A Strategy For Building Resilience In The New Global Context
Global leaders gathered in Davos-Klosters, Switzerland last week for the 45th Annual Meeting of the World Economic Forum (WEF), amid a torrent of news that made the theme of the conference, "The New Global Context," very much of the moment: the Swiss Franc has been decoupled from the Euro; the European Central Bank is championing $1.3 trillion in quantitative easing; the IMF has downgraded its global growth forecasts for this year and next; and terrorism remains top-of-mind after events in Paris and a new hostage situation involving ISIS.
The notion of a new global context was echoed in the conclusions of Global Risks 2015, the 10th annual global risk report published ahead of the Davos meeting by WEF, in partnership with Zurich Insurance Group and other leading institutions.
Shift in views of global risks' likelihood and impact
The report highlights the emergence of a new global context against the backdrop of increasingly interconnected global risks that are set to test the resilience of businesses and societies in the years to come.
In previous iterations of the report, global decision-makers surveyed have typically identified economic risks as those most likely to occur over the next 10 years. However, Global Risks 2015 shows that three of the top four risks, in terms of likelihood, are geopolitical in nature.
Interstate conflict is reckoned to be the risk most likely to materialize, with failure of national governance, and state collapse or crisis, ranking third and fourth, respectively. In terms of the impact specific risks might have, interstate conflict is ranked fourth, behind weapons of mass destruction and newly emerging environmental and societal issues such as water crises and rapid and massive spread of infectious disease.
"There is growing recognition that the world and the risk landscape is more fragile and fragmented," said Axel Lehmann, Chief Risk Officer, Zurich Insurance Group, while discussing the report at Davos. "Economic risks and geopolitical risks are still very prevalent in the short term, but in the long-term view, societal and environmental risks are at the forefront. Societal issues, in particular profound social instability, are like the spider in the net—the big unknown that is influenced by every risk type."
Lehmann identified rapid urbanization as a societal issue, with the associated risks becoming global in scale. In 1950, one-third of the world's population lived in cities. In 2025, two-thirds of the population will live in cities, and 80 percent of GNPs will be produced in cities. "Huge investment in urban infrastructure is required," he said, citing the figure of $70 trillion needed by 2030.
"In Africa alone, $80 billion per annum is necessary until 2020, and only half is funded. Fifteen of the 20 global megacities are built along coastal areas, exposed to natural catastrophes. More people will be moving to cities in search of jobs and places to live—and they might be unavailable. Urbanization entails a whole range of key risks that need both stronger city-level institutions delivering practical solutions, and flexible, innovative, multi-stakeholder governance to deliver sustainable growth."
The price of geopolitical risk and the need for resilience
Gauging the impact of the geopolitical risks that are now deemed most likely to occur over the next 10 years can be an elusive goal.
In a lively discussion at Davos, Natalia Ann Jaresko, Ukraine's Minister of Finance, said that the financial markets often misprice geopolitical risk. "History has shown that the markets weren't ready for the systemic effects of the 2008 financial crisis, and they contributed to the size of the crisis because they underpriced the risk that the system was going to collapse in the way it did," said Jaresko. "The Eurozone collapse was misjudged and overpriced in time—overpriced because expectations were not being achieved in the end, and because today the Eurozone is basically where it was before, despite all of the overpriced risks."
Jaresko cited three reasons for her belief: Investors react to their own market appetite, not necessarily to the specifics of what's happening; geopolitical risk is not an objective risk that can be priced; and investors move en masse in or out of markets and in the pricing, and, right or wrong, not many are willing to buck the system.
Martin Senn, Chief Executive Officer, Zurich Insurance Group, agreed with Jaresko. "Geopolitical risk cannot be effectively priced," he said. "The real question is not whether the financial markets are mispricing geopolitical risks, but whether we have a full understanding of those risks and whether we are taking the necessary steps to build resilience as these risks are more and more interconnected and transportable. What the global risk report makes clear is that the very nature of geopolitical risks is changing. It's not just interstate conflict and terrorism that are impacting economic policy—it is natural resources, cyber issues, popular sentiment in elections. For example, this year, 45 percent of the G20 electorate is going through elections, creating significant uncertainty."
Not just about financial markets
Senn stressed that it is not just a matter of how geopolitical risks affect financial markets, but businesses, as well. "How is your business positioned with regards to supply chain exposure and the impact on the balance sheet of your organization? Risk drives return, so there are a lot of businesses that can view geopolitical risk as an opportunity if managed effectively, and not just as a downside exposure. That is why it is essential to have a full understanding of the exposures to geopolitical risks, and to take the necessary steps to build up the respective resilience."
Effective risk management in the new global context is a two-pronged effort that involves prevention and resilience. Resilience is critical because it is impossible to avoid risk events in a globally interconnected age. Resilient companies do not just manage risk within their organization—they proactively manage risk throughout their networks of suppliers, contractors and franchisees. By building strong internal and external relationships, and engendering trust and a desire to collaborate and share information, all stakeholders can communicate with each other to rapidly adapt to change.
Nurturing this trust requires leaders who can relate with suppliers, investors, business partners and others, pull them together, facilitate the sharing of information and provide direction and guidance. "Transparency, and stakeholders being able to speak up more easily with today's technology, make it even more important to build sustainable trust and reputation based on the company's values," said Senn.
Trust and collaboration are vital
The theme of profound social instability highlights an important dilemma that has been smoldering since the financial crisis, but surfaces prominently in Global Risks 2015: Global risks transcend borders and spheres of influence, and require stakeholders to work together. Yet these global risks also threaten to undermine the trust and collaboration needed to adapt to the challenges of a new global context.
For example, said Lehmann, "concerns about rising technological risks, most notably cyber attacks, remind us that geopolitical tensions are taking place in a very different environment than before. Information flows instantly around the globe, and emerging technologies such as drones enable new players and new types of warfare to enter the stage."
The evidence manifests Lehmann's point. Geopolitical conflicts are increasingly being played out online. These interstate conflicts can affect the private as much as the public sector (witnessed by the recent U.S.-UK agreement to simulate a cyber attack on their financial sectors). The growing importance of cyber-security in geopolitical disputes means that national interests often outweigh the public good in the debate about developing the global governance needed to mitigate cyber risks.
Against this backdrop, businesses need to think through how surety insurance can help protect capital and earnings by covering the risks of investing in different parts of the world. At the same time, a holistic, board-led approach that acknowledges the interconnectedness of risks supported by strong strategic planning, a healthy cash balance and a focus on lean cost structures can help create the resilience necessary to weather risks, be they a cyber attack, financial crisis or geopolitical hazard that threatens business continuity. By localizing and developing multiple suppliers, and incorporating flexibility into product and service design, you can create resilience to supply chain disruptions.
"A proactive approach to embedding such resilience into your company is critical to its future prosperity," said Lehmann. "Resilience doesn't create itself, and it requires a lot of thought and action to achieve it across an organization. But with the right insights and strategy, it is possible to create a truly resilient organization that can withstand the constant challenges of an interconnected risk landscape in the new global context."