Brexit fatigue and uncertainty should not stop businesses thinking about the risks the EU Referendum on 23 June 2016 may cause. Advance planning may help businesses to take opportunities, whatever the outcome.
In or out, results day itself is unlikely to bring immediate seismic change for most businesses, although there is evidence that markets and consumers are already spooked (see the recent The Bank of England’s Monetary Policy Committee summary and press release about the decision to maintain the Bank rate). Investment activity and planning is beginning to stall: "There are some signs that uncertainty relating to the EU referendum has begun to weigh on certain areas of activity, as some decisions, including on capital expenditure and commercial property transactions, are being postponed pending the outcome of the vote. This might lead to some softening in growth during the first half of 2016" (The Bank of England MPC 14 April 2016).
With this in mind, even though Brexit is not (and may never be) a crystallised risk, good governance suggests businesses should already be loosely planning to exploit potential benefits or mitigate any risks, whatever the outcome, either within the context of an existing business or for in flight authorisations.
In the words of Donald Rumsfeld, "There are known knowns... There are known unknowns... But there are also unknown unknowns." Regulators will want to see evidence of businesses’ awareness and preparedness for that heady combination of Brexit and Donald Rumsfeld. How can you do that when it is also important to be focused on a bigger picture?
- Be clear what the range of outcomes looks like and analyse scenario modelling to identify pressure points from outcomes and market uncertainty both before and after the vote.
- Clearly identify your priority markets and expansion plans as well as areas that could be rationalised.
- Consider how Brexit pressure points are already addressed within current business continuity or recovery plans and stress testing. Extend and amend such planning appropriately.
- Identify possible interim contingency plans and enduring solutions, which can be put in place quickly. Any plans would need to be achievable within the time taken to negotiate UK withdrawal: the exit process itself is untested, but it may be as soon as mid 2018 or a considerable time after that.
- There will be implications from an “in” vote too, although fewer. Can these be used to position a business competitively?
- Collect the right management information – what do you need and what might the regulator need? Do you also need to brief key stakeholders?
- Can you be agile and flexible to move at speed when the outcomes become clearer?
- Do you need to message clients? PR and communications teams may need to be ready with a well-judged response to the outcome.
Maurice Obstfeld, Economic Counsellor and Director of the Research Department at the International Monetary Fund underlined much current thinking: "It is obvious that there is a lot of uncertainty at the moment about what will happen in June that it is weighing on confidence and investment in the UK. A Brexit vote would … have a big effect on the UK, on its European partners and, in fact, on countries more globally who are integrated into the current set of arrangements. So, on that basis, we would view this as a significant global change. … For the moment, we do not have detailed numbers for you."
The Financial Times Poll of Polls (27 April 2016) is running at 47% stay and 41% leave. The aftermath may be turbulent with either outcome. While it may take time for the UK's position to finalise in the event of a leave vote, 'wait and see' may also be difficult as most significant business planning is complex and protracted too, particularly if this involves exiting a market or rationalising resources, with fixed timetables and processes (such as staff consultations or regulatory approvals for exit).
Here is a roundup of some of the pain points for financial services businesses:
- Market, interest rate and currency volatility can have knock on effects into capital and liquidity funding. These are core concerns for the UK regulators and businesses must demonstrate competence in managing these risks – most of the PRA's enforcement activity takes place in this space.
- While the UK is currently assessed as relatively sound with a stable outlook by the three main ratings agencies, there is a risk that the UK's credit rating or projections may be downgraded with Brexit. If that happens, businesses must learn lessons from the crash and ensure fund portfolios are rebalanced in line with product descriptions, and offer documents and wider implications must be assessed. It is important to model how this affects borrowing costs, investment and structuring decisions and other capital and funding planning.
- Losing passporting rights is a prominent risk across financial services. Could Brexit trigger a need for the business to relocate or revise its business model? A firm needs to anticipate whether it wishes to continue to access markets or leave and where its costs ceilings are for its strategy (e.g. additional prudential arrangements, duplication of effort for regulatory compliance)? It may not be viable to reorganise to set up a hub in the EU to continue to take advantage of passporting, meet requirements to operate as a third country firm or for incoming EU businesses to set up in the UK on a third country firm basis, for example, because of capital and operating costs in proportion to profit.
- A firm will need a clear understanding of its current staffing and resourcing in order to understand how Brexit may affect these and necessitate change.
- If reorganising, a consideration will be around commercial contracts and client agreements. Outgoing UK businesses are likely to face some restrictions when accessing EU markets (akin to non-EEA businesses). How can clients and suppliers of a branch that needed to become a subsidiary be migrated? What law and jurisdiction provisions are relevant to the firm’s major commercial agreements and standard terms and conditions? How many contracts have been formed on this basis? Are there any termination or other provisions that may affect continuity of supply? A firm may want to use an existing or recent due diligence process to assess the ball park impact – and related costs.
- Disputes are the flip side of agreements. Again, it is unclear whether Brexit would affect the costs of cross-border litigation, law and jurisdiction provisions or alternative dispute handling (because the "out" scenario is not crystallised). But a core part of risk mitigation planning is to know the potential scope of exposure. Due diligence, regulatory reporting or internal risk reporting may provide readily accessible ball park figures.
- Are there wider commercial and operational impacts? Businesses will already manage costs, risk exposure and investment decisions using options and derivatives (e.g for currency exchange risk or commodity purchases); should this be considered more widely? Will insurance be more expensive as a result of investment outcome volatility; will finance, services, products, facilities and overall operating costs simply increase, pressing product pricing and profits? Will consumers tolerate price increases or the end of "free banking"? Will this provide an increasing push towards automation, consolidation and de-risking? It could go either way: help or hinder the provision of retail financial services and positive consumer outcomes.
- Specialist products and operations need careful assessment – special purpose vehicles, insurance products, funds and similar may need adjustments to remain viable (e.g. funds may need to adjust for local private placement regimes). Where will the costs of adjustment fall? Will performance be dragged down with such costs? Consider whether portfolios need rebalancing or whether investors need to receive updated projections on an exceptional basis or at the next reporting juncture.
- Regulatory uncertainty is nothing new but is likely to be exacerbated. Regulation is a significant Eurosceptic nuisance. One thing is clear: regulation (financial services-specific or otherwise) will not be ditched overnight. Most post-Brexit outcomes anticipate a need to keep or implement major EU legislation as part of the free movement principles and to aid trade agreements or to deal with risk in the domestic system. In addition, much financial services regulation stems from global initiatives at G20 level, as measures were conceived to prevent a repeat of the risk contagion seen during the 2007-2008 crisis.
Businesses should continue with implementation projects (such as MiFID II or PSD2) notwithstanding the Referendum and possible Brexit. A firm’s response to such change will still be an integral part of preparedness for any outcome.
- Businesses – and mobile or wealthy individuals (such as staff or clients) - need to think about tax.
Business profits will clearly continue to be taxed, but it is unclear whether Brexit would lead to any material changes in tax policy and application. On the one hand, many aspects of the UK tax code have been influenced or directed by core EU principles such as freedom of establishment and free movement of capital (e.g. loss relief for UK companies with branches elsewhere in the EU) and removal of those constraints could enable a tightening of tax policy to protect the UK fiscal base.
On the other hand, EU membership arguably introduces constraints in areas of the UK tax code that could be more competitive without those shackles (e.g. VAT, the core principles of which are harmonised across the EU, and venture capital investment reliefs, which are subject to EU State Aid rule restrictions).
However, a post-Brexit UK would still be subject to international commitments to initiatives such as the OECD’s Base Erosion and Profit Shifting (BEPS) project, which is already leading to tighter taxation rules for international businesses operating in the UK, and it seems unlikely that trend would cease. Additionally, any international arrangements (e.g. EEA entry, EFTA membership or other bilateral agreements) could well come with conditions that include requirements to toe-the-line in matters of tax policy.
- There are many issues to consider generally for financial services, and for technology businesses within that sector. The impact on regulators and the knock on into the sector must also be considered. Useful initiatives (such as the Sandbox, FAMR advisory tech, Regtech) may be squeezed as resource gets diverted to assessing regulatory implications, trade agreements or policy considerations. The regulators may well become more stretched or fee levies increased.
In or out? That is best left to the ballot box. But uncertainty should not prevent businesses considering risks. A limited amount of advance planning should help navigation in the aftermath and may help businesses to take opportunities.