A World Disrupted: Geopolitical Risks Affecting Investors in 2021

With Joe Biden's election to the presidency, the anti-trade rhetoric that emanated from the White House during the Trump presidency is almost certain to dissipate. Import tariffs imposed on traditional US allies, such as Australia, Canada, and the EU, may ease as President Biden seeks to reinvigorate these relationships in times of geostrategic uncertainty. Investors need to be aware, however, that these tariffs may not be lifted as quickly as they may like as the new administration contends with the COVID-19 pandemic and its effects on the US economy. Political considerations and concerns about the size of the US trade deficit may also require a more considered and deliberate approach to tariff and trade policy.

However, if allied governments persist in targeting US companies (for instance, the EU tariffs to counteract perceived US subsidies of Boeing) new flashpoints may emerge. For more information on these tariffs, see Legal Update, EU imposes tariffs on $4 billion of US imports following WTO ruling in Boeing subsidies dispute.

It may, however, be harder to restore the US-China trade relationship to a status quo ante given that the two countries increasingly view each other as strategic competitors. Economic interests are proving hard to decouple from politico-military ones and, as such, there may be greater continuity between administrations in terms of their approach to tariffs and trade with China (see Key Trade Relationships of Concern).

One important component of the globalization debate has been the issue of offshoring. This was, of course, a key grievance on which President Trump campaigned in 2016 and it is notable that President Biden, during the campaign, promised to tackle the issue (see Biden Harris: The Biden-Harris Plan to Fight for Workers by Delivering on Buy America and Make It in America). Investors will have to wait to see if Biden follows through with promises to use tools, such as tax policy, to prevent US companies from moving further manufacturing abroad; however, he has already announced tighter standards on requirements to use American products and services in government procurement contracts (see Legal Update, President Biden Signs Executive Order Strengthening Buy American Policies). Regardless of the approach the Biden Administration takes, the pandemic has exposed US reliance on China and other countries for key supplies, generating greater support for "reshoring" (the transfer of a company or a business operation that was moved overseas back to the country where it was originally located). In addition to securing key supplies, proponents of reshoring argue that it:

It is worthwhile to note, however, that other governments are also actively tackling this issue in the wake of the pandemic. The Japanese government recently announced plans to encourage Japanese companies to reshore manufacturing of critical goods in sectors, such as healthcare, out of China and either back to Japan or to other parts of the ASEAN region. It intends to use subsidies and other financial incentives, rather than adopting punitive measures. It remains to be seen whether either method works to counteract this long-term trend. For more information, see Reuters: Japan wants manufacturing back from China, but breaking up supply chains is hard to do.

The permanent trade deal agreed between the UK and the EU at the end of 2020 puts some Brexit-related uncertainty to rest. However, many aspects of the new EU-UK relationship remain to be finalized. This includes a permanent agreement on regulation of the financial services sector, which is of vital importance to the UK economy. The bigger question is how the two entities will evolve over the longer term. For now, many businesses are struggling to adapt to more significant bureaucratic hurdles.

The UK government needs to find ways to maintain the country's attractiveness as an investment destination while counteracting the damage that Brexit has done to the UK political union as support for Scottish independence rises. However, the EU also faces political challenges in ensuring that the UK's departure does not weaken the body. An early test will come in 2021 as EU leaders craft an economic recovery plan, with fears that any measure favoring some member states over others may sow further internal discord.

For more information on the EU-UK agreement, see:

Economic nationalism remains a potent force in policy making around the world. That potency is, in some ways, amplified by the current state of the global economy. As governments confront some of the greatest economic disruption they have faced in decades, domestic politics may drive them to further protectionism, even if that may not be in their long-term interests. It is important, therefore, to look beyond the debate on trade and globalization to the fractious domestic politics of some of the world's largest economies, to gain a better understanding of the overall policy environment.

In the wake of the great financial crisis and the Eurozone debt emergency, many governments embraced fiscal austerity. Adherence to these principles has now evaporated as national treasuries amass record deficits to counteract the economic effects of the pandemic. However, these measures are not without political consequences and voters still want to see funds used appropriately.

Therefore, financial support under COVID-19 relief programs often comes with conditions attached. Businesses must give express commitments about how these funds are to be used. In other cases, recipient companies must undertake not to pay dividends to shareholders or bonuses to senior executives while in receipt of support. The level of media scrutiny of companies receiving these funds has also increased appreciably. Businesses face the risk of potential attendant reputational damage if, for instance, they are found to have taken that support when otherwise not required.

Given how the pandemic has disrupted national economies, it is also worthwhile considering the longer-term changes that may arise. Once COVID-19's immediate effects have dissipated, many countries are likely to embark on debates about full structural changes in healthcare and related sectors. Asset price increases caused by central banks' quantitative easing also potentially give rise to inflation risk and the associated political challenges that often accompany it. Governments must also eventually restore national finances to some degree of balance. This may mean a return to austerity, never a popular measure politically, or, alternatively, radical changes in tax policy, with businesses likely to bear much of the brunt of these measures.

A perennial concern for investors is the risk of expropriation or nationalization of assets. This risk is often heightened in times of economic distress. Investments in extractive industries (for example, mining and oil and gas) are often particularly susceptible to these risks as governments look to these billion-dollar investments to shore up revenue. While resource nationalism has abated somewhat in recent years, it is still a potent tool for governments facing economic challenges (see Article, Resource Nationalism: A Return to the Bad Old Days?).

Expropriation and nationalization are not always done against the will of investors, however. Governments sometimes take ownership of assets that are not sustainable within the private sector. It is that particular set of circumstances that is currently leading to the de facto partial renationalization of some components of the UK railway industry. In other countries, there is speculation about struggling airlines coming within government ownership.

In either case, the key questions for investors are whether they are compensated for their losses and whether they are afforded any protection using bilateral investment treaties, stabilization clauses, or host government support agreements against outright or creeping expropriation. For more information on these documents, see Practice Notes:

Investors should also review their political risk insurance policies to see what coverage they may have against expropriation, any other actions governments take to manage the pandemic, and any other consequences of the pandemic on their investments and business operations. For more information, see Practice Notes, What Lenders Need to Know About Political Risk Insurance and Issues to Consider When Submitting a Claim Under a Political Risk Insurance Policy.

In addition to expropriation and nationalization, the continuing effects of the pandemic on certain countries' economies may also present issues for cross-border investors. Reduced economic activity and revenues coupled with increased government spending on efforts to mitigate the effects of the pandemic, may cause some countries to default on their sovereign debt payments or impose currency restrictions to manage their reserves of hard currency. As the pandemic continues to rage, there may also be political instability and civil unrest in certain jurisdictions, putting investments at risk. For more information on these risks, see Cross-Border Lending: Preliminary Considerations Checklist and Practice Note, Political Risk Insurance: Is it Necessary?.

These are just some of the ways in which current economic uncertainty creates policy risks for investors. While many industries are likely to return to comparative normalcy when the immediate public health emergency abates, others will have changed permanently. The process of economic recovery and renewal is already generating intense political debate globally. Its outcome is likely to be influenced in no small measure by the degree to which politicians in some of the world's largest economies can find consensus or whether politics remain highly fractious and volatile.

The bilateral relationship most capable of generating further weaponization of trade and investment is, of course, that of the US and China. However, events of last year showed that other countries, such as Canada, Japan, Australia, and many EU member states, are increasingly having to balance their own economic relationships with China against national security and foreign policy concerns. As investors look to 2021, they must be conscious that numerous potential flashpoints in those relationships exist. These include:

Any new deterioration in foreign policy is almost certain to lead to further punitive measures in cross-border trade and investment, with consequences for investors.

However, it is not just investors with interests in China that need to be mindful of these ongoing risks. As already noted, businesses must continue to assess the complex web of sanctions and other restrictions in place against Russia in the wake of the 2014 Ukraine crisis (see Practice Note, Export Regulation: OFAC Economic and Trade Sanctions). Concerns about European dependence on Russian energy supplies have also led to sanctions in this sector (see Legal Update, Senate and House Override Veto and Pass 2021 National Defense Authorization Act With Significant AML Updates). Similarly, a three-year embargo on trade and investment with Qatar by Saudi Arabia, Egypt, and other states in the Gulf Cooperation Council only came to an end in January of this year.

Many governments also continue to address broader human rights concerns using measures, such as so-called "Magnitsky" sanctions or mandatory reporting requirements for businesses, on matters, such as human slavery and use of conflict minerals in supply chains (see Conflict Minerals Rule Compliance Toolkit). A more competitive geopolitical environment is yielding a more complex risk and regulatory matrix for businesses to understand.

One particularly striking development is that protectionism is now often justified on grounds of national security. It is that reasoning that is likely to lead the Biden administration to differentiate between strategic allies and competitors of the US when considering which of the Trump administration's tariffs to unwind. Governments are also prepared to cut off trade as a punitive tool. Consider, for example, China's de facto embargo on commodities trading with Australia in apparent retaliation for that country's criticism of certain Chinese foreign policy decisions.

In tandem with the growing weaponization of trade, government scrutiny of inbound foreign investment has generated considerable legislative activity over the last decade. As previously noted, the current pandemic gave even further impetus to the expansion of these laws last year to include investments in sectors, such as healthcare, food, and agriculture. Other countries are almost certain to enact similar measures in 2021, such as the UK's proposed National Security and Investment Bill. The net effect is a cross-border M&A environment that is now much more politicized and less predictable.

There is an emerging debate in many countries about the extent to which foreign companies, particularly those with close ties to government, should be allowed to participate in critical infrastructure development or to purchase strategically important goods, such as semiconductors. In 2020, one of the most active debates globally dealt with proposed involvement of Chinese companies in construction of national 5G networks. For information on how this issue is being addressed in the US, see Legal Updates, BIS Extends Temporary General License Authorizing Huawei Transactions a Fourth Time and Requests Comments on Future Extensions and Wiley Rein: Commerce Tightens Huawei Restrictions; Aims to Close Loopholes.

These security concerns are even arising in countries with an historically neutral approach to international security issues, such as Sweden. These bans often lead to countervailing measures by the countries subject to them, further inhibiting trade.

Many countries are also restricting Chinese investment in the energy sector, including the sale of electricity components (see Legal Updates, DOE Bars Certain Utilities from Procuring Electric Equipment from China and FERC Seeks Comment on Usage of Products and Services Provided by Foreign Adversaries in Bulk Power System). While President Biden has issued a suspension in the executive order that underlies these regulations, they have not been revoked. The Biden order instead only requires that these policies are reviewed by his appointees (see Legal Update, President Biden Requests Regulatory Freeze on New or Pending Rules to Allow for Review and Approval by His Appointees and Designees).

As policy makers seek ways to exert pressure on other countries while avoiding the costs and complications of military intervention, sanctions have become a particularly popular tool. They have been used extensively against:

The military coup in Myanmar in January 2021 will also likely lead to a global debate on the reimposition of at least targeted sanctions against military leaders and their extensive economic interests. Sanctions are also increasingly mooted as a policy tool against China and the Trump administration's 2020 ban on US persons holding investments in Chinese companies with close ties to that country's military are financial sanctions in all but name (see Legal Updates, BIS Enacts Rules to Restrict Exports to China, Russia, and Venezuela and Thompson Hine: Commerce Issues Military End User List for Exports to China and Russia).