The imminent exit of the UK from the EU will not only create political and economic instability that could impact economies globally, but also heighten the insecurity of investors including Indian corporations investing in the UK and EU.
India was the third largest investor in the United Kingdom (UK) in 2014-15, behind only the US and France, but ahead of China. The only European country that receives more investment from India is the Netherlands. The fallout of the UK referendum to leave the European Union (EU) has, on a more immediate term, led to uncertainty and volatility in the financial markets, with the greatest effect being the depreciation of the British pound.
While a depreciating pound makes investments in the UK attractive, it also makes existing contracts unviable and impacts earnings of Indian companies. The actual exit of the UK from the EU (Brexit) will involve the UK invoking Article 50 of the EU treaty (Treaty of Lisbon), which marks the beginning of the legal process to leave the EU. Once invoked, it could take the UK up to 2 years or more to exit. It will now be incumbent on the newly appointed UK Prime Minister to take a decision on invoking Article 50.
In this update, we examine Brexit's likely impact on Indian companies having a presence in the UK and Europe.
UK as a European Headquarters
Many Indian companies across different sectors ranging from banking and financial services to IT, pharma and manufacturing have established their European headquarters in the UK. The language, legal system, London's status as a commercial and financial hub, and access to the single European market have been key determinants for this choice.
The UK's imminent exit from the EU would impact the free movement of people and products between the UK and the EU, and could therefore force Indian companies to realign their investment strategies and set up new headquarters within the EU.
Disruption of economic cooperation and trade
Indian companies manufacturing in the UK for the European market have so far benefitted from preferential access to the EU market. They have also enjoyed lower tariff barriers while importing and exporting within the EU. This could likely change, if UK exits the EU, unless the UK negotiates a deal with continued access to the EU single market.
Listing on UK bourses
The London Stock Exchange (LSE) has been one of the preferred choices for overseas listing of Indian companies. There are over 58 India focussed companies listed on the LSE, and over 30 Indian companies which have Global Depository Receipt listings in London. Listing in London is increasingly seen as a preferred way of raising capital, particularly equity capital, as Indian companies get access to a wider pool of quality European asset managers. Tapping London's large foreign exchange market, London has also fast emerged as a preferred destination for listing rupee denominated (Masala) bonds.
However, London's status as Europe's financial centre is under threat and with the ensuing volatility in financial markets, raising capital in London may no longer be an attractive option in the short term. In the long run, it is possible that London may seek to make itself more competitive, and be an attractive capital raising destination.
Trade deal with the UK
If the UK does exit the EU, the UK will have to negotiate a separate trade deal with India. Negotiations on the EU-India free trade agreement (FTA) have been underway for over nine years. India has been pressing for greater market access in services, data secure status and liberalised visa regulations, all of which will benefit the IT sector in India.
While India has struggled to have its demands met under the EU-India FTA, Brexit may provide a timely opportunity for India to negotiate better terms in a separate trade deal with the UK, which may be keen on strengthening its international trade ties post the exit. In fact, Sajid Javid, UK's trade minister till the recent ministerial reshuffle, had met with Indian Commerce Minister, Nirmala Sitharaman, shortly after the referendum to initiate discussions on a separate trade deal.
Opportunities for Indian investors to acquire assets in the UK
Uncertainty notwithstanding, some Indian investors may want to take advantage of the depreciation of the pound and lower valuations to acquire quality assets in the UK. Opportunities range from strategic acquisition of UK companies for their technical knowhow and brand value to acquiring prime real estate at cheaper valuations in cities such as London.
Taking advantage of the cutting edge innovation in the UK, Indian companies in the advanced engineering, automotive and technology sectors could benefit by setting up R&D centres in the UK or making strategic acquisitions. Investments in commercial real estate and in the hospitality sector may also be attractive for Indian investors.
Contracts under English law and patents
We do not see any adverse impact that Brexit could have on contracts of Indian companies governed by English law. However, UK's imminent exit does raise questions on the EU unified patents regime which is scheduled to come into effect in 2017.
This new patent regime will provide a one-stop-shop for grant of a unitary patent that will provide uniform protection across 26 EU countries (excluding Spain and Croatia) and will provide a huge cost advantage by reducing the administrative burden for a patentee. The new patent regime also provides for the establishment of a new patent court, the Unified Patent Court (UPC), that will offer a single, specialised patent jurisdiction.
Under current agreements, the unitary system can only come into effect if ratified by a minimum of 13 nations including France, Germany and the UK, the three EU markets with the highest patent registrations. UK was also slated to host a division of the court for life sciences and pharmaceuticals disputes.
Brexit would throw a spanner in the works for the unitary patent regime. If the EU proceeds on this deal without the UK, Indian companies will have to apply for separate patents for the UK and the EU. Some may even find it beneficial to register patents outside the UK, depending on the target market.
Increase in investment in other EU countries
The EU will remain an important trade and investment partner for India, and Brexit will at its best encourage a disbursement of Indian investment into other EU member states, especially for those looking to tap the wider EU market.
In fact, India has, over time, been strengthening its relationship with other key EU member states such as Germany and France.
While the UK attempts to determine its next steps in relation to Brexit, the consequent uncertainty has dampened business sentiment and investment. The UK and the EU are important markets for the Indian IT industry, which may bear the brunt of any economic slowdown in the UK. It is also quite plausible that the immigration-centric campaign of the UK 'Leave' faction may result in more stringent visa regulations in the UK, further impacting the free movement of labour.
However, with the UK keen on maintaining its status as a key trading partner to India, India could push for favourable terms while negotiating a separate FTA. Further, with the falling pound, UK opens itself up as an attractive investment destination for Indian companies looking to acquire assets at lower valuations.
If the UK is able to negotiate an arrangement where favourable access to the European common market continues, the way Norway currently has, it could go a long way in mitigating some of the concerns of Indian companies. In the interim, Indian companies seeking the benefits of such single market may have to take a wait and watch approach to their investments in the UK and EU.