SVA Brief - Managing Business in an Adverse Economic and Geopolitical Scenario
SVA is pleased to continue its series of political risk analysis pieces, each of which focuses on a key regional issue, and so seeks to highlight the changing risk outlook for businesses dealing in the Asia-Pacific region.
This piece focuses on the changing tide of capital flows and adverse geopolitical risk affecting businesses operating across Asia.
The worsening geopolitical and economic outlook is redirecting capital flows around Asia, forcing companies to retreat from certain markets, and to reallocate capital elsewhere around the region.
This shift poses material risks to companies, in terms of recouping invested funds, and in terms of handling political, reputational and commercial risk in unfamiliar locations.
SVA can advise companies in avoiding these pitfalls, and in protecting their interests.
The changing situation
Rising interest rates, geopolitical tensions and a much weaker Chinese economy have reshaped capital flows around the Asia-Pacific region. The tide of capital into the region has now effectively reversed.
China’s appeal to the west has steeply diminished. In the last quarter of 2022, China saw some USD11.2 billion flow out of the country, and the balance of yuan-denominated bonds held by foreigners closed the year at USD493 billion, down 15% over the year.
Greenfield foreign direct investment (“FDI”) into China fell to a record low in 2022; the first quarter of 2022 saw a 50.5% drop in the number of FDI projects. Similarly, only about USD15 billion worth of mergers and acquisitions took place in the first half of 2022, compared to USD60 billion annually from 2015 to 2019.
Other Southeast Asian markets have also seen the departure of capital, albeit to a much less worrying extent than in the 1990s. Even so, some smaller states such as Laos currently find themselves under great pressure.
The reasons why
A clear reason for this shift is economic. A property slowdown, lengthy COVID lockdowns and weaker demand for exports have taken their toll in China, compounded by an increasingly erratic domestic policy framework, and the pull of US interest rate rises.
However, as important has been a steep decline in Sino-American relations, with trade restrictions, financial sanctions and limitations on technology transfers all eroding business confidence.
What is clear, now, is that European and American firms are drawing back from China, and targeting other jurisdictions around Asia, or even outside the region, such as Mexico.
Not much optimism
Notwithstanding the end of COVID restrictions in China, a return to pre-pandemic capital flows seems most unlikely.
After all, the Chinese balloon incident over the US in February 2023, the recent US allegations as to PRCresponsibility for the COVID outbreak, and the imposition of restrictions on chip technology have highlighted just how fragile the Sino-American relationship has become – and hence how large and unpredictable the threat to business.
Moreover, upcoming US measures will further erode confidence. Of particular significance are those relating to Taiwan; a pending Taiwan Policy Act, which could offer Taipei something close to diplomatic recognition; and a trade agreement with Taiwan. Both will certainly anger Beijing.
Measures to stifle bilateral trade and investment are also in the works. The US-China Economic and Security Review Commission recommended in 2022 that Congress examine China’s compliance with the 1999 granting of “permanent normal trade relations” ahead of China’s World Trade Organisation (“WTO”) entry. An inquiry now seems possible, with more trade restrictions likely.
Separately, the US Congress may also establish a mechanism akin to the Committee on Foreign Investment in the US (“CFIUS”), scrutinising outbound investments into China, rather than inbound to the USA. Congress may also target prominent companies that invest in China but play down environment, social and governance (“ESG”) shortfalls.
Such measures will have the greatest consequences for US investors, but will affect European and Australasian companies, too – especially those with a large presence in North America. Some may now reappraise exposure to China, and sell down interests, repatriate funds, or invest elsewhere.
Of course, not all states in the region are losers. Vietnam offers relatively low-cost manufacturing prices, without quite the same geopolitical pressures as China; trade and capital flows are thus shifting in its favour.
Even so, relocation does not alleviate all risks. After all, companies that could handle themselves in China are now having to deal with unfamiliar places; and they must learn about new risks. The need for professional (non-box ticking) due diligence investigations is much higher than ever before.
Similarly, investors may find that cashing out is not straightforward. In the case of China, one problem is that property market declines may leave assets undervalued; another is that Beijing retains strict capital controls; and a third is that the legal basis of certain foreign investments, such as those operating through Variable Interest Entities in the PRC, may be questionable.
As such, the prospect of delayed settlement, or even non-payment, is real.
How to respond
Boards can act to mitigate risks. One key step would be to carry out extensive and realistic due diligence that takes account not only of traditional commercial risks, but also hitherto ancillary political and regulatory considerations. SVA are specialists and market leaders in this field.
Boards can also assess how best to proceed with a draw down, with attention to recouping funds in the face of falling values, rising levels of debt, and a potentially unfriendly regulatory framework. Asset search investigations may prove invaluable in that context – especially before litigation commences.
What to do now?
The reshaping of regional capital poses new risks for investors in the Asia-Pacific region. These risks are not however insurmountable. Considerations for companies thus include:
- Continued adherence to robust due diligence standards is as important as ever. Internal compliance efforts seldom are effective in this respect. Boards should require background investigations, and ensure that oversight is in the hands of a “neutral” party – and not under the control of a local deal team. Such measures are especially important when moving into new, lesser-known markets.
- Analysing and auditing the structure of investments through the lens of (geo)political risk is crucial, so as to forestall threats. Such an assessment should take place at a senior level, and on a group-wide basis, as needed. Such analysis is as necessary for departures from markets, as for new investments. Again, SVA are specialists in this field.
- Board-level risk structures should adapt to take account of the changing direction of capital flows. A focus just on reputational and media issues, for instance, will not suffice in this, a much more complex environment.
- A review of regulatory risks must also examine vulnerabilities in the face of
- “weaponisation” of supervision and enforcement actions. Executives must understand that failures can result in investigation or prosecution. Regulatory approvals may also be of particular consideration when selling out of an investment.
- Public relations strategies should be attentive to the risks that a clumsy mis-statement could harm a business’s withdrawal from, or entry into, a market. Geopolitical tensions can lead to the deliberate distortion of narrative, and result in a company being “dragged into” a row. Putting lipstick on the pig is no longer a wise strategy.
- The conduct of early-stage asset search investigations into counterparties should be a key part of the selling out process. Initial steps should include exercises aimed at identifying the real financial strength of counterparties, and the location of key assets. The gathering of additional information may also assist in leveraged negotiations.
- The preparation of a strategy for ensuring payment will assist clients and legal counsel in reclaiming funds. Such appraisals might consider the need for asset search investigations, which can sprawl across many jurisdictions; a key consideration is determining at an early stage how best to act to reduce costs. SVA can help develop such strategies.
- The conduct of deeper investigations into the location and nature of particular assets is often necessary. Such measures should hone in on proxies, such as family members or business associates, who may have nominal control of assets, and SVA may make use of forensic techniques to identify assets.
SVA has unique experience of assisting companies in helping to mitigate such risks, and we stand ready to assist with the above.
SVA (www.stevevickersassociates.com) is a specialist international risk mitigation, corporate intelligence and risk consulting company. The firm serves financial institutions, private equity funds, corporations, high net-worth individuals and insurance companies and underwriters around the world.
SVA has three core lines of business, which are: Business Intelligence and Political Risk; Corporate Investigations; and Special Risk. SVA has a dedicated crisis management team which, for our retained clients, stands ready to assist companies during crisis situations.
SVA is based in Hong Kong, Singapore and Malaysia, and is the only firm with local and senior expertise drawn from Intelligence, Operations and research functions of the former Royal Hong Kong Police Force.