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Directors urged to pay heed to growing political risk

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Political risk is on the rise as the pandemic ebbs, making it even more imperative that company directors properly assess the peril and its potential impact on shareholder value, Axa XL says.

For Australian companies with overseas investments, especially in economies with less developed governance systems, political risk is increasingly an important consideration for directors.

Political risks associated with operations in a foreign market are clearly part of a director’s “care and diligence” responsibilities, Axa XL says.

What this means is that directors could “potentially” face shareholder suits if adverse government actions or other forms of political risk like civil unrest in the market concerned wipe out most or all of the company’s value.

And if a shareholder suit is filed, Axa XL says the alleged wrongdoing is likely that the directors “should have thought of that” or “should have done something but didn’t”.

“Although political instability and social unrest declined sharply during the pandemic, they will likely start to surge again as we return to some semblance of ‘normal’ life,” the insurer said.

“The factors fuelling instability before the pandemic, including growing income inequality, escalating competition for natural resources, and the fearsome effects of climate change, are only becoming more acute.

“Thus, it seems likely that these and other forces will continue to create numerous challenges for governments worldwide, especially – although not exclusively – those in less developed countries where the governance systems can be relatively immature.”

Political risk is not just confined to Australian resources companies, which typically have significant investments in the form of mining leases or concessions in less developed economies in central/south-east Asia or Africa.

Axa XL says directors in Australia, like other developed economies, can be held personally liable for actions they take or don’t take that impact shareholder value.

“As conditions globally become more volatile, directors for companies with investments in less stable, developing countries should consider taking out an appropriate level of political risk cover or be prepared to document why they believe it wasn’t warranted,” the insurer said.

“Although this applies especially to energy resource and mining companies, directors for companies in other sectors with investments in such countries also should be mindful of the political risks in those countries and their potential exposure to shareholder actions in the event developments in a country destroy shareholder value.”

Click here for the Axa XL piece on political risk.