe out all their historic emissions.

The Financial Services world has woken up to this in the last couple of years and there are approximately 40 banks, working with the UN environmental programme to set net zero targets. The Spanish bank, BBVA, is mobilising $100 billion to deliver the Sustainable Development Goals7, of which climate is one, and they've already committed $40 billion. The corporate world is also using financial levers, and in 2017 PepsiCo raised a green bond for $1 billion8, and they've said spent nearly half of that so far, mostly on green energy, waste removal and getting rid of plastics in their value chains9. Just recently, Tesco have also seized the opportunity and established a revolving credit facility of £2.5 billion where the interest rates are tied to progress on their emissions, energy and food waste targets10.

The opportunity space

There's a lot happening, and the opportunity is there for organisations to align their thinking to avoid those waves. While it can often feel like a nebulous topic to grasp, there are clear benefits and I see the next 10 years as vital for us to actually keep on target with climate change. I personally worked on this when I was at Logica and put together a business case, that saved the company £32 million in four years, and our annual profit level was about £50million. We can see companies are taking hold of this, they are collaborating, ING11 and a number of banks and other companies have set collaboration to put electric battery charging infrastructure in to decarbonize boat transport and on the rivers throughout Europe as well.

There's going to be unprecedented work together, it'll be a collaboration of private public, and I think there's an opportunity for us to build more resilient organisations and capitalise on this as well. So I'm hoping I'm giving you a message of optimism, that we can invest our way out of this current recession, and at the same time, address some of those potential and existing risks that threaten resilience not just about individual companies, but of our society as a whole.

Key Takeaways

David Hoile

The range of resiliency actions that could be taken to crises, or catastrophes are complex and need holistic thinking. So, you're essentially trying to answer the question of how do you connect the short and the long term, the financial and the extra financial, like climate? How do you integrate risk and uncertainty? So, for me, the way to do that is by analysing the problem, using scenario-based cost-benefit analysis, applying it at a sum of the parts business level, and understanding the critical barriers that either affect your ability to be resilient, or how those barriers might be reshaped, so that you can build appropriate resilience.

Elisabeth Braw

I think the point is that risks and crisis go far beyond the what immediately concerns the company, and that's the big change. Now, climate change, will pose the largest risk to companies and cause potential disruptions on a magnitude that is much larger than they've seen before. So that then leads to the reality where they have to work with other companies and indeed, with the government, to prepare, and for leaders within the companies to refine expand their thinking on what sort of risks that companies could face and how to counter them because if we work together; government and industry are obviously much better equipped to counter and minimise the extent of the harm that those crises can do. So, I think the bottom line is, if we team up, we are in a good position to minimise the results of any crisis.

Tony Rooke

I think strong collaboration is the secret for us to come out of these crises stronger, and to weather them stronger. And my key message is; there is opportunity coming, there is capital coming, it is an opportunity to strengthen and reinvent your business. At a time when it feels like we're hanging on by your fingernails, these opportunities will put a firm ledge beneath our feet and allow us to actually leap back up onto the roof.


Footnotes

1 https://www.bis.org/speeches/sp200514.htm

2 https://www.thegef.org/sites/default/files/publications/GEF_GlobalCommonArticles_
July2018_CRA~.pdf

3 https://ec.europa.eu/commission/presscorner/detail/en/QANDA_20_336

4 https://www.bbc.com/news/world-europe-55273004#:~:text=EU%20leaders%20have%20
agreed%20on,it%20transition%20to%20clean%20energy
.

5 https://www.atlanticcouncil.org/blogs/new-atlanticist/what-chinas-march-to-net-zero-emissions-means-for-the-world/

6 https://sciencebasedtargetsnetwork.org/

7 https://www.bbva.com/en/bbva-to-mobilize-e100-billion-by-2025-to-fight-climate-change-and-drive-sustainable-development/

8, 9 https://www.pepsico.com/news/press-release/pepsico-provides-update-on-us1-billion-green-bond10132020

10 https://www.tescoplc.com/news/2020/tesco-renews-25bn-committed-facility-establishing-link-to-sustainability-targets/

11 https://www.ing.com/Newsroom/News/ING-invests-in-green-inland-shipping-.htm

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