Geopolitics tensions: the perfect storm for finance
19 July 2022
Just as the silent generation gave way to the baby boomers, who now give way to Gen X, Millennials and Gen Z, so too do a group of geopolitical risks supersede the last. Growing trade and political tensions between the globe’s superpowers, a once-in-a-lifetime pandemic, and now war on the European continent – each brings with it a complicated set of challenges for which financial firms must adjust both operations and investments.
William Telkes, Chief Economist at Spuerkeess
“Geopolitical risks belong to what certain analysts define as the uncertainty trinity, together with economic and policy uncertainty,” states William Telkes, Chief Economist at Spuerkeess. They refer to any event that affects the relations between different countries and have significant impacts on economic, human, and diplomatic interests, Telkes goes on to explain.
These risks have also become increasingly intertwined given globalisation. No matter the benefits it creates, it has also created a perfect storm for crises which were once isolated to a country or regional level to quickly manifest at a global level. Prior to the current situation, tensions and risks were already rising. “We shouldn’t forget that Putin already invaded Ukraine in 2014, we had deteriorating relations between the US and China, rising protectionism in a variety of countries and regions, refugee crises, terrorist attacks, tensions in the Gulf, conflict with North Korea, and the covid crisis which further destabilised the world and which could be a catalyst for a retreat from the globalised mindset,” explains Elisabeth Krecké, Economic Expert at Geopolitical Intelligence Services.
From a macroeconomic perspective, given the effects of monetary and fiscal policies initiated, or bolstered, during the pandemic, 2022 was about managing a soft landing. “It’s now about whether we can avoid a hard one” says Sanela Kevric, Head of Benelux Sales at Fidelity International. “Previously, markets had been talking themselves into the view that any incursion would be limited to the breakaway regions of Ukraine. Now they have to wrestle with the prospect that it will be much broader and drawn out.”
The conflict will also affect how firms think about their cross-border capital investments more broadly, and the kinds of ethical, social and reputational risks that these now carry, as well as the effects of withholding from a particular marketplace.
Given the very nature of these risks, being prepared can be almost impossible. “Are financial services firms’ risk management frameworks designed to take these kinds of risks into account?” questions Krecké. When monitoring the effect on portfolios the critical issue is to have a consistent long-term measure. “There are indicators that make it possible to understand the importance of geo strategic events without targeting them directly, for example the VIX index or Economic Policy Uncertainty Index,” says Telkes. However, monitoring the possible effects on the firms themselves can be a more complex task.
“Geopolitical risk assessments require significant resources,” highlights Krecké. “Not only does the firm need to have in-house competencies relating to research, but you also need to plan for how your business could be affected by these events, what events might occur, what the security implications globally might be, and how the situation might affect assets on the ground.” Geopolitical risk due diligence might not have been something that financial firms considered significant, but recent events have likely changed that notably.
Unsurprisingly, these events have a strong influence on markets in general. “The war in Ukraine has already caused significant economic damage, and it will continue to shape the near-term outlook for global economies, particularly Europe,” its direct impact on the markets has largely been priced in for now, notes Kevric. Rather, “outcomes over the coming quarter will be heavily influenced by the timeline to a resolution and the easing of trade disruptions,” she continues.
Looking at all these threats we currently face as a whole, many have the potential to further fragment our economies. It could potentially slow down globalisation and therefore certainly affect financial services.
While Telkes notes that investment portfolios are constructed to take into account several potential scenarios and diversification in terms of geography and sectors is critical, the increasingly complex and interconnected geopolitical situation is creating very concrete and real implications for investment firms.
We saw the negative effects of this interconnected nature of financial services most clearly in 2008 and again in 2012, with the global financial crisis and the European sovereign debt crisis. “Prior to global financial crisis, we didn’t realise how interdependent financial institutions actually were and how one could drag down others in its fall to the point of making an entire system collapse,” stresses Krecké. “The sovereign debt crisis also highlighted just how quickly trust in sovereigns’ creditworthiness can be lost and what effects the widening of yield spreads can have.”
How then is the rapidly escalating geopolitical situation shifting the global nature of finance? Global companies have had to make difficult choices regarding products, employees, customers, and supply chains due to the ongoing war. Kevric explains that the same is true for financial services. “The conflict will also affect how firms think about their cross-border capital investments more broadly, and the kinds of ethical, social and reputational risks that these now carry, as well as the effects of withholding from a particular marketplace.”
This has become a clear conflict between democracy and autocracy. It could be possible that this translates to two worlds of finance: one of the democratic world and one of the autocratic world, and it’s unlikely these two will be as interconnected as they once were.
Short term then, we are likely to see a pull back from the globalisation that has typified financial services and the evolution thereof for the last forty years. “Looking at all these threats we currently face as a whole, many have the potential to further fragment our economies. It could potentially slow down globalisation and therefore certainly affect financial services,” notes Telkes. Krecké questions whether these changes could lead to a shift in finance. “This has become a clear conflict between democracy and autocracy. It could be possible that this translates to two worlds of finance: one of the democratic world and one of the autocratic world, and it’s unlikely these two will be as interconnected as they once were.”