We live in an era of complex geopolitical risks. The current geopolitical environment presents significant challenges for companies and their boards of directors. In the following guest post, Burkhard Fassbach, a D&O lawyer in private practice in Germany, reviews the important risk management approaches and insurance solutions available for companies to try to address these complex geopolitical risks. I would like to thank Burkhard for allowing me to publish his article as a guest post on this site. I welcome guest post submissions from responsible authors on topics of interest to this site’s readers. Please contact me directly if you would like to submit a guest post. Here is Burkhard’s article.

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I. Introduction

Globally operating corporations are increasingly affected by geopolitical risks. These include acts of war, terrorism and unrest. The war in Ukraine and increasing tensions between the U.S. and China are just two examples. These risks can cause major damage. Disrupted supply chains can lead to business interruptions. Protection can be provided by an effective corporate risk management system and adequate insurance solutions. The article also highlights the de-risking strategy of the German government with regard to China, business continuity management, the use of IT tools for risk analysis, the role of the management and the supervisory board as well as the business judgment rule. The Guest Post shows how companies can best protect themselves.

II. Political Risk Insurance

The insurance market offers companies Political Risk Insurance (PRI) and Political Violence Insurance (PVI). The scope of insurance cover described below is based on product information from the insurer HDI Global. The complete information can be found here.

Political Risk Insurance (PRI) offers insurance cover in cases of Confiscation, Expropriation, Nationalisation, Deprivation, Import/Export Embargo, Currency inconvertibility/Non-transfer, Forced abandonment, Selective discrimination, Forced divestiture, License Cancellation, Arbitration award default.

Political Violence Insurance (PVI) offers protection in connection with War, Civil War, Rebellion, Insurrection, Uprising, Coup d’état and other Civil unrest, Terrorism and Sabotage. The insurance cover includes compensation for losses due to property damage, business interruption, costs for the relocation of insured property, damage to life and health of personnel. The insurance cover may also include loss of rent, loss of profit, delay in commissioning, liability insurance to cover property damage and personal injury to third parties.

The policies have been established in the insurance market for decades – particularly in the Anglo-Saxon world – and are increasingly in demand in Germany. Political risk insurance is offered by AIG, Allianz Trade, AXA XL, Chubb, HDI Global, Lloyd’s of London, Munich Re and QBE, among others. The target group ranges from medium-sized companies to large multinational corporations in a variety of sectors. The insurance market offers capacities for sums insured of up to EUR 250 million (in some cases even higher). Premiums have risen in recent years due to increasing political risks. Insurers have also partially excluded individual geographical regions from the  insurance cover and reduced sums insured. In addition, higher deductibles are required. The policies are considered accumulation risks because loss events generally affect a large number of insured companies at the same time. Reference is made to an insightful article authored by Ronja Fihn, Head of Property at Willis Towers Watson Germany, with the headline “Political risks affect every company”. The article can be found here.

III. Risk Management

In order for companies to obtain protection despite a tough insurance market, they must deal with their specific political risks. According to Section 91 of the German Stock Corporation Act, the management board of a listed company is obliged to set up an effective risk management system. The standards drawn up by the Institute of Public Auditors in Germany (IDW PS 340 nF) can be used as a guide for the design of the risk management system according to the German legal scholar Gerald Spindler in Munich Commentary on the German Stock Corporation Act, 6th edition 2023, margin no. 35 on Section 91 AktG. Experience has shown that the IDW standard also has an impact on the risk management system as a whole and on companies that are not directly subject to Section 91 of the German Stock Corporation Act. It is necessary to audit the material risks arising from strategic decisions.

With regard to political risks, reference is made to the “Handbook of Political Risk Insurance” published by Alexander Braun and Marius Fischer of the “Institute of Insurance Economics” at the University of St. Gallen. The book can be found here. The following points in particular should be noted:

The first issue is the characterization of political risk. This includes the definition of political risk, in particular political macro and micro risks at home and abroad. The second step involves identifying and assessing political risks. Finally, the focus is on risk mitigation, in particular through business continuity management.

Companies also assess geopolitical risks with the help of IT tools. One example is the Oxford Economic and Political Risk Evaluator (EPRE), which can be found here. The EPRE forecasts economic and geopolitical risks in 164 countries through regularly updated country risk scores, in-depth country profiles and event-driven analysis. Global risk coverage includes political, regulatory and operational analysis of political events from partner networks to monitor the impact of political and operational issues.

As part of risk management, companies should have a business continuity strategy in place. Business Continuity Management (BCM) refers to the development of strategies, plans and actions to protect activities or processes whose interruption would cause serious damage or devastating losses to the organization (such as operational disruptions) or to enable alternative processes. The aim is therefore to ensure the continued existence of the company in terms of economic sustainability in the face of risks with a high level of damage. Good business continuity management in relation to political risks should in particular include alternative production sites in less exposed regions or comprehensive IT security precautions.

On July 12, 2024, the National Law Review published a well worth reading article with the headline “Navigating a Shifting World: Geopolitical Risks and Your Board’s Role” authored by Louis Lehot, a U.S. lawyer from the law firm Foley & Lardner LLP. The article covers a recent event hosted by the National Association of Corporate Directors (NACD) Northern California Chapter and Foley & Lardner LLP and can be found here.

According to the experts, the paradigm shift is essentially characterized by the transition from globalization to regionalization, with countries focusing on trade within their own sphere of influence. This is accompanied by a shift from integration to fragmentation, combined with an increase in nationalism and competition between major powers. The consequence for companies is increasing restrictions. Trade and investment face growing hurdles. Countries are prioritizing “national interest” and “national security” over the benefits of free market access. In this volatile environment, management and the board have a crucial role to play in actively identifying and assessing potential risks arising from geopolitical threats and regulatory changes. This includes assessing vulnerabilities, reviewing various scenarios and developing risk mitigation strategies. As a result, Louis Lehot recommends in his article in the National Law Review the following key questions boards should be asking management about the complexity of a changing geopolitical landscape (Quote):

• How do we gather and analyze intelligence on geopolitical developments?

• What crisis plans are in place for different scenarios? How often are they reviewed?

• How is management staying informed about regulatory changes and compliance requirements related to geopolitical risks?

• How are we ensuring compliance in volatile markets?

• Is our supply chain resilient to geopolitical disruptions? Do we have back-up plans?

• How can the board support management in addressing these challenges?

• How might geopolitical issues impact our company culture and employees worldwide?

• Has management done a tabletop exercise to strategize on the impact of potential geopolitical developments?

• Can the board do a tabletop exercise to practice its own role?

• Is there a plan or playbook ready to respond to such a crisis?

The major auditing firms also advise companies on geopolitical risk management. Stefano Moritsch, the Global Geopolitics Lead for KPMG, is quoted in an article in The Atlantic to the topic “A NEW CORPORATE APPROACH TO GEOPOLITICAL RISK” as follows: “Boards are waking up to the reality of geopolitical risk being very high on their agenda and are now working to increase their resilience.” John Rodi, the leader of the KPMG Board Leadership Center is quoted as follows: “In the past, many companies may only have received geopolitical updates once a year. Today, depending on the company and industry, the board may get a geopolitical update every quarter or more frequently.” The interesting article in The Atlantic can be found here.

IV. De-Risking

The De-Risking concept is illustrated below using the German government’s official China strategy from July 2023 as an example:

“Germany is maintaining its economic integration and close trade relations with China. In future, however, the aim will be to increase economic resilience and minimize risks. In critical areas in particular, the German government wants to reduce dependencies and diversify economic relations overall. The aim is to establish and expand balanced partnerships in Asia without closing itself off to China.” The Strategy Paper can be found here.

Business Journalist Sonja Álvarez wrote about the German government’s China strategy in German business magazine Wirtschaftswoche on January 30, 2024: “In order to accelerate the desired diversification of the German economy, hardly any investment guarantees are being approved for China. The German government uses the guarantees to protect investments by German companies abroad against incalculable political risks, including expropriations, acts of terrorism, payment stops and wars. If such a loss occurs, the federal government compensates for the loss of assets up to a certain percentage – this is intended to protect the company so that it can make investments even under difficult conditions. The German minister of economics Robert Habeck has also considered a further tightening: With a so-called “outbound investment screening”, investments by German companies in China could be monitored more closely in order to prevent an outflow of know-how and technology transfer into critical areas.” The insightful article can be found here.

Norbert Röttgen, member of the German Parliament and expert for foreign affairs, expressed the expectations that politicians have of companies in his statements on the Internet platform X in January and April 2024 as follows: “The yardstick for Germany’s solidarity with Taiwan is our China policy. The decisive factor is whether we manage to reduce our dependence on the Chinese market. Only then will our economy be able to survive sanctions and counter-sanctions in the event of a conflict. The German government’s China strategy is being ignored by large parts of German industry. German dependence on the Chinese market continues to grow. Investments in the Chinese market are not falling, they are rising. And at record levels. If there is a conflict with China over Taiwan, this will affect parts of the German economy to the core.” This all reminds Norbert Röttgen of the fatal statements on NordStream2, which was seen by the government as a purely private sector project. The German government and industry must work together to develop a strategy to avoid overinvestment and open up new growth markets. There is also no all-clear in the area of raw material dependency. On the contrary: the success of the German energy transition is heavily dependent on raw materials and technology from China. Following its energy dependency on Russia, Germany is increasingly slipping into a new dependency on China. Norbert Röttgen’s statements on X from January and April 2024 are available here and here.

V. Business Judgment Rule

The need for information also plays a central role in business decisions. Under the business judgment rule, the Management Board must act on the basis of appropriate information. What is appropriate depends very much on the specific individual case. Within the time available, the Management Board must obtain the information required to prepare a thorough decision and make an appropriate risk assessment of the specific situation. What information is appropriate depends not only on the time frame already mentioned, but also on the scope of the decision, the variety and size of the decision variables and the extent of the risk assumed. Depending on the complexity of the matter to be assessed, this may also require external consulting services to be obtained according to legal scholar Susanne Kalss in Munich Commentary on the German Stock Corporation Act, 6th edition 2023, margin no. 429 on Section 93 AktG.

External consulting services are widely used in corporate practice for business decisions relating to geopolitical risks. In this regard, reference is made to the Agora Strategy Institute. The think tank analyzes geopolitical challenges and develops comprehensive scenario planning. In particular, it evaluates political market and country risks as a basis for investment decisions and international business development. Specific recommendations for action are derived from the analysis of market-moving political events and the assessment of the impact on sectors and companies. Further valuable information can be found here.

VI. Conclusion

Companies can counter geopolitical risks through effective risk management and insurance solutions. All potentially relevant risks must be permanently monitored. An individual risk analysis is required – also with the support of IT models and, if necessary, external consulting services. It is important to mitigate and diversify political risks through preventive measures.