The British prime minister has helpfully assured us that "Brexit means Brexit", but many commentators have pointed out that there are, in fact, different degrees of separation – and some have suggested that the UK is heading for a "hard Brexit". In fact, it isn't always clear what is meant by that term: to some it just means that the UK will leave the single market (which has always looked highly likely, given the EU's insistence on freedom of movement of people as a pre-requisite of membership); to others, it indicates a Brexit without any meaningful trade deal at all, even as regards access to the single market from outside. Perhaps that latter option should be called a "very hard Brexit", or – as some have paradoxically put it – the "easy Brexit".
Such a "no-deal" break up would certainly require the least negotiation, and the fewest concessions on either side. And there may be good tactical reasons for the British government to hint that it would be happy with that outcome: as any experienced negotiator knows, letting the other side know that you have a credible and satisfactory alternative to a negotiated agreement – a "walk-away" option – is very important. But in these very complex pre-talk talks, both sides are actually speaking to multiple constituencies simultaneously, and hints of a "no-deal" Brexit risk pushing UK businesses into making firm plans for such an outcome. Those plans may be hard to reverse.
It is, of course, prudent for firms to make such plans, because – although the UK government would clearly like to improve on its fall-back position – no meaningful deal (or even no deal at all, meaningful or otherwise) could turn out to be the only Brexit on the table. This week's EU-Canada trade agreement debacle emphasises that the EU finds it hard to close a deal, even if its central negotiating team wants to reach a settlement. It will be much harder to find a solution to the Brexit conundrum satisfactory to all remaining 27 Member States, many of whom will hope to gain competitive advantage from the UK's decision – especially if they try to get it done in two years and refuse to extend the deadline. The UK could leave without a deal and carry on talking, so that a trade agreement follows later, but it could be many years later.
So what does "no deal" look like for private equity firms? There are two aspects to that question, of course: the impact on a firm's own structure, and the economic impact on its portfolio and investment strategy.
The first question is easiest to evaluate, although the answer depends hugely on the firm's investor base, fundraising strategy and, crucially, on whether the national private placement rules, which currently operate for third country managers, remain in place indefinitely. For some managers, it will certainly make sense to manage their fund(s) from elsewhere in the EU, even if much of the work actually gets done in London (or New York, or elsewhere) – and some firms are planning for that already. But for many others, that won't be necessary; they will go back to operating without the passport, just as many US, Channel Islands and other "third country" based fund managers have been doing for the last few years. The UK may decide to liberalise some aspects of its regulatory framework, and the rest of the EU may try to close its borders to outsiders, but dramatic change on either front seems unlikely. So, for most managers, "no-deal" is not much more than an eminently solvable structural hurdle (with the possible exception of those UK managers who rely on EIF funding, a subject to be addressed by a forthcoming Private Equity Comment).
But the more difficult questions will be at portfolio company level. As all businesses start to plan for the worst, some investee companies (both those in the UK exporting to the EU, and those in the EU doing business with the UK) will find that the prospect of trade barriers will have a real impact on their business plans. That is not just bad for them and their investors, but also for the UK and the wider European economy. Unfortunately, however, politics makes it look like a plausible result, even if it turns out to be a temporary one.