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1 Transcript Geopolitical risks hitting closer to home for North American companies Linda Conrad, Head of Strategic Business Risk, Zurich, and David Anderson, Global Director of Political and Trade Credit Risk, Zurich Welcomee to Zurich s podcast. I m Linda Conrad, Head of Strategic Business Risk for Zurich. I m here with my colleague David Anderson, Zurich s global director of political and trade credit risk. We re here to talk about the growing intensification of geopolitical risk over the past few years and what it means for North American companies with exposure around the world, from two perspectives: the firm s balance sheet and their supply chain. Thanks Linda. We ve seen the World Economicc Forum s Global Risks Report and a number of other surveys show geopolitical risk as a top risk for the past few years, and that s certainly borne out in what we are seeing in the political risk insurance space at Zurich. Claims are up significantly, and demand for solutions has increased. That s interesting you say that because, in talking with North American executives, it seems like a mixed bag: Some companies are very much on top of geopolitical risk, and others are really not focused on it. Why do you think that is? I think awareness about potential corporate impacts of geopolitical risk in this region is improving but not yet where it needs to be given the risk level. There are a variety of reasons for that. Number one, the North American population does not feel the effects of geopolitical risk as immediately as Europe, where, for example, millions of refugees are trying to enter from failed states and where Russia is viewed as a real potential military threat. Second, certain industries such as oil/gas and mining are more accustomed to dealing with geopolitical risk than others, while others may be less aware that they may be exposed. Third, the insurance industry and others like political risk forecasting firms need to do a better job of educating customers about the risks and the means to mitigate them. I completely agree, because I see it in discussions on the supply chain. I think geopolitical and supplier risk feels nebulous to a lot of companies. In other words, we know geopolitical risk is high, because we read the paper every day, but what does that really mean for North American companies with exposure in the emerging markets? 1

2 It is a broad area and can be intimidating for companies when they first dive into it. But, for us, it comes down to specific balance sheet exposures. Fixed assets and equity investments are exposed to risks like war, civil war, terrorism, expropriation, currency inconvertibility and others. Accounts receivable are exposed to the risk of default by buyers, and the reason for that default could be anything: political risks, massive depreciation of the buyer s currency, bankruptcy or sovereign default, etc. Do you look at geopolitical risk in the supply chain in a similar way? Each year, Zurich works with the Business Continuity Institute on a study about business interruptions stemming from supplier disruptions. For the past six years, over 75% of companies reported having supplier disruptions, with half suffering more than one break per year. Many of these disruptions can be linked to geopolitical upheaval, yet companies often neglect to consider their risk and recovery plans from such events. Even if much of your profitability or sourcing is domestic, there is still a high probability thatt critical components or raw material comes from overseas, leaving them exposed to such global trade issues. So if we ve seen and as many surveys indicate that political risk has risen to a high level, we would expect to see that emerge in our claims history. What are you seeing there? It s an interesting story. In , we experienced the global financial crisis, and trade credit insurers (who were not involved in exotic assets like sub-prime mortgages or similar securities) paid out over $10 billion around the world as liquidity dried up, banks stopped lending and buyers defaulted. In the years since then, the frequency and severity of political risk claims has been the highest we vee seen for decades. To give you some examples, Zurich has had a customer s facility in eastern Ukraine hit by rockets, then occupied by pro-russian militants, then looted. Another customer had to abandon his equipment in Libya because war broke out and he couldn t safely operate anymore. In Yemen, we ve had a similar case. In Central African Republic and Thailand, civil strife erupted and customers assets were damaged. So the claims history has leaned much more heavily toward political violence, resulting in more claim payments in that area. And nobody should be surprised at that, given what is going on in the world. Let s not forget that a lot of the assets you are talking about are suppliers for other companies. Major supply chain disruptions caused by geopolitical events include cotton and other commodities that were impacted by the so-called Arab Spring uprising, or about 50% of the world s hard disk drives that were halted following floods in Thailand that weree exacerbated by political issues in that country. Some would say, well, OK, there are some risky countries, so stay away from the suppliers or operations in those risky places. How do you react to that? 2

3 You don t know what will be risky in one year, never mind 5, 10, or 20 years. Risk is so interconnected and moving at such a higher rate of speed (largely because of the Internet and globalization) than ever before. I m not saying don t bother assessing risk and looking at what forecasters say, but do it with healthy skepticism and humility. Do your scenario planning, build resilience, diversify your country bets, and be prepared for the worst. Also, there are insurance solutions. Remember that very few predicted that Russia would annex part of Ukraine, a self-immolation in Tunisia would set off uprisings and war throughoutt much of the Arab world, or that Brazil would now be in a deep economicc and political crisis. On the supply chain side, North American firms learned a lot of these lessons in the 1980s and 90s as part of the globalization of the economy. To compete, they had to source from the emerging markets, but the risk assessment and disaster recovery plans didn t keep up. All this seems to indicate thatt companies should do some additional risk analysis. At Zurich, we have developed a supplier risk analysis and insurance to help better understand and protect against political, financial, regulatory, natural catastrophe and other potential challenges at a supplier. For country analysis, we use a cool tool called the Zurich Risk Room, an app which can help give some risk insights into which countries make the most sense for sourcing, manufacturing or globalization of operations. Speaking of globalization, China, as the world s manufacturer, obviously represents a huge concentration of supply risk for many firms. With military tension in the South China Sea and many economists talking about an economic hard landing there with unknownn political ramifications, what is important to understand? I m glad you brought up China, because about 70% of the world s goods go through just six ports, many of which are in China. I m also reading about how the slowdown in the Chinese economy is what is really connected to the prolonged commodity price dip we are in, which of course is really hurting China s supply chain. But how do these low oil prices (and other commodities) affect your world? The emerging markets tend to be particularly dependent on commodity exports, so when those exports dry up (from both volume and price), these countries come under significant economic stress. That can manifest itself in a lot of different ways, but some of them are currency depreciation, interest rate increases, capital controls and government payment arrears. Citizens in thesee countries then feel the economic effects in the form of higher prices for goods, shortages, economic slowdown and reduced government spending. And then the economic stress can lead to political stress. Experts cite low commodity prices as a primary driver of political risk in Latin America and Africa in As a net importer of commodities, the U.S. benefits from low commodity prices, but are you seeing risks emerge in the supply chain to the U.S.? 3

4 As the Global Risks Report 2016 points out, the current geopolitical landscape indicates that politics is now dominating economics. While globalization has brought many new opportunities to nations, it has also renewed insecurities and rivalries. Supply chain resources that have been taken for granted such as access to raw materials, cyber infrastructure and secure financial transactions may become politically restricted, posing new risks for companies that rely on free and open markets to commodities, financial instruments and customers. Businesses may find more and more roadblocks because of anxieties around trade, technology transfer and intellectual property. All this geopolitical instability calls into question the reliability of a company s supply chain. Supply chains are already being pushed to perform both more cheaply and faster because today s markets and consumers demand new products and innovations at an increasing pace. So a company cannot afford to misss even a matter of days to get the right products to the right customers. It soundss like supply chain risk management should really be a key part of a company s larger strategic business plan. Exactly. Just as these global risks are interconnected on a macro level, supply chain risks are interconnected throughout an entire organization, and can have an enormous impact on profitability and reputation. So creating a resilient supply chain is critical to ensuring a successful business strategy. Assessing the likelihood and repercussions of supply chain failures before they happen is an important part of corporate business continuity planning. And having a resilient supply chain can truly be a competitive advantage for a company seeking to satisfy the on-demandd needs of its customers. This is somewhat of a paradigm shift for many North American companies and their risk management approach: giving closer scrutiny to the interconnections between geopolitical exposuress and other risks in their supply chain. Or perhaps we should call it a supply web! We re seeing that global risks are becoming increasingly more interconnected, whichh means a more profound effect on economies, politics and businesses with a presence and operations around the globe. Linda, would you say then, that there is a need for organizations to address these global risks more directly in their business strategic and risk management planning? Definitely. There is a resiliency imperative today. This new geopolitical context that organizations are working in requires understanding how thesee risks impact strategy and operations both short- and long-term. Listen, no organization can control the geopolitical and economic events happening around the world. But it can work to control what their response will be, so it will be less impacted if or should I say when global dynamics change. Effective risk management moving forward should take into account the interconnections between geopolitics and their supply chain, and then proactively adjust their strategy and operations to either avoid or reduce the negative effects through improved resiliency. I know for customers with trade credit exposures, we recommend spreading their balance sheets across multiple countries to include those that are not heavily dependent on commodities for economic stability. What do you advise for managing risk with an organization s supply chain? 4

5 First, it starts by ensuring that supply chain issues are addressed at the highest levels of an organization the C- suite and the Board. These highest executive levels need to own the risk agenda for supply chain issues because it is so inherently intertwined with business strategy, planning and profitability. So once adopt? Any risk analysis and identificationn needs to be company-wide and holistic a truly 360-degree look at where supply chain vulnerabilities may lurk. Our Enterprise Risk Management work with Fortune 500s and other global industry leaders usually starts with scenario identification and then stress-testing these scenarios to determine the business impact across key suppliers and key locations. There are also some great risk assessment and modeling tools available to better visualize and quantify exposures and design response plans. We see that disaster recovery efforts can cost about 4 to 10 times what a company may estimate. I would imagine that most organizations could take a look at strengthening their scenario and emergency planning to better analyze these complex and uncertain interconnections in order to truly build resilience. Yes, building resilience is the endgame with whatever scenario analysis or modeling an organization adopts. And your point about having a holistic, integrated enterprise risk management process is particularly key an organization can t afford to have different riskss managed by different people and policies there is too much potential for risks to have a cascading effect, especially between the physical and digital realms. That digital realm is of particular concern to North American businesses because of the increasing dependencee on cyber information and advanced technologies to not only deliver to current customers, but to fuel future growth too. In fact, the Business Continuity Institute study estimates that 50% of supply chain disruptions come from IT outages / communication failures. The Report calls data flow the oil of the 21 st century, and keeping that oil flowing having reliable data transferr is especially critical to supply chain resilience. The complexity and interconnections of global risks and their impact on North American companies will continue to be a hot topic this year and beyond. We invite our listeners to stay a part of the conversation with Zurich North America at zurichna.com to visit our Knowledge Hub featuring articles, videos, blogs and white papers on this topic. One final thing: If risk avoidance becomes your only strategy, you may miss strategic sales and supply opportunities in countries with the highest potential for long-term expansion. So the key may be to better understand and address how corporate objectives intersect with the exposures in the Global Riskss Report, to help your company better capitalize on growth opportunities. Thanks for joining us. # # # supply chain risk is elevated to this level, what types of risk analysis and tools should the organization 5

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