The Challenge of Integrating Political Risk Into the Enterprise Risk Management’s (ERM’s) Architecture (Part 2/4)

by Amir R. Saghafi CISRP, CRCMP, CSOE, MMgt
Governance, Risk and Compliance (GRC) Consultant

This article represents the second part in a series with the same title appeared in the October’s edition of ERMA’sRiskView Monthly Newsletter. The following work addresses the issues of categorizing the political risk and challenges linked to identifying their potential relationships.

Categorizing Political Risk
Risk identification and measurement is a dynamic, practical progression that is composed of various activities and undertaking aimed at assessing and managing such risks in a timely and effective manner. Accordingly, risk categorization plays a vital role in this process as it provides a foundation by which hazardous phenomena or events are grouped into manageable categories. These categories in effect are value-based definitions of [common] characteristics of the origin and type of risk events or occurrences and their implications on the total enterprise. Political risks, like other types of risks faced by the enterprise, need to be defined and categorized in accordance with amatching analogy.

It should be carefully taken into consideration that due to the varying nature of events and elements that may give rise to execution of any given political power with potential negative consequences to the enterprise, categorizing political risks is a highly subjective endeavor. This entails that the process of categorizing political risk does not involve a linear pattern of analysis and communication from a singular business unit, but rather embroils a speculative approach through which all involved business units across the enterprise analyze and communicate threats and opportunities.

Therefore, the identification and categorization of political risks is a highly speculative undertaking involving both chances of loss and gain based on opportunities and threats perceived, and responded to, by the management. This, however, does not limit the adoption of a more general or standardized categorization of political risk by the enterprise. The two most notable main categories are micro and macro-level risks that can be further divided into more customized subcategories.

Micro and Macro Political Risk Factors
Amicro-level risk refers to a type of a political risk specific to a business or specific sector or an industry only. Micro-level risks are therefore do not include all enterprises and may be presented in various forms and levels such as specific regulations on aparticular industry (i.e. financial services, oil and gas, etc…) and taxation of certain business lines or undertakings such as placing tariffs or import bans on goods and services. On the other hand, macro-level risk refers to a type of a political risk that is not confined to target or influence a business or a specific sector or industry but rather embodies a widespread audience to include those affected in a country and/or region. Terrorism, energy-price volatility, political turmoil and security breaches are amongst top notable macro phenomena construing political risk in the context.

Although both micro and macro-level political risks may expose the enterprise to significant negative consequences, yet often time macro-level risks tend to convey larger dramatic and precipitous events followed by potentially larger losses. Example of such occurrences may be of those when an unexpected political shift such as a revolution or a shift of power takes place and/or the economic system is being altered significantly.

In consideration of the aforementioned, nonetheless, micro and macro-level political risks are not fully independent from one another These two categories of political risk may well share common domains within the economic, social, and governmental spheres. The suggested interlink and the presumed extent of overlap defines the foundational assumptions and elements that furtherdemarcate assessment methodologies associated with each category of risk. Macro-level risk elements in particular play a major role in developing environmental inputs for scenario planning processes and strategy reviews through which potential outcomes and matching capitalization strategies are identified and measured in both normal and extreme cases. However, it should be carefully noted that the distinction and the presumed level of interrelation between these factors are neither unblemishednor strong[1]. Often the variables under consideration lack sufficient visibility to be quantified or measured and hence, difficult to be fully distinct, defined, and utilized in evaluations of risk exposure(s) pertinent to the risk analysis process, which in turn transforms the categorization process highly subjective and judgmental in such instances.

[1]Alon, Ilan, Herbert, Theodore, T. (2009). A Stranger in a Strange Land: Micro Political Risk and Multinational Firm. Business Horizons 52(2); P.128.