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Navigating Geopolitical Risk and Opportunity: Challenges for Responsible Investors

Keynote Address to Responsible Investment Association Australasia (RIAA) Conference Australia 2024, Panel Session on Navigating Geopolitics: Responsible Investors' Risk in an Uncertain World, Sydney, 1 May 2024

Geopolitical events come in many different shapes and sizes, and not all of them will have any significant impact on the financial decision making of investors. But many do certainly pose risks for investors generally, and both risks and opportunities for responsible investors in particular, and it is our task in this session to identify those that are currently most salient for Australian investors.

Geopolitical challenges I think can be best defined as those which are the product of behaviour by political actors – their action or inaction, or competitive interaction – in a way which affects international relations, or has some other cross-border impact. It’s that cross-border dimension which distinguishes geopolitical risk from ordinary domestic political risk.

Geopolitical risks are usually conceptually distinguished from economic risks (primarily associated with market dynamics) and natural risks (associated with the non-human environment, even if – as with climate change – produced by human activity). But in practice the concepts overlap: what starts out as a catastrophic natural risk or market failure can, if badly mismanaged by the relevant political actors, rapidly become a serious geopolitical issue, for example by becoming a trigger for violent conflict over resource distribution or exploitation.

The most drastic manifestation of geopolitical risk is deadly conflict, but other negative political, military, economic and human impacts can include arms races, trade wars, supply chain disruption, debt default, food insecurity, mineral and energy resource shortages, cyberwar, terrorism and atrocity crimes, unregulated population flows, major human rights violations, social division and impoverishment.

Today’s world is not just ‘uncertain’, as the title of this session describes it, but as volatile and fragile as it has been for a very long time. So one can see problems and potential problems of this kind almost anywhere one looks. But our task in this session, and the practical task for investment managers, is not to try to address everything – that way lies thousand-cell spreadsheet madness! – but rather to focus on those geopolitical challenges which are currently most salient for investors generally, and responsible investors in particular.

There is an ongoing debate as to what exactly it means to be a ‘responsible investor’, and you may not all agree with the relatively broad definition I adopt for the purposes of this presentation. But what to me distinguishes responsible investors from just ordinarily prudent and competent investors, is that they are very conscious of the rewards associated with acting not just financially prudently, and strictly according to the legal book, but ethically as well – not just avoiding bad, but doing good, and not just in relation to Environmental Social and Governance (ESG) standards narrowly defined, but more generally.

I think it is clear that being committed to maintaining high ethical standards brings with it hard-headed reputational rewards that are likely to bear fruit in a fund’s or firm’s relations with its customers, employees, members or shareholders, regulators, and other stakeholders, present and future. At least so far as basic ESG commitment is concerned, RIAA’s annual Benchmark Reports, as well as a body of international research, do seem to confirm that – short term volatility notwithstanding – positive ESG performance reaps its own financial reward.

So what are the main geopolitical challenges that pose risks for Australian investors generally, and both risks and opportunities for responsible investors, now and in the near to mid-term future? My own top ten, in no particular hierarchical order, are these.

1. US-China Confrontation. While bilateral tensions have eased considerably since last November’s Biden-Xi summit, there will continue to be a risk of violent confrontation between the two superpowers so long as the US continues to assert, and China vigorously resist, its claim to both global and regional primacy. The prospect of outright war has been much exaggerated by the West’s own “wolf warriors” – not least the Murdoch and Nine press “Red Scare” brigade here in Australia. But obvious flashpoints exist, in the South China Sea and above all in relation to Taiwan; there is certainly a risk of Chinese over-reach; and history teaches us that without very deft diplomatic handling small incidents can rapidly escalate into full-blown crises.

The primary risk in all of this for Australian investors is that, as a consequence of our alliance relationship with the US (about to enter a whole new realm of, I think unhappy, dependence with AUKUS) we will be drawn into a war not of our own making – with an accompanying impact on our economic relations with China, by far our biggest trading partner, that will make the boycotts of recent years pale into insignificance.

The prospect of a second Trump presidency, likely to be incapable of anything resembling deft diplomacy, with a long track record of treating allies as encumbrances rather than assets, and absolutely determined to wage trade war on China (and indeed the EU and anyone else with whom the US runs a deficit), adds a whole new element of uncertainty to the China-US challenge. For Australian investors wrestling with this uncertainty, I think panicky disengagement from all things Chinese would for now make little sense, but diversification strategies certainly have to be on the agenda.

2. Russian Aggression. Russia’s invasion of Ukraine remains the most indefensibly naked act of cross-border aggression since World War II, with the now-entrenched Vladimir Putin’s behaviour both at home and abroad – including in the UN Security Council, where it now plays a regularly spoiling role – lacking any redeeming characteristics. Australian investors have never been particularly engaged with Russia, but for any of those remaining and not caught by sanctions, and certainly for responsible investors, the case for disinvestment is hard to resist.

3. Nuclear War. The Ukraine war has also reminded us that the geopolitical challenge of nuclear war remains alive and real. In the context of NATO’s involvement, Putin has been talking up the possible use of nuclear weapons in terms unheard of since the height of the Cold War. And in the context of China, North Korea and Iran the prospect of new nuclear arms races in North East Asia and the Middle East is more real than it has been for some time.

While I think the odds of any deliberately aggressive use of nuclear weapons remain low, the odds of their use through human or system error or miscalculation remain alarmingly high: I have long argued that it is nothing more than sheer dumb luck that has prevented a nuclear holocaust over the last seven decades. The reality is that nuclear weapons are the most indiscriminately inhumane ever devised, any major nuclear exchange would be a threat to life on this planet as we know it, and their deterrent utility in any context has been hugely exaggerated. There are some kinds of defence expenditures with which responsible investors should have nothing to do, and that is anything associated with the production of nuclear weapons.

4. Middle East Meltdown. The Middle East remains a tinderbox, which any one of a number of matches could set alight, with familiar consequences for human security, energy security, trade disruption, terrorism and, particularly in the context of refugee outflows, broader European destabilization. While the financial implications of most of this for Australian investors will be muted, the Gaza War and the ongoing inability to find any credible solution to the Israeli-Palestinian conflict, poses an inescapable ethical challenge for responsible investors here, given the emotional resonance the whole issue has in the wider Australian community.

I have long resisted, as likely to be divisive and counterproductive – too easily misdescribed as anti-semitic – the call of the Boycott Divestment and Sanctions (BDS) movement for major action against Israeli businesses. And I completely accept that the hideous slaughter of the innocent by Hamas militants on October 7 entitled Israel to respond with all the force that international law allows. But the alarmingly disproportionate character of the Israeli military response, which has generated huge international concern, poses a real challenge for responsible investors – making it timely, I think, to disengage from those Israeli businesses, including arms suppliers like Elbit, profiting from activity in the Occupied Territories. Sometimes an ethical point just has to be made. And I think in this case such action would be consistent with the guidelines laid down in the in RIAA’s excellent Investor Toolkit on Human Rights & Armed Conflict, which predated Gaza.

5. Climate Inaction. I hardly need to labour for this audience, the scale and gravity of the geopolitical challenges – in particular for energy security, human security and in some cases, not least in our own Pacific region, state survival – posed by inadequate political action in response to global warming. While there are financial and regulatory risks for investors generally in the transition to cleaner economies, the particular challenge for responsible investors in this context is not so much a risk as an opportunity – the opportunity to invest in genuine (not just greenwashing) projects that involve serious carbon reduction.

6. Pandemic Inaction. With Covid 19 so fresh in all our minds, there is again no need for me to labour the challenges involved if we are equally unprepared for a global pandemic repetition: travel and supply chain disruption, and renewed enthusiasm for trade barriers and tariffs, with all the negative implications of that for economic growth and geopolitical stability. The risk for investors generally is not planning for these contingencies; the opportunity for responsible investors lies in commitment to disease surveillance systems and vaccine research and development.

7. Cyber Aggression. Cyberattacks by both state and non-state actors, on both government and non-government targets, for both political and criminal purposes, are increasing in scope, scale and AI-driven sophistication, and desperately needed international cooperation to address them is becoming increasingly elusive with major power tensions as omnipresent as they now are. The message for investors is simply to be aware, as most now are, of the scale of the challenge involved, the need for businesses to devote substantial resources to cyber defence, and to plan responses as best they can to different levels of possible disruption.

8. Terrorism. The horrifying recent Islamist attack in Moscow was a reminder that, for all the wake-up call given by 9/11, the risk of renewed major terrorist disruption (not just lone-wolf attacks of the kind which tragically occurred in Sydney a few days ago) is real – with every prospect of being compounded by fallout from Gaza, and the resumption of Taliban rule in Afghanistan. The risk of such large-scale action, with large scale consequences, in Australia is not high, and probably not much that investor can do in response – except, again, in key sectors have plans in place to cope with major system disruptions.

9.Major Human Rights Violations. Major human rights violations occurring in other countries may not be of much concern to investors generally except insofar as they generate binding sanctions and other regulatory constraints, but they do pose challenges for self-consciously responsible investors. It’s not all that hard for Australians to disinvest completely from a country like Myanmar, with whom we have little economic stake. But rather trickier with a huge economic partner like China, however badly it treats its Uyghur or Tibetan citizens, or contemptuously tears up its democratic commitments in Hong Kong. Or with India under the increasingly authoritarian and anti-Muslim leadership of Narendra Modi, with whom we would like to both do China-scale business and forge a security relationship. What responsible investors can do is at least not to engage in any way with those economic actors who are actually themselves participating in human rights violations, including – to take just one very salient current example – modern slavery.

10. Post-Conflict Peacebuilding. The last challenge on my list goes to opportunity rather than risk. The RIAA Investor Toolkit on Human Rights & Armed Conflict makes the point that ethical investor responsibilities don’t stop when a conflict is ended, arguing for continuing monitoring of potential human rights violations. But there are many other opportunities for responsible investor commitment in post-conflict peacebuilding – including reconstructing governance institutions, rebuilding shattered physical fabric, and perhaps above all alleviating the plight of refugees and others displaced by the conflict. Responsible investors should certainly explore the potential of such mechanisms as blended finance and peace bonds to make a difference – uniting commercial capital with traditional government development assistance.

I’m not suggesting for a moment that juggling what may be, often in practice, the competing imperatives of financial return and ethical reward will always be easy or straightforward. Funds and firms that are so pure of heart that they go broke are in no-one’s interest. Trade-offs and compromises will always have to be made, just as every government – as I certainly found as foreign minister – has to balance its idealism with a degree of pragmatism. It’s always a matter of case-by-case judgment. But for responsible investors as I have defined them, some red lines will always be more clear, and some ethically attractive low return investments more worth exploring, than they would be for investors generally. And rightly so. That comes with the territory if you value your reputation for decency, as I am sure every member of RIAA does.