As the anniversary of last year’s referendum vote approaches, developments continue apace. On Wednesday 29th March, Prime Minister Theresa May sent a letter to Brussels triggering Article 50 and setting in motion the UK’s departure from the EU. More was to follow: on 18th April, May called a snap general election for 8th June, remarking that “division in Westminster will risk our ability to make a success of Brexit.”
News of the snap election comes as yet another surprise at a time when surprises are becoming commonplace. Few had believed a year ago that the referendum would result in the UK leaving the EU. A poll carried out by Deloitte a few months earlier found that only 26% of CFOs had embarked on contingency plans covering the eventuality of an EU exit. Meanwhile, research carried out by Greenwich Associates in May 2016 found that fewer than a quarter of the treasurers surveyed had hedged against currency or interest rate volatility in the run up to the referendum – even though more than half believed there was a medium to high risk that the UK would vote to leave. As Tobias Miarka, Managing Director of Greenwich Associates, noted at the time, “These risks are much on the mind of corporate executives, but companies have taken little or no action to mitigate them.”
Almost a year on, the risks have become more tangible. The UK lost its last remaining AAA rating following the referendum, while the value of the pound fell to a 31-year low against the dollar. Higher costs for importers have led to price hikes in UK supermarkets, with the impacts of Brexit also including a slowdown in business investment.
Nevertheless, while it appears certain that the UK is going to leave the EU – barring further shocks during the upcoming election – considerable uncertainty remains about the exact form that Brexit will take, and what this will mean for corporations. “In the longer-term, there are a lot of outstanding questions that nobody can give the answer to,” says David Stebbings, Director, Head of Treasury Advisory at PwC. “How is it going to affect my business? How will it affect the banks that I deal with? Will my cash management structures survive? Should I still base my pooling in London? Will my bank still offer the same services on the same basis that it does now, or will I have to go elsewhere for them? We don’t know the answers to these questions because we don’t know the nature of Brexit, or how the banks and the London financial markets will be in once Brexit takes effect.”
Possible outcomes
Article 50 may have been triggered, but with a two-year negotiating period ahead there are still a number of different possible scenarios when it comes to the form Brexit will eventually take. Points which will need to be determined include the status of EU nationals in the UK, the transition of EU regulations and whether banks retain their passporting rights.
Each of the possible scenarios could have considerably different implications for UK’s economy and business environment. Research carried out by Oxford Economics before the referendum found that the range of possible outcomes extended from an increase in business investment of £2.4bn to a fall in business investment of £21.1bn.
The details of Britain’s trade deal with the EU, which could be crucial to the economic implications of Brexit, may not be complete by the time the UK exits the EU. At this stage a number of different outcomes remain possible, with some of the variables including membership of the European Economic Area (EEA), membership of the customs union, a free trade agreement for goods and trade with the EU based on World Trade Organisation rules on tariffs.
Arrangements which are already in place in other countries give some sense of the possible outcomes. Norway, for example, is a member of the EEA and the European Free Trade Association (EFTA), contributes to the EU budget and has full access to the single market. Switzerland, which is a member of EFTA but not the EEA, has a free trade agreement with the EU but does not have full access to the single market. Turkey has a customs union with the EU but is not a member of the EEA or EFTA. However, while these arrangements may give some idea of the different directions Brexit could take, at this stage most of the questions remain unanswered.
Understanding the impact for treasury
For corporate treasurers, the possible impacts of Brexit include both short-term and long-term challenges. The fall in sterling since the referendum last June has been particularly notable. “While that hit last June, the effects are now becoming apparent,” comments Stebbings. “Many companies that import into the UK had hedged for a certain period. We’re now seeing that hedging come to an end, and the effects of the fall in sterling are hitting company results or forcing them to raise prices.”
While there are actions that companies can take to address the fall in sterling, Stebbings points out that the longer-term picture is less clear. He notes, “One of the key issues is what the banks are going to do – how are they going to operate in three or four years’ time? What services will the banks provide from London – a lot of companies have got London-centric header cash pooling structures; will London still be the place to do this? Will the banks provide it, and will it work for the corporate depending on where it has its treasury vehicle?”
It is unclear at this point whether companies will need to move either their own operations or their banking relationships as a result of Brexit. Research published by Ovum and Temenos following the referendum found that over 42% of UK corporates believed that some of their operations will need to be moved out of the UK, while a quarter said that they would need to explore additional or alternative banking relationships. For 17%, that could include moving – or considering moving – their lead banking relationship.
While the exact form of the trade arrangements to be negotiated post-Brexit are clearly a concern for corporate treasurers, there are also other details which will affect treasury – particularly regarding issues such as passporting and equivalence. Currently, financial services companies use the EU passporting system to operate in other member states across the EU. At this stage, it is not clear whether the UK will still be able to use passporting after exiting the EU. While this is one possibility, the concept of equivalence, whereby markets recognise each other’s standards, may also have a role to play.
Nick Burge, Head of Structural and Regulatory Solutions, Global Corporates at Lloyds Bank Commercial Banking, outlines the major scenarios that Brexit could include from a banking/markets perspective:
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Continuation of current regulatory access arrangements – passporting and equivalence.
Corporates would be able to continue with current treasury activity on an unchanged basis.
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Hard Brexit with no passporting and no equivalence.
If there were no provisions for cross-border services, companies would need to have arrangements with providers in each of the 27 EU countries as well as for UK based activity. This could have an impact on different services including syndicated lending, cash pooling and derivatives.
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A new equivalence regime.
There is uncertainty around whether the existing equivalence provisions under MiFID will apply to the UK following recent comments from the Commission. Additionally there are no equivalence provisions in the capital requirements directive for banking services. There will be much discussion around a bespoke equivalence regime as part of UK exit negotiations which will have an impact on treasurers.
Despite these uncertainties, Burge says he is not seeing treasurers changing strategy or adopting any knee-jerk reactions. He adds, “The overriding view from companies is that they will be able to continue to source financing and financial services as they do today, backed up by banks and policymakers to ensure market continuity.”
That’s not to say that treasurers are not paying close attention to the implications for their companies. Burge notes that treasurers have mixed opinions on the impact of Brexit, depending on the size and structure of their business. “One main concern is how they will be able to operate across borders if there is a hard Brexit,” he observes.
What to consider
While the impact of Brexit will vary depending on individual companies’ business models, industries and geographical footprints, there are a number of questions that many treasurers should be asking. Rick Martin, Group Treasurer of GasLog, says the company, which owns, operates and manages liquified natural gas (LNG) carriers, is looking at a number of different factors where Brexit is concerned:
“Being a global shipping company, we are looking at what it might mean for world trade, and are articulating how the global gas trade is just that – not at all tied to the perturbations within a particular geography,” says Martin. Other considerations include understanding the possible implications for the company’s financing arrangements and “making sure that we are ahead of the curve, should it have unhelpful impacts on our lenders and/or where we are depositing excess cash.”
In addition, Martin says the company is seeking to ensure that it has the best possible handle on what Brexit could mean for interest and FX rates. “We are also ensuring that we do all we can to provide assurances to colleagues from outside the UK regarding their stable employment with GasLog.”
Martin says that given the uncertainty regarding the process of negotiation with the EU, the company is working hard to keep a range of options open to address the various potential outcomes. He adds, “Fortunately, we believe that the combination of our industry, corporate structure, broad network of business partners, and flexibility of our workforce are such that we will be able to deal with such changes as might reasonably occur in timely and effective fashion.”
Preparing for Brexit
What steps should treasurers be taking to prepare for the challenges ahead? “First off, a treasurer should have a structure in place to sit down regularly with the CFO and management team,” comments Carl Sharman, a Director in Deloitte’s Treasury Advisory practice. “This will require the treasurer to have an understanding of how Brexit impacts the whole business community as well as their own organisation.”
Sharman notes that Brexit is essentially “a challenge like any other”, and that poor business performance is likely to be a reflection on management’s ability to respond rather than being down to the macro environment. “By now, many senior management teams will have identified risks and moved to manage them,” he says.
Before making any commentary on the markets, Sharman says that treasurers should consider whether it is actually necessary, and that they should be careful to only reference specific impacts to their sectors or businesses. He adds, “be positive – support the business to take advantage of new levels of exchange rates and explore new markets. Take the lead in providing the confidence expected for your colleagues across the business.”
Sharman notes that how banks prepare for, and react to, potential changes in the regulatory framework may also change how they transact with their corporate clients. He points out that this could result in some activities being routed through a different entity in the banking group, for example.
“Talk to relationship banks, lenders, analysts and debt investors, and understand what they are thinking and what their worries are, and if your business is seen externally by them as a risk,” he advises. “In other words, is it especially exposed to European markets, import or export, workforce impacts, etc? Effective PR is also paramount and good internal management can strengthen market perceptions.”
Finally, Sharman suggests that treasurers should also talk to legal advisers, particularly about continuity of contracts and covenant compliance. “Deregulation (especially MiFID decoupling) is going to be a huge part of the exit process, so keep an eye on your documentation and make sure your internal governance is fit for purpose,” he says. “Remember that many European directives have been transposed into national law and as such will survive intact post-Brexit.”
Rising to the challenge
While it is clear that Brexit will present considerable challenges for corporate treasurers over the next couple of years, it is also worth considering the opportunities that may arise. Just as the financial crisis helped to elevate the profile of treasury within the organisation, Brexit could give treasurers an opportunity to shine – and, indeed, to further the goals of their departments following years of budget constraints.
“Brexit may give a greater focus on the financial risks that the business is facing,” explains Stebbings. “So it makes you look at forecasting and systems, and may raise the business case for treasury to have more resources. We’re certainly seeing more companies thinking about treasury management systems, automation and improving the way that they do treasury in order to understand the risks more effectively.”
At the same time, treasurers should take the opportunity to get their house in order so that appropriate actions can be taken when the need arises. Straightforward improvements such as gaining a clearer view of the number of bank accounts held by the company can help to position treasury so that any necessary changes can be made as the situation develops.
For the time being, treasurers should also take the time to understand what their main banks are currently planning and what the impact would be if certain services were changed. Treasurers should also understand how their cash pooling structures could be affected by different scenarios and what, if any, actions should be taken so that they can adapt quickly if needed. “The main thing is to be ready when things become clearer,” says Stebbings.
While it is important to monitor the situation as it develops and understand the implications of different possible outcomes, treasurers should also be aware that Brexit is not happening in a vacuum. “Brexit isn’t the only thing that’s affecting treasurers – there’s also the new BEPS legislation, new accounting regulations and the impact of cybercrime,” points out Stebbings. “So there are a number of things on the treasurer’s agenda, and Brexit is just one of them.”
Conclusion
As the UK prepares for its third major vote in as many years, the direction Brexit will take remains unclear. But while this makes it difficult for corporate treasurers to assess the longer-term impact of Brexit on their businesses, there are plenty of steps that treasurers can and should be taking now to understand the different possible exit scenarios and the potential implications of these for key banks and suppliers.
