Risk Management Practices

A Frame of Reference:
Geopolitical Risks to Canadian Financial Services

Erik Brown, Research Analyst, Global Risk Institute
Bruce Choy, Managing Director, Research, Global Risk Institute


INTRODUCTION

In this paper, we assess the disruptive transition in geopolitics, from a multilateralist and interconnected world to an emerging paradigm of “Splintered Integration.”

In this emerging paradigm, state competition overlays and even pushes back against globalization. Economic interconnectivity remains deep but uneven, with greater restrictions in some domains than in others.

  • Prominent features of Splintered Integration include U.S.- China strategic competition, economic segmentation, technology governance and cyber conflict.
  • Facing the breakdown in multilateralism and the recent shift toward Splintered Integration, Canadian policymakers and financial institutions (FIs) should revisit their strategy and risk policies.

We then provide a new Frame of Reference with which to model past transitions and explain the present change in geopolitics. This frame does not make predictions about the future but helps FIs to interpret the implications of a range of potential geopolitical changes for risk management purposes. The model involves a 2X2 future scenario matrix defined by two uncertainty drivers: political state cooperation /competition and economic integration/fragmentation. The four quadrants reflect distinct geopolitical scenarios, each with implications for the range and frequency of risks:

  • Beggar-thy-Neighbour — A world of negligible cooperation and highly regionalized economies in which risks have limited range but high frequency.  The 1930s provide a historical case study.
  • Regional Order — A world of strong cooperation but limited to blocs defined by geography or shared political/legal norms. There is minimal economic integration across these blocs. This world is exemplified by the Post-WWII (1945-91) U.S.-led order.
  • Hyper-globalization — A world of strong multilateralism with diverse and wide-ranging interconnectivity across domains. It is illustrated by the immediate Post-Cold War era (1991-2000s).
  • Splintered Integration — The emerging paradigm of decreased multilateralism. Global integration remains comparatively deep overall, but with pushback and even reversal in some sectors. Risks in this world have both increased range and frequency.

We conclude with four calls to action for FIs in a world of Splintered Integration:

  • a. Boards and senior management should review existing and planned exposures in light of the increased range and frequency of geopolitical risks.  Updates to risk appetite and policies, in a manner that reflects their unique organizational and geographic profile, will likely be required following the review.
  • b. The first line (business managers) should integrate heightened geopolitical awareness with existing political/country risk assessments to find growth opportunities. Structures for streamlining on-the-ground assessments and information flow to management is essential to be nimble in timely business decision making.
  • c. The second line (risk oversight) should review country risk assumptions in policies and models, and structure their review cycle to remain responsive to geopolitical change. Detailed assumptions on portfolio diversification, structural foreign exchange risk and market stability/volatility should be revisited.  Methods like scenario planning and stress testing can help organizations account for increased global complexity and determine whether existing corporate strategies are resilient to shocks.
  • d. And the third line (independent assessment) should adjust and implement flexible audit schedules to ensure that they are similarly responsive to shifting trends.

 

Download and read the full report 

A Frame of Reference Geopolitical Risks to Canadian Financial Services