What is Political Risk
Let me explain political risk directly to you: it's the risk that your investment returns could take a hit because of political changes or instability in a country. This instability might come from a new government taking over, shifts in legislative bodies, actions by foreign policymakers, or even military interventions. You might hear it called 'geopolitical risk,' and it grows more relevant the longer your investment timeline stretches. I consider it a form of jurisdiction risk, plain and simple.
Breaking Down Political Risk
You need to know that political risks are tough to measure because there aren't many comparable examples or case studies for any single nation. Some of these risks can be covered by insurance from international agencies or government entities. The fallout from political risk might just reduce your returns, or in worse cases, it could block you from pulling your capital out of an investment altogether.
Types of Political Risks
Beyond the usual market-driven business factors, political decisions directly affect companies. Governments make choices that influence individual businesses, whole industries, and the broader economy—think taxes, government spending, regulations, currency values, trade tariffs, labor laws like minimum wage, and environmental rules. Even proposed laws can shake things up. These regulations come from all government levels, including federal, state, local, and those in foreign countries.
You'll often find details on some political risks in a company's SEC filings or in a mutual fund's prospectus.
Insuring Against Political Risks
If you're running or investing in multinational businesses—those operating internationally—you can buy political risk insurance to offset or eliminate certain threats. This lets you and your team focus on core business operations, secure in the knowledge that political risk losses are minimized or avoided. Coverage typically includes events like war and terrorism.
An Example
Take Wal-Mart Stores Inc., for instance; in its fiscal 2015 10-K filing with the SEC, under operating risks, it outlined specific political risks. Regarding suppliers, it pointed to potential political and economic instability in foreign countries where suppliers operate, along with labor issues and possible foreign trade policies or tariffs.
In the section on regulatory, compliance, reputational, and other risks, Wal-Mart detailed threats from legislative, judicial, regulatory, and political or economic factors. These include political instability, legal and regulatory limits, local product safety and environmental laws, tax rules, local labor laws, trade policies, and currency regulations. It specifically called out Brazil for the complexity of its federal, state, and local laws.
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