Investors have factored political risk into their operations for years, and most understand the importance of good governance to their operational and financial performance. Human rights have also been a concern to socially responsible and faith-based investors for decades. But many mainstream investors do not acknowledge or fully appreciate the connection between civic freedoms and the sustainability and profitability of the broader business environment.
Corrosion of civic freedoms can have a direct effect on the predictability, transparency and stability of the business environment, particularly over the medium to long term. The weakening of political and civic institutions often results in democratic backsliding, raising the level of financial risk. For example, when a government diminishes the powers or independence of the judiciary in a host market, it can shake confidence in the rule of law and may reduce or even deny the availability of effective dispute resolution mechanisms.
Shrinking civic space also creates an ‘information black box’ for companies and investors alike, reducing transparency and, with it, the ability to assess risks that may be disruptive to business. When illiberal governments restrict access to online services or disrupt networks, as increasingly happens during protests or elections around the world, business and civil society both suffer. Over the long term, an open society with checks on government power is more likely to enable both expression and stability for sustainable capital than a closed society that restricts these freedoms and the flow of information.
When illiberal governments restrict access to online services or disrupt networks, as increasingly happens during protests or elections around the world, business and civil society both suffer.
Given this essential connection between business and open societies, and the fact that investors are being asked to take a more active role in geopolitics, recent trends in politics around the world should be a source of concern to investors. Growing illiberalism, populism and polarization have elevated political risk for businesses, including in democracies such as Hungary, India, Israel and Poland. Civic space has shrunk considerably over the last decade, with media freedom declining in a record number of countries. An increasing number of governments worldwide are cracking down on the ability of NGOs to operate and placing online freedom of expression under threat through internet shutdowns and the use of surveillance. These trends are part of a broader pattern involving democratic regression and authoritarian resurgence.
A recent example illustrates the strong link between shrinking civic space and business risk, with investors acting in response. In December 2022, the Israeli government announced proposals to curb the powers of the judiciary by limiting the Supreme Court’s power to exercise judicial review, granting the government control over judicial appointments, and limiting the authority of its legal advisers. This initiative not only triggered months of mass protests, but also compelled some venture capital funds to move their money out of Israel due to concerns that the reforms would harm both democracy and the country’s economy. In a reflection of how tightening civic space can damage financial prospects, a recent report suggests that £20 billion in capital has been taken out of Israel since the current government took office in December 2022. In April 2023, the credit rating agency Moody’s cited deterioration of governance in its decision to downgrade Israel’s credit outlook, affecting both the Israeli government (because funding government borrowing is more expensive with a worse credit rating) and Israeli domestic business (which derives its credit rating from the sovereign rating). The IMF has since warned that continued uncertainty could significantly slow Israel’s economy.
Focusing on the ‘inside out’
The relationship between investors and civic freedoms has two aspects. On the one hand, there is the impact of civic freedoms in a host country on an investor’s return on investment (‘the outside in’), and on the other, the impact of the investor’s activities on the civic space of the host country (‘the inside out’).
When it comes to the ‘outside in’, most investors now see mitigating systemic risks as part of risk management, which will improve the overall return of the markets. This represents a move away from ‘modern portfolio theory’, which focuses on how to create portfolios from capital markets without taking account of global societal risks. There is also growing recognition by investors of the relationship between strong institutions, the rule of law and civic space and their return on investment. SDG 16 (Peace, Justice and Strong Institutions) is directly relevant to civic space, with Target 16.10 committing UN member states to ‘ensure public information and protect fundamental freedoms’. In response to a 2020 survey, 84 per cent of investors and ratings agencies stated that business reporting on SDG 16 is ‘very relevant’ and would provide greater insight into the factors central to a business’s ability to succeed. Investors recognize the benefits of markets that feature civil society organizations because the latter encourage greater transparency, expanding information resources beyond those channels that are controlled.
The ‘inside out’ aspect of investors’ relationship with their host environment is reflected in the UN Guiding Principles on Business and Human Rights. Adopted by the UN Human Rights Council in 2011, these principles compel companies and investors not to cause or contribute to adverse human rights impacts through their business operations or relationships, and to carry out due diligence to identify, prevent and mitigate those impacts. This corporate responsibility applies not only to investments in countries, but also to investments in companies that may contribute to undermining civic space and human rights, sometimes acting in concert with a host government. But the ‘inside out’ aspect currently gets much less attention from investors than the ‘outside in’. In practice, there are many businesses that thrive in exploitative environments (at least in the short term) and are willing to engage with, and operate in, countries with illiberal or authoritarian regimes. Given their potential and, at times, demonstrable political and economic clout, investors may exacerbate inequality, human rights abuses and the shrinking of civic space when they turn a blind eye to civic freedoms and invest in countries with repressive governments.
Given their potential and, at times, demonstrable political and economic clout, investors may exacerbate inequality, human rights abuses and the shrinking of civic space when they invest in countries with repressive governments.
The importance of the ‘inside out’ aspect has, however, come into sharper focus as the boundaries between corporate responsibility and geopolitics blur. There are now growing expectations from the public, employees and civil society that business should address geopolitical issues beyond active conflicts, rather than be passive bystanders, and should do so in alignment with international human rights standards. Besides the economic and reputational incentives to support civic space, there are also discretionary opportunities for investors to go beyond mere legal compliance and be proactive, acting as responsible stakeholders that recognize the stake they share in, and the benefits they have gained from, the international rules-based order. This ‘geopolitical corporate responsibility’ applies not only to multinational corporations but also to institutional investors, who share similar commercial and reputational stakes as they too become enmeshed in geopolitical crises.
In the technology sector, for example, risks to people and to investments are rapidly converging, particularly in the development of AI. Investors have a unique and highly influential role to play in determining whether the behaviour of tech companies is responsible and respects human rights, especially as regulation – which would usually play a safeguarding role – is struggling to keep up with the pace of technological development. For example, spurred by concerns about generative AI such as ChatGPT – including threats to privacy, democracy and even humanity – some large institutional investors, including Aviva, Fidelity International and Legal & General Investment Management, are starting to put pressure on technology companies to strengthen their due diligence and safeguards in relation to the human rights risks of AI.
