10.3 What Is Political and Legal Risk?

Political risk is the possibility that an organization can be negatively impacted by political events attributable to a country’s government, such as armed conflict, constitutional changes, or major policy developments (Stowe, 2022). It is an event or a set of circumstances that affect a firm’s profit potential.

Legal factors are the official outcomes of political processes as presented in laws, regulations, and court decisions – all of which have a direct impact on a firm’s performance.

Political risk can be an issue at the best of times, even in the most developed markets; for example, the European Union (EU) applied political and legal pressure on five of the largest US tech companies: Apple, Amazon, Facebook, Google, and Microsoft (Silicon Valley firms). EU’s policy makers want to retain control over the internet to ensure that profits earned in Europe by Silicon Valley firms are taxed locally. Google and Facebook also had to make changes to their policies to comply with privacy requirements as described in the EU’s General Data Protection Regulation (GDPR).

However, organizations need to be extra vigilant when expanding to emerging markets, where the political risk may be more difficult to identify and deal with. Emerging markets are becoming major consumption centres and offer attractive opportunities, and many companies are diversifying their business into these markets, that is why the political risk is becoming more pronounced.

Common types of political and legal risks include:

• government interference and expropriation
• transfer and conversion of currency
• political instability, violence, and corruption
• intellectual property (IP) protection

Government Interference and Expropriation

This risk evaluates the likelihood of weak governance conditions and or government actions that have an impact on a country’s commercial environment (Graham, Johnston, Kingsley, 2017). For example, in 2017, as a result of anti-government protests in Venezuela, authorities seized the General Motors plant, which employed 2,700 people (Miroff, 2017). GM called the expropriation of its plant illegal judicial seizure of assets and had to withdraw from the country.

Another example of expropriation is Turkey, where the government started cracking down on businesses that they believed were linked to the failed military rebellion of 2016 (Yackley, 2016). The impact it had on foreign companies was that they needed to add an extra level of due diligence to their business dealings with Turkish companies. This extra step was necessary for protecting their assets or their assets would have gotten seized for being associated with the wrong companies.

Transfer and Conversion of Currency

In most developing countries where the government has a high level of control over its currency exchange, the government may impose various forms of control on the purchase or sale of foreign currencies by residents, on the purchase or sale of local currency by non-residents, or the transfer of currency outside the country. These controls help countries better manage their local currency. These controls also create risk for foreign companies doing business in the country. During economic and financial crises, governments may impose restrictions on the amount of foreign currency leaving the country, which translates into non-payment by the customer and creates risk for foreign exporters. For example, in 2003, the Chavez government in Venezuela announced controls over foreign currencies leaving the country (Forero, 2003). Many foreign companies that had customers in Venezuela lost their payments due to these restrictions. Their customers were willing to pay but they were not allowed unless they were paying in Venezuelan pesos.

Political Instability, Violence, and Corruption

Any violent or hostile act that results in overthrowing the government of a country or changing its policies poses a political risk to that country’s commercial environment. A report by the global think tank, where 64 countries around the world were studied, found that corruption is another leading indicator of political instability. A recent example of political instability and violence is the Russian invasion of Ukraine and a conflict that forced many Western companies to fold and leave Russia for good. It also created risk for foreign companies that operate in Ukraine.

Intellectual Property (IP) Risk

Intellectual property is a term used for intangible assets owned by a company and legally protected by the company from outside use without authorization. Types of intellectual property range from domain names to trade secrets, patents, trademarks, and designs (FasterCapital, 2024). All developed and developing countries involved in international trade have laws protecting intellectual property. However, not all of them have a strong legal system to enforce the law. Intellectual property protection is being promoted by the World Intellectual Property Organization (WIPO), which was established in 1970 as part of the United Nations’ 15 specialized agencies.

References

FasterCapital. (2024, April 8). Intellectual property risk assessment: Understanding the types of intellectual property. https://fastercapital.com/content/Intellectual-property-risk-assessment–Intellectual-Property-Risk.html#Understanding-the-Types-of-Intellectual-Property

Forero, J. (2003, February 6). Venezuela imposes currency controls to shore up economy. New York Times. https://www.nytimes.com/2003/02/06/business/worldbusiness/venezuela-imposes-currency-controls-to-shore-up.html

Graham, B.A.T.; Johnston, H.; Kingsley, A. (2017, October 18). Governments aren’t seizing businesses these days. They’re just siphoning off funds through transfer restrictions. The Washington Post. https://www.washingtonpost.com/news/monkey-cage/wp/2017/10/18/governments-arent-seizing-businesses-these-days-theyre-just-siphoning-off-funds-through-transfer-restrictions/

Miroff, N. (2017, April 20). Venezuela seizes a General Motors plant amid anti-government protests. The Washington Post. https://www.washingtonpost.com/world/venezuela-seizes-a-gm-plant-amid-antigovernment-protests/2017/04/20/e58a229c-25c7-11e7-928e-3624539060e8_story.html

Stowe, L. (2022, September 14). 5 strategies for mitigating political risk. Fiscal Note. https://fiscalnote.com/blog/strategies-mitigating-political-risk

Yackley, A.J. (2016, August 18). Turkey seizes assets as post-coup crackdown turns to business. Reuters. https://www.reuters.com/article/idUSKCN10T0HG/