Although the official campaigning has yet to begin, the implications of the upcoming referendum on the UK’s European Union membership are already being felt. The uncertainty about whether or not the British public will vote to leave the World’s largest economy has pushed the value of sterling down to its lowest level against the dollar since the depths of the global financial crisis seven years ago. The consequences are impossible to predict, but the market movements that we have witnessed so far suggest that the period following an ‘out’ vote would be anything but calm.
The Remain campaign
As things currently stand, a clear majority of financial services firms across a wide range of sectors are in favour of remaining within the European Union, with a 2014 study of boardroom sentiment by TheCityUK finding 84% of those interviewed in favour of remaining within the block.
BlackRock recently suggested a vote to leave, ‘would hit sterling, potentially sparking a wave of credit downgrades, spikes in gilt yields – increasing government borrowing and hurting domestically-focused UK equities’. HSBC, meanwhile, have suggested that sterling could fall up to 20%, pushing up inflation and import prices for firms, whilst having a negative effect on GDP. The Centre for Economic Performance, part of the London School of Economics, has predicted that GDP could contract between 6.3% and 9.5% if the UK left the EU, ‘a loss of a similar size to that resulting from the global financial crisis’.
Many UK, US and EU banks have spoken out in favour of Britain’s EU membership including Goldman Sachs, JPMorgan and Deutsche Bank, while a recent survey by the British Bankers Association found, amongst those who had a position on the matter, 98% were in favour of continued membership.
The case to Remain
One of the principal benefits of EU membership is access to the single market, which allows the free movement of goods, services, capital and labour throughout its member states. These four freedoms reduce costs, increase consumer choice, boost demand for British goods and thus create more jobs. Some studies have suggested up to 3.5 million British jobs are linked to trade with the EU.
Another benefit of the single market is its raison d’être; a single set of rules and regulations that allow UK companies to attract business un-impeded from across the 28 member states. Within the financial services industry, the EU’s ‘Passporting’ regime allows unfettered access to over 500 million potential customers for UK based firms.
A ‘leave’ vote would almost certainly mean exit from the single market, as well as an exit from the EU, as a post-Brexit government would find it politically untenable:
- to continue to allow the free movement of people when immigration has been the driving force for many advocating an out vote; and
- to have to abide by EU directives in order to obtain single market access without having a voice, when the issue of sovereignty has been of fundamental importance.
Another recent poll by TheCityUK found that 37% of EU banks based in London would relocate staff abroad should the UK vote to leave – the UK financial services sector employs two million people within the UK and contributes 12% of tax receipts.
Deutsche Bank is actively conducting investigations about a potential repatriation of staff to Germany, while US banks have been drawing up preliminary plans for a potential move to Ireland, which would provide a low corporate tax base, English-based law, an English speaking population, as well as full access to the Single market and Eurozone. The implication of an exit for the sector could be dramatic.
On the other side, however, there are those who believe a British exit from the EU, or ‘Brexit’, would better serve the interests of the UK. This group has grabbed headlines and become known as the ‘Brexiteers’.
At the forefront of those advocating a ‘leave’ vote is the hedge fund industry, with two of the five richest UK-based hedge fund managers being linked to the Brexit campaign. Among them are Sir Michael Hintze of CQS and Crispin Odey of Odey Asset Management. Toscafund, a hedge fund worth £3 billion and with stakes in Redrow and Home Retail Group, has also come out in favour of Brexit, suggesting that Britain would be ‘a better place’ should the UK vote to leave.
The argument here is based on the belief that there is no plausible alternative to London as a financial sector within Europe and an exodus to Dublin is unlikely.
The case for Brexit
One of the main arguments often cited in support of Brexit is the cost of EU laws and directives. A United Kingdom outside the EU would be free to abolish swaths of regulations. OpenEurope, a Eurosceptic think tank which supports EU reform, estimated in 2015 that the 100 most burdensome rules cost the UK economy £33 billion. These include the Working Time Directive, which limits the number of hours worked to 48 (although the UK has an opt-out from this policy), and the EU Climate and Energy Package. The recently introduced bonus-cap has also frustrated many in the financial services sector and serves as another example of the over-regulation emanating from Brussels.
An often cited argument for leaving the EU is the direct cost of membership. The UK government paid a net figure of c.£8.5 billion to the EU in 2015, which takes into account the £5 billion rebate, UK public sector receipts and EU spending in the UK. Most of these payments are made to farmers via the Common Agricultural Policy (CAP) and to poorer regions of the UK under the Structural and Cohesion Funds.
The ‘leave’ campaigners advocate that the UK government would be better placed to spend this money, and that the savings could be used to build more hospitals and hire more police officers for example.
With less than two months remaining until the actual vote, and with both campaigns currently tied in opinion polls, the news will continue to be dominated by the arguments for and against the UK’s EU membership.
The uncertainty surrounding the outcome has already had an impact on the UK economy with firms cutting back investment and deferring additional employment decisions until after the vote. Unfortunately, this uncertainty is almost guaranteed to continue until at least the 23rd June, with the outcome of the referendum being the decisive factor as to whether this continues thereafter.
Pension schemes should be ready to act if gilt yields rise and we recommend that those schemes considering adopting a dynamic approach to de-risking agree in advance how decisions will be made so that they may act quickly. Any rise in gilt yields may be temporary and the importance of capturing higher yields is therefore even more important.
As far as growth assets are concerned, we continue to advocate a diversified approach, as we expect volatility to increase ahead of the referendum.