Coverage of HSBC’s (HSBA) first-half results was overshadowed by news that the group chief executive is to step down after less than two years in the post. For a bank known for stability and predictability, John Flint’s unanticipated departure understandably preoccupied the market.
Beyond those headlines, half-year results offered something else that should interest investors: an intriguing snapshot into the ways geopolitical issues – long regarded in banking circles as interesting but rarely central to business models – are cutting through to financial performance in what regulators nowadays refer to as ‘globally systemically important’ banks.
There are lessons from this snapshot that investors can apply elsewhere.
Look at HSBC’s results report, and you will see repeated references to the impact of geopolitical issues in its markets, and how these make it more challenging for the bank to meet financial targets.
This should not come as a surprise for a bank with a balance sheet so highly concentrated in Hong Kong and a business focus on financing the global trade flows that are coming under pressure, particularly from developments in the US-China relationship.
What is novel is the way HSBC appears to be using its risk management framework to respond. Because, unlike many other banks, the level of detail about geopolitical issues in its half-year results report suggests HSBC is taking a more internally joined-up and proactive approach to managing the varied direct and indirect impacts of geopolitical uncertainty on its business model.
The results report variously describes the use of company-specific stress tests to model the capital adequacy impacts and wider risk management implications of geopolitical issues. In turn, these issues are ranked in the bank’s ‘top and emerging risks’ framework, which would imply additional senior management focus, and explicit recognition that geopolitics feeds into macro risks arising from developments in the credit cycle.
This plays into calculations about possible geopolitically-driven credit losses, informing the financial impact assessment that follows from analysing what the bank calls ‘alternative downside scenarios’ on global trade and financial markets.
Of course, none of this guarantees that HSBC is therefore immune from the vicissitudes of a volatile world. But taken in the round, the report reflects a more strategic appreciation of the risks and their inter-connected financial impacts on the bank than other lenders. Management appears keen to mitigate risks these holistically, proactively and transparently.
What does this mean in practice for investors, especially if worst-case geopolitical scenarios transpire? Judging by the report, shareholders can be more confident that, for instance, in deciding to hold more capital as a result of internal stress tests, HSBC as a whole would be better insulated from a deterioration in Hong Kong’s business environment, should social stability there decline further.
The half-year results report also suggests internal stress tests are continually being deployed to help the bank better withstand any declines in business or higher credit losses that would flow from a worsening in US-Chinese economic and trade relations, thus helping to preserve shareholder value.
The personal touch
A financial institution’s traditional answer to geopolitical complexity is to appoint an ex-foreign ministry official, or perhaps a former political heavyweight, to advise the board. But this approach rarely filters further down into the organisation and, in this case, it is most unlikely to have been the catalyst for revisions to HSBC’s internal approach and processes.
Because the impacts of geopolitics are so varied, large banks’ responses require substantial internal coordination. In large and complex financial institutions, this type of coordination is easier said than done, and relies on considerable knowledge of how banks measure, manage and respond to risk, and an ability to traverse organisational silos.
Investors would be right to view HSBC’s geopolitical exposures as both unique and acute. The Financial Times’ recent revelations about the bank providing US authorities information on Huawei, then a client, which led to the arrest of the technology group’s chief financial officer, is a good example of one such risk.
But it is hard to imagine that further deterioration in Hong Kong’s stability, or a politically-driven decline in Sino-American trade relations, are issues that investors would otherwise deem inapplicable to the performance of other large financial institutions.
Nor is this just about Pacific nations. Large banks face risk exposures, direct and indirect, in the Middle East, whether in deteriorating relations with Iran, broader regional instability, or nagging doubt over Saudi Arabia’s long-term stability as it juggles unprecedented socio-economic reform alongside fiscally-deficient oil prices.
In Europe, the business impacts of British departure from the world’s largest trading bloc preoccupy the financial sector, but recent political developments in Italy continue to present a challenge to the broader financial system. Latin American politics present challenges, too, most recently in Argentina. ‘Traditional’ political risks have not gone away, either.
In other words, wherever you look, all large financial institutions with a pan-continental presence must now contend with multiple geopolitical risk exposures.
Company bosses know this. Financial sector chief executives routinely point to geopolitics as an issue that keeps them awake at night. For the first time, a survey this year showed more chief risk officers are concerned by geopolitical volatility than cyber warfare.
But there is scope for companies to improve their internal approach. Prudential’s (PRU) half-year results, for instance, contain several references to geopolitics, but give little away about what approach they have taken to assessing and mitigating possible financial impacts.
To the extent they mention an internal response at all, the Pru refers to "closely monitoring" the situation in Hong Kong and relying on an existing internal business resilience framework that very likely focuses on non-financial risk and is unlikely to have been designed for the economic impacts of volatility on the scale now faced by this systemically important insurer.
Close monitoring of a situation is essential for effective risk management, but it is not by itself sufficient. No doubt substantial management attention is otherwise focused on the Pru’s demerger plans. But the half-year results report says little specifically about, for instance, how senior management is using tools such as stress-testing, or making calculations about the business impact of deteriorating credit or liquidity dynamics in response to geopolitical volatility.
It would be surprising if the Pru’s risk function had not considered these issues internally. But in saying so little about their internal approach, Prudential leaves investors with scant opportunity to judge whether efforts to protect shareholder value from geopolitical volatility are adequate.
All major financial institutions with business in politically sensitive parts of the world must be careful in their public comments about political issues, lest they offend one government or another.
The Pru is no exception and is right to tread carefully in its public statements. But this need not stop it spelling out to investors what it is doing to adapt its internal approach in the face of a general period of geopolitical upheaval across much of the global economy.
No doubt a determined investor could find further room for improvement in HSBC’s approach to managing the impacts of geopolitical volatility. But when you look at the way talks about tackling these risks, the approach looks more internally-integrated, systematic and dynamic than most, if not all, comparable financial institutions.
Perhaps this is inevitable given HSBC’s global business model and business concentration in Asia. But global compamies – and not only banks – face many of the same risk exposures. Investors would benefit from taking note of what a better internal approach can look like, and challenging company management teams accordingly.
Derek Leatherdale is managing director and founder of GRI Strategies, which works with financial institutions to improve their management of complex political and geopolitical risk. Prior to this, he founded and ran HSBC’s Geopolitical Risk function.
