Getting a grip on Brexit

Brexit is a challenge which many corporates probably had not anticipated in early 2016. As negotiations continue and the UK begins to unwind its relationship with the European Union (EU), it is becoming rapidly apparent that Brexit will consume a lot of treasurers’ attention, resources and time.

Brexit: what we know

Sixteen months have elapsed now since the UK voted to leave the EU, a body it had been a member of for more than four decades. In March 2017, PM Theresa May invoked Article 50 of the Treaty of Lisbon formalising the beginning of Brexit negotiations, which to date remain shrouded in uncertainty and deadlock amid UK-EU disagreement. The key areas of contention remain indecision over citizens’ rights, the imposition of a hard border in Northern Ireland, and a lack of consensus about UK financial liabilities owed to the EU.

The timing of HSBC’s 7th Treasury Exchange Conference in London was fortuitous, happening on the same day that EU Chief Brexit Negotiator Michel Barnier confirmed EU-UK talks had made insufficient progress to justify expediting the beginning of meaningful trade negotiations. Nonetheless, reports are circulating that the EU is at least in the preparation stages for post-Brexit trade talks, but it will not discuss the matter with the UK government. Many believe that trade negotiations and conversations about transitioning will not start until December 2017 at the earliest. However, an end result that satisfies both negotiating parties remains a distant prospect.

A number of obstacles exist which could derail or delay negotiations, not least of which is finding a compromise over the UK’s exit bill. One panellist acknowledged that it will be very difficult and fraught for the UK politically to deduce a real number for the bill. “A major risk to the negotiations would be an ideological confrontation in the UK cabinet leading to a political collapse, which in itself would eliminate any chance of an agreement. But delays are not entirely the fault of the UK. The EU has a culture of legalism and rigidity, which is adding to the problems,” said the panellist. 

Corporate concerns

The immediate impact of Brexit was felt strongly by corporates as GBP dropped 20 per cent overnight leading to a dramatic increase in raw material import costs, although this was tempered by UK exports becoming more competitive. Nonetheless, most organisations had braced themselves for any Brexit-induced FX risk, and were hedged well in advance of the referendum. Despite this, Brexit poses a number of challenges at corporate treasury departments.

Cash management processes could face significant disruption post-Brexit. If the UK exits the EU and does not join European Free Trade Association, it will cease to be party to the Single Euro Payments Area (SEPA), meaning payments emanating from the UK into the EU could be subject to charges or levies. Treasurers are certainly alarmed by this prospect of added costs. “The question is whether we will be able to set up a SEPA direct debit out of London, and whether our bank or the EU will raise a levy on transactions. This could make cash pooling structures very complex from a legal and tax perspective. It may force us to shift our EU SEPA operations to a jurisdiction in the EU and retain non-EU operations in the UK,” said one treasurer.

Corporate treasurers with active hedging strategies are conscious of the risks Brexit poses to the centralised clearing of their over-the-counter derivative instruments, particularly euro-denominated swaps, the majority of which are cleared in the UK. Clearing has emerged as an area of contention between the UK and the EU, with the former demanding that euro-denominated swaps be cleared in an EU jurisdiction, or be subjected to European Securities and Markets Authority or European Court of Justice oversight. Despite the UK having fully implemented the European Market Infrastructure Regulation, equivalence is not assured and some corporates feel that the politicisation of euro-denominated clearing in negotiations could result in liquidity fragmentation and increased margin costs if transactional volumes migrate to multiple EU jurisdictions, in addition to the UK.

Other long-term consequences of a hard Brexit could include severe disruption to supply chains through added customs checks, changes in the application of VAT, and a general swell in administration such as forced renegotiations of IP contracts. Corporates have also repeatedly urged the UK government to guarantee that access to EU talent is not unduly restricted. “Access to EU talent is one of the main reasons why the single market has done so well, and it is essential for economic growth. Even before the referendum, businesses complained they were struggling to retain and recruit skilled staff.  Today, there is a perception that the UK is a less attractive market for EU employees, so it is important any post-Brexit immigration system is kept simple,” said one speaker.

Managing the risk

Clarity on the final outcome is unlikely to happen for some time, which creates a huge problem for multinational organisations who simply cannot implement Brexit contingency planning and execution at short notice. Change management on such a scale requires enormous investment and resources, so it is unsurprising that many multinational organisations headquartered in the UK are bracing themselves for a worst-case scenario whereby the UK is excluded from the single market. In response, corporates are scoping out multiple options accordingly to minimise post-Brexit business disruption.

“Businesses have a window from the end of the UK tax year until the end of the EU tax year in December 2018 if they are to shift operations into the EU to ensure continuity on March 29, 2019,” said an expert. A handful of banks have confirmed that they are strengthening subsidiaries in various EU markets so they can maintain their passporting rights post-Brexit. It is hoped a serious dislocation to services can be averted through a timely transition plan, but a significant amount of work and headway needs to be done if a cliff-edge departure from the EU is to be avoided.

Brexit is a huge project for any corporate treasury, with a recipe for significant disruption and business interruption, which has been exacerbated by a lack of certainty from politicians. Brexit presents a number of short- and long-term risks to corporates, so it is essential that they adopt a well-coordinated continuity plan incorporating input from all departments, whether it be treasury, IT, legal, communications or human resources, in order to implement a sensible and thoughtful strategy.

References

1 Financial Times – 12 October 2017 – Barnier warns Brexit bill talks at deadlock
2 BBC – 13 October 2017 – Brexit: EU to prepare for future trade talks with UK
3 BBC – 13 October 2017 – Brexit: EU to prepare for future trade talks with UK
4 PwC – Supply Chain: Your Brexit Competitive Advantage
5 ACT – August 2016 – Brexit Q&As – Painting by Numbers
6 PwC – Supply Chain: Your Brexit Competitive Advantage