Geopolitical resilience: The new board imperative

 

This article was written by Ziad Haider, Jon Huntsman Jr. and Chris Leech. The original article was published by McKinsey. You can find the article here.

Today’s world is more connected economically than ever before yet is experiencing significant geopolitical fragmentation. In this context, geopolitical risks are among the top three issues that CEOs believe they must act on in 2023.1

For management, the imperative of navigating geopolitical risks is obvious, but for a board, the road map is unclear. What is a board’s role, relative to management, in building and stewarding a resilient and thriving enterprise under geopolitical storm clouds?

In this article, we focus on this question and suggest approaches and frameworks for directors’ consideration. In doing so, we draw on our discussions with the boards of leading global companies and our experience as geopolitical risk practitioners and board members.

A world connected and fragmenting

The global order today is experiencing cross-cutting forces. On the one hand, according to McKinsey Global Institute research on global flows, the ties that bind are strong.2 Exports, as a percentage of GDP, have doubled since 1990; trade in intangibles, data, and intellectual property has grown twice as fast as goods; and cross-border talent flows are at an all-time high. At the same time, we are experiencing significant geopolitical fragmentation, or as German Chancellor Olaf Scholz has put it: “The world is facing a Zeitenwende: an epochal tectonic shift. New powers have emerged or reemerged. In this new multipolar world, different countries and models of government are competing for power and influence.3

Adapting from the distinguished Harvard political scientist Dr. Joseph Nye’s analysis on the future of power,4 there are three levels to the global order from a geopolitical lens: a unipolar level on the military dimension with the United States dominant; a tripolar world on the economic dimension with China, the European Union, and the United States in lead positions; and a multipolar political dimension with “middle powers,” such as India and Saudi Arabia, pursuing varied forms of nonalignment and exercising greater global clout.

Amid these tectonic shifts are two major fault lines: in Europe, Russia’s invasion of Ukraine, and in the Indo-Pacific, strategic competition between China and the United States. These events have prompted the key question looming over many boardrooms today: Having scaled back in or exited the world’s 11th-largest economy (Russia) last year, how should companies guide operations in and around the world’s second-largest economy (China)? Viewing the options on a spectrum, should they, as European Commission president Ursula von der Leyen put it, further derisk (and if so, how), or should they “decouple?”5

Most boards feel unprepared to grapple with this core question. And it is by no means the only question. How should one approach multidecade investment planning in a rapidly evolving geopolitical context? How do companies navigate the growing regulatory thicket of export controls, sanctions, and data localization requirements that are often at cross-purposes and increasingly constrain a seamless global footprint?

In surveys of global boards conducted by our colleagues, most directors say they are very prepared to deal with challenges close to home but feel unprepared for larger-scale forces such as major crises, macroeconomic shocks, and climate change. Most say they find these forces too ambiguous to understand fully.

Boards must quickly adapt to this emerging global order. To do so, they need greater granularity in how they understandmonitor, and mitigate the geopolitical risks facing their global footprint. We examine these elements below and outline a set of guiding questions for boards to utilize.

Understand: Acquire expertise and competency

Boards must, first and foremost, upgrade their capabilities to conduct more nuanced discussions and decisions around managing geopolitical risk.

Doing so starts with the who. Does your board have the core competency and clear governance to engage on geopolitical risk? Ensuring so requires reassessing board composition criteria, committee setup, and overall board scope. Steps to consider include the following:

  • A diverse board with the relevant skills and experience to provide forward-looking strategic direction and actively engage in problem solving. Board composition strategies and selection criteria, often defined by nomination committees, could include explicit requirements around ensuring a subset of members have experience in geopolitics (whether from media, regulatory affairs, or government) and exposure to key markets of elevated geopolitical sensitivity. These directors could also play a role in conducting business diplomacy and engaging key stakeholders across markets in a manner that adds to and advances management’s core strategic objectives from a level of risk oversight that only directors can convey.
  • A set of board committees with domain awareness and expertise. The board could shape the remit of key committees to support the board overall in dealing with geopolitical risk across different dimensions. For example, risk committees could ensure that issues of public policy and regulatory affairs are a core agenda item, or they could consider establishing a stand-alone committee with members of relevant expertise to focus on related questions. Similarly, compensation committees could tie a portion of CEO and leadership compensation to having managed down the organization’s geopolitical risk through defined criteria, thus enabling them to earn a geopolitical resilience premium. Providing the right incentive structure to upgrade capabilities can thus help ensure the right people are at multiple levels of the organization.
  • A clear delineation of roles and responsibilities between the board and management team. Boards and management teams ought to have a clear delineation of responsibilities in terms of leading on managing geopolitical risk. Typically, the board would fundamentally focus on providing a clear direction and strategy, stress-testing scenarios, and providing guidance, instead of, for example, defining specific controls needed.

Boards must, first and foremost, upgrade their capabilities to conduct more nuanced discussions and decisions around managing geopolitical risk.

With the who in place, the next question is what information should be provided to the board to educate members continually on key topics.

Creating a baseline of facts related to the context of the organization—even on a board with pockets of core competency—is critically important in a global organization, where board members may span different markets and consume different media sources. While a diversity of views should be welcomed and retained, boards should also sustain aligned and continued education by having a specialist geopolitical risk unit provide regular updates about key geopolitical developments and implications for the organization.

In addition, boards should consider hearing directly from external sources of insight, by either standing up an advisory council of individuals with related expertise or bringing in two to three external speakers over the year. Whether council or speakers, ensuring a diversity of perspectives is critical. Exposure to a multipolarity of perspectives is necessary for navigating a multipolar world and establishes credibility with colleagues across a global firm.

In terms of the when, simply put, geopolitical risks do not heed a quarterly calendar. Rather, boards must up their clock speed and their ability to make decisions to at least monthly reviews of key developments with ad hoc meetings in between as needed.

An underappreciated dimension of upgrading a board’s capabilities is the where. Boards should consider holding their meetings in a diverse range of markets, including key emerging markets, with a structured agenda for external engagements and site visits. This not only deepens a board’s understanding but also signals externally and internally the organization’s commitment to a market. Of course, holding a board meeting in a more geopolitically sensitive market also requires careful consideration of factors such as timing, optics, security, confidentiality of discussions, and internal and external scrutiny.

Finally, the how. We often get the question of how management should stand up a geopolitical risk unit to support the board and management. There is no one size that fits all. Some companies have stood up units within their government and regulatory affairs teams (for example, key global tech players for whom political risk is often interwoven with regulation); other companies within the risk team (notably, global financial institutions expanding out from a focus on credit and market risk); and still others within their security teams (for instance, global firms with supply chain and infrastructure exposure). In fact, geopolitical risk cuts across all these teams and others, such as communications, finance, and tech. More important than where the unit is housed is for it to have the following characteristics:

  • The unit should be empowered to coordinate inputs across teams to deliver integrated analysis for and aligned action on behalf of the board and executive team.
  • To coordinate inputs and action, it should establish a working group with representation across internal teams. This working group should convene regularly.
  • The members of the unit should be strategic thinkers who can see issues from different vantage points, including of their own colleagues in geopolitically sensitive markets. They should be drawn from across the organization.
  • The unit should have budgetary support to engage vendors and speakers and to externally source geopolitical risk scenarios and sources of insight.
  • A board member should be paired with the unit to provide strategic guidance on content and framing and to ensure briefings and products will resonate with fellow board colleagues.

Key questions to ask management include the following:

  • What are the most significant geopolitical risks facing our organization?
  • What are the actual implications of these risks for our organization?
  • Do we have the core competency to understand and mitigate these risks?

Monitor: Use relevant frameworks

Upgrading the board’s understanding is foundational. Understanding then needs to be channeled into ongoing monitoring through frameworks that focus the board’s mind.

One such framework is a geopolitical risk dashboard that reviews markets tiered by geopolitical risk exposure—a dashboard to be developed and regularly refreshed by the geopolitical risk unit. Higher-tier markets are ones where organizations have to navigate sharply competing interstate interests, such as escalating US–China strategic competition, that could have an impact on the organization and where the board’s continued focus and attention is important. A lower-tier market would, for example, entail localized risks, such as political instability; internal teams would manage such issues as they arise, with the board delivering visibility and guidance when needed.

Each month, the board can be presented with the dashboard reflecting key developments in the markets under each tier (flowing from the updates described above), their impact, and importantly, the controls being developed—including by whom and over what time frame—to manage the attendant risks. For example, in a higher-tier market where a new set of sanctions and export control restrictions have been imposed, the dashboard could explain the restrictions; the impact they have on the company directly or on its clients, suppliers, or partners; and how internal compliance processes will be adapted in response.

While some of the board’s deliberations on a particular market—such as whether to exit a sensitive market—may be actionable, boards also ought to leave scope for review and discussion. For example, the geopolitical risk unit could shine a spotlight into regions where the organization operates that are infrequently reviewed closely. This would ensure the board maintains a sharp global antenna and can provide management with the benefit of a broader view of controls.

In contrast to the geopolitical risk dashboard framework that is tilted toward immediate risks, another framework that boards can leverage to lift their gaze is what we call a “black swans, gray rhinos, and silver linings” framework to assess and categorize key geopolitical scenarios. Black swans are unknown risks of high impact, while gray rhinos are foreseeable risks of high impact. Silver linings, on the other hand, represent areas of opportunity amid geopolitical flux.

Boards should stress-test such scenarios upon their development by the management team, with support from the geopolitical risk unit. During this effort, boards can provide guidance about key watchpoints and contingency plans for a core subset of scenarios that have the greatest impact on the organization. Key questions to ask include the following:

  • What are the key markets that merit ongoing monitoring and discussion at the board level in terms of geopolitical risk exposure?
  • Is management’s geopolitical risk dashboard fit for purpose?
  • Do we have a robust early-warning system and sources of insight to anticipate the risks in our key markets before impact?
  • Are we paying sufficient attention to the aggregate long-tail geopolitical risk of our presence in a series of smaller volatile markets?

Mitigate: Guide the development and application of risk controls

To manage geopolitical risk effectively, boards should also pressure-test management on its set of controls. Some of the most thoughtful institutions with whom we have engaged have put in place controls that include:

  • ensuring their management teams are building resilience in their supply chain
  • reviewing insurance policies
  • recalibrating their corporate structure and tech stacks in sensitive jurisdictions
  • investing in their public and regulatory affairs capabilities
  • thinking through how best to engage with and retain their colleagues’ commitment to a common enterprise amid the centrifugal forces of nationalism.

One key control is for the board to ensure their organization has clearly defined its activities and entities in geopolitically sensitive markets. Such a framework or “compact” ought to be developed by the management team; however, the board has an important role to play in providing oversight and guidance. Also, the board could, where warranted, commission the development of additional compacts.

Compacts guide investments and operations in sectors with heightened regulatory and reputational risks. They specify levels of engagement: areas and entities with which the organization will not engage at all due to, for example, legal restrictions or acute physical security or reputational considerations (red); those where the organization will surge because there is clear upside and the area or entity is relatively insulated from risk (green); and those that require careful deliberation and a decision-making framework that weighs the opportunities and risks around activities and relationships that may be perceived as “lawful but awful” (yellow). The process of developing the compact helps create important internal alignment and buy-in amid diverging views on risk appetite—a critically important dimension of managing geopolitical risk.

Key questions to ask include the following:

  • How much risk are we willing to accept in relation to the growth and competitive opportunity we see? Are our controls set at the right level?
  • Should our controls manage the geopolitical risks as they are at this moment in time, or should they look ahead to how the risks may evolve and take a more restrictive position on an anticipatory basis?
  • Do we have an adequate level of political risk insurance in place?

For many board members who came of age in the world of hyperglobalization, today’s fracturing global order requires a mental shift and an effort to upgrade their capabilities. Partnership with the executive team is vital in building the foresight, response, and adaptation capabilities needed to manage future shocks.

Ultimately, boards have a key role to play in exercising oversight to lift management’s abilities and imagination so their company can navigate the prevailing geopolitical currents and seek new growth horizons. No board today has a monopoly on the truth of how to do this, but at the companies that will thrive, boards are leaning into a world in flux with grit and granularity.

 

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