Geopolitics and its effect on Financial Services
The best-laid schemes of mice and men
Go oft awry,
And leave us nothing but grief and pain,
For promised joy!
(Robert Burns, 1785)
Geopolitics is a peculiar thing - it sometimes presents as a state dinner steeped in decorum, and other times it's more like a playground fist-fight between toddlers. The thing that separates the two is often how much of the pie there is left to split. The more scarce the debated resource is, the less civil the narrative will be. This dichotomy echoes in its effect on the people who live close to the nexus event. To some, it's a time of anxiety, loss, and grief. For others, it's a time to reap profit, flex ego, or consolidate power.
What counts as Geopolitical Tension?
I believe it was a comic villain, Ultron, from the Marvel Cinematic Universe who said "I think you're confusing peace with quiet". So to clear up the confusion, first some definitions. What constitutes 'geopolitical tension'? The answer most relevant to us in the financial services industry is anything capable of moving a market. It can be as small as a rumor that drives up the prices of tissue rolls, bags of rice, or the US Dollar. Similarly, it could be something as large as a war disrupting the supply chain of petroleum products which in turn drives the price of transport, fertilizer, and food.
However, geopolitics affects more than just the prices of goods and services, it also affects the law. And anyone participating in the economy is subject to these laws and policy directives as they evolve during times of high tension.
The financial system is squarely at the center of it
Financial services is a heavily regulated industry and every tiny change in foreign policy, sanctions, tariffs, and exchange controls can make a huge difference to the day-to-day operations and types of services an institution can offer.
Take for example a remittance service provider, they are by definition in the business of moving money from one country to another - safely, quickly, and legally. Pause for emphasis on that last word. How does such a company know if they're allowed to send money to someone in another country? What about how they plan to send it? Can they send that much in one go?
To answer these questions, banks, service providers, and fintechs employ an army of compliance and legal experts to ascertain not just if their overall business model is legitimate, but also to determine the permissibility of individual transactions deemed to be potentially higher risk. These professionals use not just their own judgment and interpretation of the law but also refer to guidance from regulators, industry associations, and international organizations such as the Financial Action Task Force (FATF).
How quickly can things change?
One of the important things to remember is that while the buildup to an event often bubbles and simmers for months or even years, when the time finally comes, things escalate quickly. Oftentimes in a manner of hours or days. In financial services, this means that it's important to look out for cues and anticipate potential changes based on the type of geopolitical instability at the time. Here are some things to keep an eye out for:
Sanctions Lists - look especially at the national lists between the conflicting countries and their major trading partners. An early warning indicator would be heated debates between heads of state preceding a military conflict.
Embargoes - with embargoes it tends to mean a complete cutoff from trading with a specific geographic location, either a specific region or an entire country. It often disallows transactions in that currency as well making the last leg of the payment journey virtually impossible. Look for executive orders being signed at the presidential level to understand the impact of the change.
Capital Controls - this comes in the form of capping the overall amount of funds that can be sent into or out of a country or in a specific country. This can be especially disruptive to Remittance service providers as any amount exceeding the control value may need to be supported by documentary evidence of its purpose. It can also mean extra paperwork for trade payments.
Currency Fluctuations - often during a geopolitical conflict there will be a lot of uncertainty and fear. This has an adverse impact on trade, supply hoarding, bank runs, and general speculative currency activity. This poses a risk to anyone who arranges cross-border transactions that require foreign exchange (i.e. denominated in two or more currencies). This can be overcome internally via robust hedging, or externally by denominating contracts and settlements in non-correlated currency.
As a financial services provider or even a user of the system, what should I do?
Vigilance, vigilance, and more vigilance! Having a keen eye on the horizon will ensure that you are never caught unawares in a situation with a rapidly escalating conflict. You will never be able to control any of the factors that lead to the turbulence but you do have control over your risk mitigation actions.
If you run a smaller business and don't have the backing of an army of compliance and legal personnel, it's best to get help from your financial service provider who likely has some form of product in place for a business of your type. Leverage their expertise and size of operations to smooth out the shocks to yours. Risk management as a service, if you will.
On the other hand, if you happen to be a Fintech company looking for someone to put a roadmap in the hands of your small to midsize compliance team, then do contact us for a no-obligation chat about what your plans are and how we can help you achieve them.