what is political risk
Political risk is the risk that investment returns may suffer due to political changes or instability in a country. Unstable factors affecting investment returns may stem from changes in government, legislatures, other foreign policy makers, or military control. Political risk, also known as “geopolitical risk,” becomes increasingly important as investments are made over longer time horizons. They are considered a jurisdictional risk.
break political risk
Political risk is notoriously difficult to quantify because of limited sample sizes or case studies when discussing individual countries. Some political risks can be insured through international agencies or other government agencies. The consequences of political risk can drag on investment returns and even eliminate the ability to withdraw capital from investments.
Types of Political Risk
In addition to commercial factors generated by the market, businesses are also influenced by political decisions. Various decisions made by governments affect individual businesses, industries and the economy as a whole. These include labor laws and environmental regulations such as taxes, spending, regulation, currency valuation, trade tariffs, minimum wages, etc. These laws, even just proposed, can have an impact. Regulations can be made at all levels of government, including federal, state and local, as well as other countries.
Some political risks may be identified in company filings with the Securities and Exchange Commission (SEC) or in mutual fund prospectuses.
Insure political risk
Companies operating internationally, ie multinational corporations, may purchase political risk insurance to eliminate or mitigate certain political risks. This allows management and investors to focus on business fundamentals while understanding how to avoid or limit losses from political risk. Typical operations covered include war and terrorism.
Wal-Mart Stores Inc. outlines certain political risks it faces in the Operational Risks section of its fiscal 2015 SEC filing on 10-K. Among supplier-related risks, Walmart cited potential political and economic instability in countries where foreign suppliers operate, labor issues, and possible foreign trade policies and tariffs.
In its Regulatory, Compliance, Reputational and Other Risks section, the company outlines risks related to legislative, judicial, regulatory and political/economic risks. Risk factors mentioned include political instability, legal and regulatory restrictions, local product safety and environmental laws, tax regulations, local labor laws, trade policies and currency regulations. Walmart singled out Brazil, and the complexities of its federal, state and local laws.