Brexit: The effect on corporates
The UK’s departure from the European Union will have significant short-, medium- and long-term impacts. Steve Elms, EMEA Head of Corporate and Public Sector Sales, within Citi’s Treasury and Trade Solutions team, is joined by fellow Treasury and Trade Solutions sector specialists John Murray, Roberto Di Stefano, Peter Cunningham and James Lee to assess the outlook for the airline, automotive, healthcare, and technology, media and telecoms sectors in the wake of the UK’s decision to leave.
While the unexpected outcome of the UK referendum on European Union (EU) membership – Brexit – created short-term volatility, financial markets have since largely recovered their losses, although sterling has remains close to historic low levels on a ‘trade-weighted basis’, some 17% below its pre-referendum level against the dollar... In the short term little will change for corporates active in the UK: the UK’s exit from the EU is more than two years away and corporates’ needs for payments, receivables and treasury management will continue as before.
However, with the government now committed to serving notification under Article 50 by the end of March 2017, which will herald at least two years of negotiations in advance of the UK’s official exit, there is still no clear picture as to how the UK’s trading relationships with the EU and the rest of the world will evolve, meaning companies face a significant period of medium- and long-term uncertainty.
Many companies have looked to revise their earnings and growth forecasts as a result of the impacts of depreciating currencies, consumer and business caution, and the resulting slowing of the economy. From a treasury perspective, these top-line impacts should prompt companies to redouble their efforts to improve expense management, streamline processes and enhance working capital.
The outcome of negotiations will be critical to determining to what extent certain corporate functions will continue to operate in the UK.
We are seeing many clients adopt a wait-and-see approach before making any wide-ranging strategic and treasury decisions, and we predict many companies will wait until Article 50 is triggered next year in the hope that the UK’s goals will be clearer – for instance, what kind of trading relationship the UK will seek to establish with the EU.
The inability to access the single market and the curtailing of EU tax treaties and directives may trigger certain company – and supply chain – activities to relocate, which, in some cases, may have an impact on the location of regional treasury centeres (RTCs) or in-house banks.
But it should be put into context: measures such as section 385 of the US Internal Revenue Code and the OECD/G20 Base Erosion and Profit Shifting project are seen as having as significant an effect on RTCs, in-house banks and pooling structures as Brexit.
Nevertheless, the UK should remain an attractive environment for such functions given its secure, business-friendly regime and ability to provide and attract talent, all within the close proximity of global banking partners.
The airline sector is crucial to the UK. It contributes USD100 billion to the economy and is tied to 1.3 million UK jobs. In 2015, there were 160 million trips from the UK, two-thirds of which involved travel to Europe.1
Uncertainty following the vote to leave has already led to reduced forecasts from Ryanair, easyJet, IAG and Lufthansa: the latter three have issued profit warnings. Earnings are likely to come under pressure from a weaker pound and slowing GDP growth. As a result, traveller numbers are expected to fall by 3% to -5% (reducing airline yield) as it is suspected that foreign holiday costs increase and consumer confidence falls.2
In response, airlines are reviewing their capacity needs. Ryanair has confirmed that it will reduce capacity at Stansted and focus on its future growth in EU airports, while Delta Airlines plans a cut in transatlantic capacity to the UK this winter.
Regulatory change is anticipated as the greatest challenge facing airlines. The regulation within the EU aviation market has produced safe, efficient, and economical air connectivity across Europe, while the EU and US Open Skies agreement – which allows carriers from either market unlimited access to the other – has benefited all carriers. Both markets are potentially threatened by Brexit.
Ideally the UK will remain part of the European Common Aviation Area (ECAA), which would give UK-based airlines continued access to all EU airports. However, this would require acceptance of EU aviation law across all areas limiting the UK’s ability to define its own policy. The alternative would be to negotiate a bilateral agreement, similar to that between the EU and Switzerland.
Without a successful agreement, there is a possibility that UK-based airlines, such as easyJet, will no longer be able to operate intra-EU routes. The UK may also need to negotiate agreements with other countries such as the US.
Overall, the UK leaving the EU could represent a huge challenge for UK-based airlines, which, in addition to considering its strategic implications, must also review their cash, liquidity, and treasury structures, which, in turn, could lead to them to seek advice on their options.
The impact of Brexit on the healthcare sector is likely to be significant and varied. For pharmaceutical companies, Brexit could reduce sales if an economic downturn leads to reduced spending on the National Health Service, although the UK is just 3% of global sales (according to Intercontinental Marketing Services).
More importantly, Europe accounts for 56% of UK pharmaceutical exports: any change in trading rules could have major consequences.3 Similarly, the potential implementation of new manufacturing and safety standards in the UK could increase costs.
The UK is a global centrer of excellence for research and development. However, it relies heavily on EU funding: GBP1 billion (equivalent to 25% of public funding) comes from the European Research Council and could be lost following Brexit.4 It is unclear if the UK government will have the capacity or appetite to replace this funding: one alternative could be increased pressure on the private sector to invest more (it contributes the equivalent of 1.06% of GDP towards R&D, below the EU average and 80% lower than German businesses).5
Opting out of EU clinical trial regulations could affect adjacent services, such as contract research organizations: the UK currently ranks first in the EU for the number of phase I trials, and second or third for phase II and III trials.
Brexit could result in the relocation of the European Medicines Agency (EMA). It employs 600 people in London and, more importantly, approves drugs across the EU.: Its presence in London encourages international pharmaceuticals groups to locate their European base in the UK, and foreign direct investment may fall following the EMA’s relocation.
However, the post-referendum announcement that GlaxoSmithKline will invest GBP275 million in three British manufacturing sites is encouraging. Yet, the EMA leaving the UK could also result in delays in licensing and approving new drugs, affecting patients and increasing costs.
Given the absence of detail about Brexit, corporate treasuries should focus on contingency planning in relation to cash management structures and group legal structures (i.e. which legal vehicle manufactures products, earns royalties, and distributes to end markets). In addition, given margin compression as a result of a more complex regulatory environment – as well as the potential pressure to increase R&D investment – corporates may look to fund this by increased free cash generation through improved working capital practices.
Roberto di Stefano,
The UK produced 1.6 million cars in 2015 – making it the third-largest producer in Europe – and is home to 16 of the world’s 20 biggest automotive suppliers that produce locally. Brexit, therefore, may not only have an impact on the UK economy but on the global economy.
Leaving the EU generates four main risks for the UK auto sector. Immediate risks include sterling depreciation, which, while benefiting exports, will result in increased costs of imported parts. Meanwhile, currency-hedging costs are expected to rise, especially for non-UK companies, with significant translational effects. In addition, Brexit could reduce economic growth in the UK and in the EU. Consumer spending on autos could fall as a result: in response, some non-UK companies could freeze planned UK plant investments. This could present challenges given the need for significant investment in new auto technology.
In the medium and long term, the auto sector faces greater risks. Since 77% of passenger cars produced in the UK are exported – 44% to the EU – the loss of tariff-free access to the single market and other countries that have free trade deals with the EU would make exported vehicles from the UK more expensive.6 Over time, auto companies could respond by shifting production, with low-cost locations best positioned to benefit.
Furthermore, auto firms need to be aware of the implications of Brexit for other sectors, most notably finance. Given their high leverage, supply-chain finance requirements, and complex treasury and cash management structures, most automotive companies have close relationships with the City of London. As the finance sector evolves after Brexit, auto company treasurers may need to reassess their banking relationships if the UK potentially loses its EU passport rights.
Technology, media, and telecommunications (TMT)
The UK has become a leading global hub for tech start-ups. This is driven by access to skilled workers from the UK and overseas, the UK’s pro-digital agenda, access to investment capital through the banking sector and venture capital, and a favorable regulatory and political environment encouraging entrepreneurship.
In 2015, new tech start-ups raised GBP1.3 billion in funding, creating 20,000 jobs.7 However, these start-ups, including fintech companies, are reliant on the freedom of movement of international talent, which could be harder to attract following Brexit. Similarly, the high level of investment in the UK’s tech start-ups – by banks, venture capital and tech incubators – could potentially be put at risk.
Indeed, in the month following the referendum, USD200 million was invested compared to USD340 million in the same period a year earlier, reflecting the investor uncertainty surrounding what the UK’s exit from the EU will actually mean.8
The UK’s fintech sector has been one of the few sectors to enjoy impressive growth in recent years: it generated GBP6.6 billion in revenue and around GBP500 million of investment in 2015, and it employs 61,000 people, representing 5% of the total financial services market9. Uncertainty about fintech companies’ ability to operate easily across borders post-Brexit could hamper fintech’s development.
For TMT companies, the potential impact of Brexit on the current benign regulatory environment is critical – for example, for mobile network operators (MNOs), European roaming charges are due to be abolished across Europe from 2017, and it is unclear what will happen post-Brexit for the UK MNOs. For fintech companies, the Digital Single Market, announced in May 2015 (and the UK’s championing of this), should pave the way for even greater Europe-wide e-commerce. It is now unclear whether UK consumers and companies will benefit from these changes.
However, morale in the UK TMT sector has been boosted both by SoftBank’s acquisition of UK chip designer Arm Holdings and Amazon’s post-referendum announcement that it will increase hiring and will open a series of data centeres by 2017 in the UK (a core hub country for Amazon, where Amazon has almost 16,000 employees).
As Amazon UK Country Manager Doug Gurr said recently: “Amazon has Silicon Valley jobs in the UK.” But for all TMT companies active in the UK (and their treasury teams), there is a need to analyze the implications of Brexit – as its character becomes clearer – and seek support so that any potential impact it might have can be minimized.
3. www.rolandberger.com/en/misc/press/Press-Release-Details_3458.html, last accessed on 2 August 2016.
4. www.cbi.org.uk/global-future/case_study02_pharmaceutical.html, last accessed on 2 August 2016.
6. www.rolandberger.com/en/misc/press/Press-Release-Details_3458.html, last accessed on 2 August 2016.
7. www.londonandpartners.com/mediacentre/ press-releases/2016/20160725%20-%20Tech%20investment%2016%20H1, last accessed on 1 August 2016.
9. www.consultancy.uk/news/3338/uk-fintech-capital-of-the-world-but-competition-is-heating, last accessed on 1 August 2016.
This article is for information purposes only and does not constitute legal or other advice. The information contained in this article is believed to be accurate, but Citi makes no representation or warranty with regard to the accuracy or completeness of any information contained herein. Citi is not liable for any consequences of any entity relying on this article.