Finance Forms of political risk Political change is not a “one size fits all” kind of risk. Instead, it can take many different forms, depending on the political environment in the jurisdiction, the state of economic development and other factors. It makes sense to think of political risk as a kind of sliding scale in which different kinds of change can have a different degree of impact on your portfolio. Here are some of the most common political risks which investors should keep an eye out for, presented least worrisome to most troubling: Policy changes This covers a whole range of government-initiated changes that can end up impacting the financial profitability of companies or entire industries. Tax changes are a fairly common example here: by changing the tax rate charged on income from certain business activities, governments can make such income more or less appealing, which obviously changes the value which investors are willing to pay for a share in such businesses. Another example would be concessions or operating licences granted to certain businesses, or the regulations and rules which govern what a business can or cannot do in a certain jurisdiction, or how much they can charge their customers. Such changes can change howmuch profit a business canmake, which has a direct and tangible impact on the price which investors are willing to pay to own shares in that business. This is the primary political risk in developed economies such as Canada, the United States, Japan andWestern Europe. While the rule of law and respect for property ownership are well established in these countries, tax laws, environmental regulations and other business rules are subject to constant “tinkering” by various administrations which get voted in and out at fairly regular intervals. Here’s an example that most of us will remember: the introduction of the Affordable Care Act (commonly called “Obamacare”) south of the border back in 2010 was a once-in-a-generation, government-mandated change brought upon an entire industry. The new laws and regulations had a significant impact on the valuations of most health-care companies, particularly those offering health insurance. Such policy changes didn’t suddenly make health-care companies bad investments overnight, mind you. But the changes did require investors to rethink the ability of health-care businesses to make profits, and recalculate what price they were willing to pay for the future earnings of these companies. Direct government interference One step up on the scale of political risk is the possibility of direct government interference in certain businesses or industries. These actions could include direct and sustained attempts by a government to change the nature of a given industry operating within a country, the direct expropriation of specific company assets, or even the nationalization of entire industries. While such actions are relatively uncommon in developed economies with a history of rule of law, they continue to be rather common in emerging markets. This is the kind of risk that comes with investing inChina − a controlled economy in which the government’s priority is not necessarily protecting the rights of property owners, but advancing the Communist party’s agenda and securing long-term political power. Over the past two years, the Chinese government has directly interfered with its banking sector, forcing it to prop up ailing government industries. It has also enforced significant new regulations regarding its hightech companies. And it has attempted to force businesses to use an accounting standard that’s significantly different than the one used in theWest. Unsurprisingly, such moves have dramatically changed the valuations given to many China-based businesses, as many former market “darlings” such as Alibaba, Tencent and JD.com have sold off sharply amid the fears of further government interference. A more recent example is the potential seizure of Western-owned airliners by the Russian government in response toWestern-imposed sanctions. At the time of writing, it’s still unclear whether Mr. Putin will follow through on his threat to expropriate such property. But even the suggestion has caused the stock price of a large number of leasing companies, travel and tourism operators, and airline manufacturers to take a dramatic hit. 30 | www.snowbirds.org
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