Security - the new "S" in ESG?

According to ESG Book, ASML Holdings, which makes the equipment used in the manufacture of semi-conductor chips, has the highest environmental, social, and governance - or “ESG” - rating out of any country on the planet.

This means investors can put money into the company safe in the knowledge that it employs sustainable practices, has a social conscience, and is fully above board in terms of its accounting and employment policies.

Fantastic. But what do you think would happen if it was banned from exporting its product to one of its main customers?

Well, unfortunately for ASML, due to a geopolitical dispute between China and the US, this actually happened. And as you can see from the graph below, it hasn’t done wonders for its share price.

For context, the red line denotes when Reuters reported that the Netherlands and US were planning to curb exports of some ASML equipment to China.

The reason I’ve highlighted this is to show that even if a company is as environmentally and socially conscious as Greta Thunberg working in a soup kitchen, and its governance so transparent and integrous you could use it as bullet-proof glass, a geopolitical shock can quickly change it from a B-Corp to being a corpse (I’m aware this is a pretty terrible metaphor, but, as a big fan of shit puns, I don’t care).

The potential impact of geopolitical events on a company’s bottom line have led Goldman Sachs and McKinsey & Company to assert that every company needs a geopolitical strategy, and why CitiGroup’s CEO Jane Fraser told a panel at a recent business forum that security was the new “S” in ESG.

Whether you are an investor deciding whether to put money into a business, or a business looking to make itself more attractive to potential investors, obtaining a geopolitical security assessment is becoming increasingly important.

In this article, I will cover the constituent parts of a business that need to be assessed, the geopolitical risks likely to affect most businesses, and how to identify and mitigate those risks. All for the low, low price of an email address.

The constituent parts of a business that must be assessed

When conducting a geopolitical security assessment, the geopolitical risk in the location of every facet of the business must be assessed. This includes:

• Headquarters

• Branches
  Any shops, production facilities, offices etc that are located separately to the company HQ.

• Supply lines
  The routes by which materials are delivered to the company to be made into goods, and the routes by which goods are delivered to market.

• Labour base

  Any location from which a significant proportion of the company’s labour comes from. Often this will be the same place as its HQ or branches, but some companies and industries rely heavily on overseas labour (almost 45,000 UK NHS staff are from India, for instance).

• Market

  Where the company’s products or services are sold.

• Online presence
  “That’s not a physical location” I hear you cry. Correct, but if a company wants its website to be accessible in a given location, it can be impacted by political decisions in that location (as Elon Musk recently found out).

Typical geopolitical risks faced by businesses

The exact geopolitical risks faced by a business will depend on the industry and location it operates in, but the ones outlined below are some of the most common.

Environmental risk
Damage to the physical location of one or more of the business’s constituent parts. Climate change is one of the most prominent causes of this, with flooding, extreme heat, drought, and rising sea levels are just some of the benefits generously provided by the fossil fuel industry. This article highlights seven industries at extreme risk from the impact of climate change.

Other major environmental disruptors include non-climate change-related disasters such as earthquakes and volcanic eruptions, nuclear accidents such as Chernobyl and Fukushima, and armed conflicts.

Supply risk
The availability of resources vital to the business’s operation, including base materials, labour, and essential goods such as food, water, medicine, and fuel.

Changes to legislation or political stances can cause the labour supply for certain industries to dry up (check out the impact of Brexit on the UK hospitality trade), diplomatic disputes can see the export of certain goods restricted (as our friends at ASML are well aware), and political instability and sanctions can see access to essentials reduced or cut-off completely (punitive sanctions applied on Niger in response to its recent military coup have seen shortages of medicine and food according to the UN).

Economic risk
Generally speaking the state of the economy will dictate how well most businesses perform - if it is doing well then businesses operating in that economy tend to perform well, and if the economy is doing badly then many of the businesses in that economy will tend to suffer as a result.

For example, high levels of inflation can wreak havoc on profit margins (rising petrol costs mean many driving instructors have concerns they will struggle to break even let alone make a profit), low levels of disposable income can cause a reduction in demand for luxury goods and services, and financial crises such as the 1989 savings and loan crisis have the power to completely wipe out multi-million dollar corporations.

There are exceptions to this rule, however. Businesses which position themselves as budget or economy options can often over perform when the economy is struggling as customers look to tighten their belts.

Communications risk
In the military there is a saying “no comms, no bombs”, which highlights how difficult it is to operate without reliable communication. The same is true for business.

This means internet stability is a vital asset for almost all companies, so those with a footprint in countries whose leadership has a penchant for internet shutdowns risk facing disruption. Deliberate internet shutdowns by governments cost the global economy $24bn in 2022.

It is also important businesses understand local rules and customs when communicating to consumers. For instance, promoting something to gain virtue points in one location could see a business prosecuted in another (hence the hideous double standards on display in the image below).

Political risk
Political upheaval in a region can end up leading to conflict, but even in stable times politics has the potential to significantly disrupt a company’s ability to operate. Legislation can see the export of certain goods restricted (getting good mileage out of this ASML example aren’t I?), but it can also the domestic sales of certain goods restricted or banned (sometimes for good reasons).

It’s not all doom and gloom though - legislation can see demand for certain goods or services rise as well as fall (which is why Covid must have felt like a lottery win for certain PPE manufacturers).

The political attitudes of a population can have just as big an impact on a company’s success as the political decisions of their government, both directly (a boycott borne out of political opposition to a marketing campaign by BudLight earlier this year saw sales drop 10.5%) and indirectly (for instance due to the impact of civil unrest on the wider economy).

Conflict/terror risk
War and terror can be catastrophic for businesses. They can destroy its environment, physical assets, supply lines, labour force, and customer base. These are the direct effects of conflict. But there are also second-order effects of hostile actions that need to be considered.

As the graph below shows, terror attacks can cause a reduced demand for a particular service in the immediate aftermath due to the fear they create (hence “terror” attacks).

And as we have seen with Western companies operating in Russia following its illegal invasion of Ukraine, conflict can see businesses forced to withdraw from a location either due to pressure at home, or simply have all their assets in that country commandeered by their host state’s authorities without any compensation.

How to mitigate geopolitical risk

To mitigate the geopolitical risk a company is exposed to, first you need to identify that risk. You can either do your own research, or you can commission a geopolitical consultancy to produce a bespoke geopolitical risk profile of the company of interest.

A good geopolitical risk profile of a company won’t just provide information on the geopolitical risks facing that company, but will also explain how resilient the company would be if those risks turned into actualities. For example:

• Diversification: If the company’s main product or service was banned from sale tomorrow, does it have other products or services it can rely on to generate revenue, and if not, could it diversify into other offerings? Tobacco companies began selling vapes to mitigate the decline in tobacco product sales.

• Relocation: If it suddenly lost access to its operations centre, could it lift and shift its operation elsewhere? Companies including Apple are moving their manufacturing hubs away from China due to increasing geopolitical tensions.

• Logistical flexibility: If one of its major supply routes was denied for some reason, are there other viable routes, and how much time and cost would using these routes add to the shipping process? The 2021 Suez Canal blockage cost the global economy an estimated $9bn per day.

How OSINT Ltd can help

With almost ten years of geopolitical intelligence experience served in the Royal Marines, private contracts, and the UK Cabinet Office, I can help you and your company mitigate geopolitical security risks in the following ways:

The OSINTSUM: Global Situation Update
I produce a regular geopolitical risk newsletter which offers a concise and comprehensive overview of the major geopolitical issues of the day. If you are reading this you have already signed up to receive it - look out for the next edition of the OSINTSUM: Global Situation Update arriving in your inbox in the next day or so. Click here to read a previous edition.

Geopolitical Risk Profiling
Whether you are an investor or a company looking to demonstrate your geopolitical security to potential investors, I can produce a comprehensive geopolitical risk profile for your company of interest, covering all the risks outlined in this article and any others relevant to the company.

ESG Consulting
If you run an ESG consultancy and want to expand your offering to include geopolitical risk profiling, I can advise on how to do this and provide training for your consultants.

If you would like to find out more about any of these services, email [email protected] with details of your needs and I’ll get back to you ASAP.

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