Treasury Today Country Profiles in association with Citi

Making sense of the mess

EU paper flags inside a paper envelope and UK outside the envelope

After last week’s momentous referendum result, treasurers across the globe will surely be wondering what happens next. Unfortunately, the answer to that question may take a long time to become clear. In the meantime, we review some of the initial reactions and explore a handful of the crucial questions treasurers will need to think about in the months (and, quite possibly, years) ahead.

Since the result of the UK referendum on EU membership became known in the early hours of Friday morning last week, the pound has fallen to a 31-year low against the dollar, the world’s major stock markets have plunged in volatile trading and bond yields soared in safe-haven government debt. Undoubtedly, Brexit is already sending shockwaves through financial markets across the globe.

Steering their businesses through the ongoing volatility will be the top priority for treasurers in the near term. But even tougher decisions may need to be made further down the line. Here we consider some of the practical issues many treasurers are going to need to think about as the UK negotiates its exit from the EU, and some of the potential scenarios economists, legal practitioners and other experts have outlined around them.

What does the referendum mean for current financing plans?

In the Eurozone the expectation is that rates will move further into negative territory. Forward Eonia bank-to-bank lending rates dated for the European Central Bank meeting on 8th of September fell to a level last week that suggests investors expect the ECB to cut rates to mitigate shockwaves of the Brexit vote. Across the Atlantic, meanwhile, commentators believe further Fed tightening this year is now unlikely, given the pressure US GDP could come under as businesses retrench and cut capital spending.

Diverging monetary policy could make the ‘reverse Yankee’ – a US company issuing euro-denominated debt – yet more attractive for companies that require financing. American companies have already flocked to Europe’s bond markets to borrow at rock bottom rates, and with the ECB now engaged in the purchase of corporate bonds, pulling down costs even more, others may yet join them. A stronger dollar does add, of course, some cost to converting euros back to dollars. But companies with significant euro denominated cash flows have a natural hedge against such unfavourable exchange rate movements.

Meanwhile, issuance in sterling corporate debt markets is likely to be very muted indeed for the foreseeable future. Analysts at Barclays have already revised their forecast for the sales of new sterling denominated investment-grade bonds this year, cutting their 2016 estimates from £35bn to £17.5bn. As Michael Dakin, High Yield Partner at Clifford Chance told Treasury Insights last week, it may be a while before companies feel brave enough to return. “It would be difficult to imagine anyone getting a deal done in July,” he commented.

Will withholding tax change?

One of the lesser discussed of the potential implications for multinational businesses relates to taxation. The result of last week’s referendum means that, in due course, UK companies will lose exemption from withholding taxes on intra-group dividends, royalties and interest payments currently enjoyed under EU Directives.

Although it is possible that the UK could negotiate continued access to the European directives in question, this is viewed as being unlikely by many commentators. Instead the only way for companies to maintain the benefits of being an EU headquartered group post-Brexit may be to shift the parent company and headquarters to an EU state. According to recent reports, this is now a move being actively explored by some firms.

As Clifford Chance highlighted in a recent briefing note, although double tax treaties would reduce withholding tax rates in some countries, this would remain an issue in 15 other EU countries including Germany, Ireland, and Italy.

Will money market funds be impacted?

Amid all the speculation around where the referendum result leaves the banks, treasurers might at least be able to take some comfort from the fact that Brexit is expected to be a ‘non-event’ for Europe’s money fund industry.

According to a survey published earlier this year by Moody’s Investor Services, MMF assets managed out of the UK (around $258bn in total) would most likely remain in the country. Most asset managers, the survey noted, believe MMFs would be seen as a safe asset class and, as a result, would remain stable. Fitch Ratings take a similar view. In a note published earlier this week, the ratings agency said that while Brexit may create medium-term challenges for sterling denominated MMFs (many of which are domiciled in either Luxembourg or Ireland) in terms of regulation and the supply of high quality short-term debt, the outlook for the near term is less of a concern. Since the vote, MMFs have been relatively stable with no material referendum-related flows following the vote.

Either way asset managers appear to not be overly concerned about the impact of the vote on their own operations, and expect it to be business-as-usual as the UK negotiates its exit. “While the Leave vote was a surprise, we were prepared to react to either decision,” said Deborah Cunningham, CFA, Chief Investment Officer Global Money Markets, Senior Portfolio Manager, Federated Investors. “Our funds have ample liquidity and are functioning normally — there will be no changes to our operational policies. It is a historic decision, but money markets are taking the news in their stride.”

What about the implications for banks?

The immediate impact of Brexit on the health of the banking sector must be concerning for treasurers right now. Billions have already been wiped off the value of the UK’s five FTSE 100-listed banks, and credit ratings agencies have lowered their outlook to negative for a number of big UK lenders.

Many corporates use credit ratings to select counterparties from their pool of relationship banks. Since the banking crisis, corporate investors have been increasingly challenged by the diminishing pool of financial institutions meeting their investment criteria. Many will surely be worried then that, amid all the current uncertainty, further downgrades for banks seem a distinct possibility.

Then there is the matter of what post-Brexit strategy the banks eventually adopt. In the run up to the referendum we heard a great deal of talk about banks with regional headquarters in the UK moving parts of their operations to the continent in order to retain as much access as possible to the single market. HSBC has already signalled its plans to move up to 1,000 UK staff to Paris, while J.P. Morgan said prior to the referendum that it may have to move as many as 4,000 staff to Paris after a vote to leave the EU.

Ultimately this could mean that, post-restructuring, businesses might be transacting with a different legal entity with, quite possibly, a different credit rating to one applied to the current legal entity. As the ACT advises in a briefing note published earlier this year: “Treasurers will need to ensure their relationship managers appreciate the need for early advice if any bank is withdrawing from a particular line of business or seek to have it transferred to a different entity in its group.”

Prolonged uncertainty

The significance of last week’s referendum result for corporate treasurers should not in any way be underestimated. However, it should be noted that nothing fundamental has changed yet. Political developments since last Friday suggest that the much talked about two-year countdown clock, Article 50 of the Lisbon Treaty, will not even begin ticking until much later in the year, most probably after the UK has appointed a new Prime Minister.

Unfortunately for corporates that means the current uncertainty, the root of all the market volatility they are dealing with, is not likely to abate any time soon. It also means it may be a long time before businesses – no two of which will be impacted the same – will be able to fully understand how their operations might need to change in light of Brexit. To borrow a famous quotation made the last time Europe faced an existential crisis: “Now is not the end. It is not even the beginning of the end. But it is perhaps the end of the beginning.”

In this article we have highlighted but a few key areas of consideration for corporate treasurers subsequent to the Brexit vote. Of course, the full list of possible corollaries is much longer and getting longer by the day. Treasury Today would therefore like to encourage readers to get in touch over the coming weeks and months to share any Brexit-related issues they are facing with us and other readers.

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