Risk Management

Question Answered: Brexit

Published: Sep 2016

This issue’s question

“What are the implications of Brexit for treasurers based in Asia Pacific?”

Antony Eldridge, Financial Services Leader, PwC Singapore

Antony Eldridge

Financial Services Leader
PwC Singapore

The famous British mantra of ‘Keep calm… and carry on!’ may be sound advice in the aftermath of the United Kingdom’s referendum vote to leave the European Union. After all, no-one yet knows what the UK and Europe will look like when more than two years of difficult negotiations come to an end. But for corporate treasurers the ensuing uncertainty presents a number of headaches that need careful thought, planning and action, over and above a simple phlegmatic approach.

Clearly corporate treasurers in the UK and Europe, many of which were caught by surprise with little contingency planning, have the greatest challenge. However, those in Asia, perhaps having undertaken no planning for Brexit, are having to deal with similar difficulties. Currency repricing and volatility is at the forefront, with around a 10% fall in the value of sterling and the political and economic Brexit spillover weighing heavily on the euro. Risk aversion ‘contagion’ has driven the yen and other safe haven currencies higher. The costs of hedging strategies and the wider impact on results and balance sheets, especially when dealing directly with UK and European markets, is significant. Credit and counterparty risks are also changing, with the economic impact scenarios for many UK and European companies being far from clear, though all against a backdrop of a downgrade of UK sovereign risk.

Asian trading relationships with Europe need additional monitoring. In the longer-term, Brexit and the European tariff and regulatory environment may limit Asian headquartered European subsidiaries or counterparties from the current full access across UK and European markets – possibly requiring a structural and governance rethink, as well as changes to budgets and forecasts. New trading relationships, and possibly tax treaties, between the UK and the rest of the world are likely to emerge, albeit in the medium term.

Asian MNCs’ European operations may also be impacted by Brexit induced changes in the European labour markets and impacts on the use of shared service centres across UK/European borders. The impact on banks and the financial services sector is also unclear, but certain banks may be constrained by macro-economics, or refocus, resulting in a changing financing environment for corporates.

The economic shock of Brexit, whilst epicentred in London, is rippling across the global economy; Asia will feel the impact. Whilst this is bad news for business activity, policy makers have shown determination to act despite a depleted arsenal of weapons post the financial crisis. One positive for corporate borrowers seems likely to be that globally interest rates are likely to stay lower for longer. Stock markets are buoyed by the prospect, but sight should not be lost on the fact that a slower return to normalisation cannot be a good prospect for international trade.

So whilst corporate treasurers should, indeed, keep calm and carry on, their jobs have just become considerably more difficult. With Brexit uncertainties set to linger for many years to come, on top of the plethora of other global risks, the life of a corporate treasurer is set to be become more ‘interesting’, to say the least!

Jacqui Drew, Director, Solutions Consulting, Reval

Jacqui Drew

Director, Solutions Consulting

The true impact of Brexit on corporate treasuries in Asia Pacific (APAC) is in its infancy and will develop and mature over time. Initially, many treasuries may have already felt the impact of the almost 10% volatility in the GBP exchange rate when it fell to a 32-year historical low. Significant analyses post Brexit indicate that most of the volatility was actually recovering from the inflated GBP rate leading up to the referendum based on the polls citing a “Remain” vote. However, either way, experiencing that kind of volatility on a portfolio of foreign exchange exposures is likely to have an impact on profit and loss. Volatility was not only experienced in the GBP exchange rate, but there were also knock on effects to JPY and CNY and impacts to commodity prices. Companies fled to safe haven assets (like gold) rather than property or bank stocks, which suffered as a result. Linked to the bank stock prices falling, is the reviews of both country ratings and counterparty ratings, hence we might see a surge in credit risk that will likely be passed on to corporates. For many large multinational corporations, at least one, if not all, of the above would have an impact on cash flows, profit and loss or even on pension stocks and reserves.

On a longer-term basis, if a company has treasury centres based in the UK, there might be reasons to relocate, depending on import and export requirements and new laws that come into effect. Relocating a treasury centre will be a significant investment both in terms of financial and physical resources, but here is where companies currently undergoing treasury and risk management (TRM) system selection reviews will want to consider the ease of change that cloud-based solutions afford. No doubt there will be new treaty and exchange laws that will come into play, and these could have significant and far-reaching consequences for any companies outside of the UK and EU.

On a positive note, a low interest rate environment leads to a buyers’ market for M&A and an attractive market for those looking to borrow money to invest. Not least to say, a negative interest rate environment comes with its own challenges.

So what can treasurers in APAC be doing now? Well most importantly, companies must be able to respond quickly and effectively to situations such as these. Talks of another …exit are not unfounded, and so lessons can be learnt from those companies that were building out different scenarios and plans of attack depending on the outcome of the referendum. As an example, one company entered into binary FX options to hedge against Brexit and were significantly in the money on June 24th. Other companies had run cash flow at risk scenarios to ensure relevant facilities and buffers were in place. Global visibility and exposure identification across asset classes and across the enterprise is vital to enable companies to be agile, receptive and responsive to significant shocks in the market, and to be able to seize opportunities as they arise.

Dauwood Malik, Partner, Clifford Chance

Dauwood Malik

Clifford Chance

Matt Fairclough, Partner, Clifford Chance

Matt Fairclough

Clifford Chance

There are a number of questions for Asia Pacific (APAC) corporate treasurers following the UK’s vote to leave the EU and the resultant uncertainty created. Across the region, treasurers and their advisors are still digesting the implications, process and timing of Brexit.

Given bank market uncertainty, companies should first conduct due diligence and consider: implications of ratings downgrades for financing arrangements; collateral requirements for hedging exposure or increasing the cost of borrowing; checking the availability of credit lines; ensuring they are committed; examining dependency on uncommitted lines of credit; the need, timing and ability to tap capital markets for needed liquidity; and the long-term implications of movements in exchange rates. Companies disproportionately dependent on uncommitted credit lines should consider whether to turn them into committed funding lines if they are critical for liquidity.

Companies may over time look to the non-bank funding market for alternatives to bank funding. The US private placement market is well-developed and extensively used. The European private placement market has not really been tapped so far for corporate financing. The Asian private placement market is (outside of Australia and Japan) at a far earlier developmental stage, but does also present a financing alternative. Availability is yet to be tested, however.

In addition, companies that have historically or were otherwise planning to tap into liquidity in the capital markets need to consider the timing of any such issuance of securities. While markets have stabilised in the immediate wake of the referendum vote, it is yet unknown the extent to which, in APAC, primary deals with a strong European/UK element involved can clear the market and at what price. Accordingly, companies’ dependent on capital markets liquidity will need to carefully consider the timing and logistics of their financing needs.

For many APAC companies operating in Europe, there also remains the question: what will happen to our European relationship lenders? Currently many financial services firms rely on the EU “passport” regime to provide their services in other member states. Although the UK does not require lenders to be authorised to make corporate loans, some EU countries do impose such a restriction. Therefore, in the longer-term, a highly relevant question for APAC based MNCs with European operations is whether their financial services providers in Europe can still provide their services across borders.

It will be some time before it is clear what the nature of a post-Brexit UK/EU relationship will look like and therefore what regime(s) will allow cross border access. As things become clearer, companies can begin a dialogue with existing lenders and other financial service providers as to whether they can provide their services on an ongoing basis. This may be through their existing model or under a new model – for example, could a lender book loans through a local facility office?

Ultimately, if it did become illegal for a lender or financial service provider to continue its activities, illegality protections in contracts would apply and would likely require loans by that lender to be repaid or possibly transferred to another lender.

Brian Tan

Brian Tan

Head of Business Development APAC

From the first female Prime Minister since Margaret Thatcher to the selection of Boris Johnson as the man to ramp up Britain’s overseas exports – not a day goes by without some surprising fallout from the political earthquake that was Brexit. The trouble is that away from the Westminster soap opera, businesses across the world have been left scratching their heads about what the future holds.

At the start of this year, no organisation could have predicted that the sterling to dollar rate would fall below 1.30. Nowhere is this more challenging than in Asia – as a weak pound calls into question whether importing/exporting with Britain is an advantage or disadvantage. In theory, markets across the region should be opened up for UK businesses to sell into, since British goods will be cheaper. On the flip side, due to the uncertainty that has arisen since the result, it is likely that many Asian corporates will now decide to put the brakes on trade agreements until more clarity is provided on what Britain’s relationship with Europe will look like.

Even though sterling has recently crept back up against the dollar (thanks in part to stocks’ recent rise), the truth is that because of all the uncertainty, nobody knows what level the British currency will be at over the coming months. Regardless, the only thing Asian-based corporates can be sure of post-Brexit is that it will have a direct impact at month or quarter end when they close their books. Not only will corporate treasurers across the region have to budget forecast their revenues for the quarter, they will also have to budget for what their hedging risk is likely to be. If market volatility from Brexit has taught corporates anything so far, it is that they can ill afford not to have weekly or even daily views of their risk exposure to sterling.

The question businesses need to ask themselves is how much should they increase their hedging by. Nobody is ever 100% hedged, but since Brexit, it is likely that many Asian treasurers would have increased their hedging ratios in the wake of the result. Approaches of course differ from organisation to organisation. For example, a Nikkei-listed firm with a large corporate treasury team and highly sophisticated technology is likely to be ahead of the curve. Corporate treasurers at small and mid-sized firms, on the other hand, need to first ensure that they have a reliable and accurate source of FX rates – before they can even think about hedging. After all, these rates are only as good as the data at their disposal. With more fallout from Brexit to come over the coming months, and with the price of sterling fluctuating almost daily, the last thing any corporate wants is to make financial transactions based on inaccurate data.

Next question:

“What if your bank strategy no longer includes you?”

Please send your comments and responses to qa@treasurytoday.com

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