How issuers, investors and regulators are responding to Brexit
When the UK voted to leave the EU, companies like Britvic felt the impact almost immediately. In the days that followed the referendum, the soft drinks producer saw its share price fall 10 percent. Soon after, two US investors pulled out of the stock.
‘We were caught up in that basket of FTSE 250 companies perceived as being UK-centric,’ says Steve Nightingale, director of investor relations at the firm. ‘Having spoken to the investors that left, they told us it wasn’t about Britvic per se, but rather the uncertainty that was going to prevail in the coming weeks and months – which has turned into years.’
It’s now almost three years since the referendum when the UK voted, against expectations, to leave the EU. Yet, at time of writing, there is still little clarity about what kind of Brexit we will end up with. To manage the uncertainty, it’s been necessary for companies to communicate their exposure with great care while planning for every eventuality.
Britvic’s initial response was to play it safe – and say little. ‘Having thought it through carefully and consulted with our advisers, we felt anything we said at that point could set us up to fail later,’ says Nightingale. ‘There were no hard facts: it was clearly just a huge change in British politics.’
The owner of brands such as Robinson’s, Tango and J20 has operations in the UK, Ireland, France and Brazil. Factories in the UK source 30 percent of their raw materials from the EU, so a no-deal Brexit could see these imports hit with tariffs. Britvic’s sector is also one of the five most at risk from a no-deal Brexit, according to research from Oliver Wyman and Clifford Chance. The study looks at possible tariff and non-tariff costs of reverting to World Trade Organization rules – the default option in the event of no deal.
In this scenario, it finds five industries – financial services, automotive, consumer goods, chemicals & plastics and agriculture, food & drink – would bear 70 percent of the impact in the UK. An arrangement that includes something similar to the EU customs union would see costs substantially reduced, note the authors.
While details of the withdrawal agreement remained sketchy, Britvic felt giving regular updates to the market on Brexit would be counterproductive – an approach it says the investment community understood.
‘Anything you put out would probably be inherently wrong within a few days or weeks,’ explains Nightingale. ‘You’d be in a constant scenario of updating the market. Most of the investors we spoke to were quite sanguine about it. They said, We don’t expect you to give a running commentary.’
Risk assessments It was only later in the process that Britvic decided to lay out its Brexit contingency plans. ‘Once it became clear what the potential deal could be, and the fact that there was still the possibility of a no-deal Brexit, we came to market toward the end of 2018 and formally laid out the risk assessment,’ says Nightingale.
The market was kinder to larger British companies following the referendum. The FTSE 100 generates 70 percent of its revenues outside the UK, giving it less exposure to the effects of Brexit. In fact, the sharp drop in the pound that followed the vote meant many companies would see a boost to their results: revenues in other currencies would appear bigger when converted to sterling. Three months after the shock referendum result, the blue-chip index was actually up a healthy 10 percent.
The task of preparing for Brexit looked anything but easy, however, especially for firms in heavily regulated industries such as pharmaceuticals and banking. For AstraZeneca, the first priority after the vote was to explain the company’s exposure to the UK market.
‘We were headed into the Bank of America Merrill Lynch conference in London the morning after,’ recalls Thomas Kudsk Larsen, head of IR at the FTSE 100-listed pharmaceuticals firm. ‘It was quite hectic, but we could address many people at the conference all at once. We fielded many questions on our UK exposure as a company: sales, profit, assets, people, and so on.’ While officially a UK company, AstraZeneca is well diversified across the UK, Sweden, the US and China [for its major sites]– a point the IR team emphasized to investors.
The pharma industry, like financial services, needed to prepare early for a potential no-deal Brexit given the complexity of European regulation on the industry. In July 2018, four months before the UK-EU withdrawal agreement was endorsed, AstraZeneca revealed it had already spent £40 mn ($52.4 mn) on Brexit preparations and increased its drug stockpiles by 20 percent.
‘As we moved into last year, we felt the need to talk more about our specific Brexit preparations and we covered the topic at the Q3 2018 results conference call and again repeated the preparedness message at the Q4 2018 results presentation in London,’ says Larsen.
In the presentations, AstraZeneca highlighted ‘significant preparations to handle different scenarios’, such as duplicating control processes in the UK and EU, building up medicine supplies in both locations, and identifying alternative supply routes in case existing ones struggled to function under a no-deal Brexit.
A view from the continent In mainland Europe, Brexit has also become a recurring question for IR teams. It’s become ‘kind of compulsory’ for investors to ask about it, says Ignacio Cuenca, director of IR at Spanish power company Iberdrola.
When the referendum result came in, the Bilbao-based firm knew it needed to move quickly given there would be many calls about its large UK subsidiary, Scottish Power. ‘We immediately sent a statement to our database of investors about how we saw the impact: the weight of our British business in the whole group, profit-and-loss account and balance sheet, the debt, and so on,’ says Cuenca.
‘It’s important to point out that the product we are selling to the British people is based in pounds and we generate our results in pounds. It is a purely local activity without any importing or exporting of goods. The big impact will come in the translation of the results in pounds to the results in euros in our accounting.’
While his company is insulated from the main effects of Brexit, Cuenca has noticed a chill in investor sentiment across the British utilities sector. International investors are not only concerned about Brexit itself but also the paralysis gripping the UK parliament, he explains. ‘What we have heard from investors is that the UK used to be the safest haven for a utility several years ago,’ he says. ‘Now it is one of the worst markets to invest in.’
Brexit has caused a flight of money from British stocks. For fund managers that have to invest in the UK, however, Britvic has emerged as a popular choice. A consumer staples firm with high free-cash flow and a growing dividend, the company is now viewed as a safer bet amid all the Brexit uncertainty. ‘Investors know that if we are going into a bumpy period, defensive stocks are quite a good place to have some money right now,’ Nightingale points out.
Meanwhile, Brexit preparations at the company continue, planning for all the eventualities that remain on the table. ‘It’s that kind of unique event where you know, of all the things you are doing, the vast majority of them will not come to fruition,’ Nightingale says. ‘But you don’t want to be the one who hasn’t planned for it.’
Back to 2008 British companies were struggling to get the attention of global investors even before Brexit, says Bank of America Merrill Lynch. Investor sentiment turned negative on UK stocks – meaning a net percentage were underweight rather than overweight – in April 2014 and remain negative to this day, according to findings from the bank’s regular fund manager survey.‘After the Brexit referendum the readings became more negative,’ explains Paulina Strzelinska, a strategist at the bank. ‘Similar pessimism was previously seen during the global financial crisis.’
'There isn’t a return. That bridge has been pulled up.’ That’s how Anne Finucane, Bank of America’s vice chair, described her company's relocation of its European headquarters from London to Dublin at a conference earlier this year.
Whatever Brexit we end up with – hard, soft or no Brexit at all – the decision of the UK to vote in favor of leaving the EU has led to a permanent redrawing of the financial services map in Europe. Put simply, London is on the losing end of the changes. Dozens of banks, investment companies and brokers have shifted staff and assets from the UK to centers in the EU. Dublin and Luxembourg have emerged as popular choices for asset managers, while global investment banks have spread operations across multiple cities.
But no great shift in power is expected. Rather, Brexit is ushering in a gentle rebalancing of responsibilities across the continent. At one stage, estimates put the number of finance jobs at risk in London at more than 100,000. Today’s guesses tend to fall far lower, usually somewhere between 5,000 and 10,000.
For IR teams, disruption so far has been minimal. Most of the staff movements relate to back-office roles. Portfolio managers, buy-side analysts and sell-side analysts are staying put – for the time being at least.
‘We see where people go to meet companies, we see where people change phone numbers, we see whether there is any geographical change and, in general, it’s been minimal,’ says Mark Robinson, head of EMEA issuer services for IR consultancy RD:IR. ‘The London-based guys are staying in London, the Paris-based guys are still in Paris. There’s not been a huge impact thus far. That’s not to say things won’t change depending on the degree of Brexit that we end up with.’
Many investment firms are moving their headquarters from London to the continent to retain valuable ‘passporting’ rights to sell services across the bloc. But portfolio managers can stay in the UK under a system known as delegation, which allows a fund to be listed in one country but managed from another, as long as an agreement exists between the two nations. At one stage it was feared European regulators could tighten this rule to poach business from London, which manages more than £1 tn worth of assets held by EU funds.
In February, however, UK and EU regulators signed an agreement stating that delegation can continue even in the event of a no-deal Brexit. ‘I think there is a reasonable amount of confidence that whatever happens, the relevant regulators have put laws and agreements in place to ensure a reasonable transition period,’ says Will Roxburgh, director at MJ Hudson, an asset management consultancy.
Investment in European securities Whatever ultimately happens with Brexit, London may lose business through country-level rules that govern where investment managers can be based. For example, a number of pension funds have national rules that require the appointed asset manager to be in the EU. ‘It’s the case in many member states, but some may waive the requirement, at least for a short period, in the case of a no-deal Brexit,’ says Julie Patterson, a KPMG expert in asset management and regulatory change.
National rules can also affect the makeup of portfolios: some pension funds and investment firms are required to invest a certain percentage of assets in EU securities. With the UK leaving the EU, British companies could see a drop in investment from mainland Europe. ‘UK assets that may currently comprise a significant part of portfolios will no longer be EU assets, so portfolios will need to be adjusted,’ says Patterson.
For IR teams, another potential regulatory consequence of Brexit relates to trading. There are worries that EU investors will be barred from buying and selling certain shares in London. Where companies are listed or traded across EU and non-EU locations, EU funds are obliged to use the venue in the bloc, explains Christian Voigt, senior regulatory adviser at Fidessa, which provides trading software.
Under a hard Brexit, EU investors could be unable to trade many stocks in London, even though that’s often where the best price and deepest liquidity is found. Up to 230 companies may be affected, estimates Voigt. ‘But what we are talking about is the worst-case scenario,’ he says. ‘The two things that would have to happen [for that scenario] are a no-deal Brexit and the UK and EU not issuing mutual equivalence decisions.’
Equivalency is the system under which the EU grants foreign countries access to its financial markets. It allows this as long as the rules of the foreign country are deemed similar enough to those of the EU. The bloc already has a series of equivalency arrangements with countries such as the US, Singapore and Japan.
A bargaining chip It’s expected that the UK and EU will grant each other equivalency status – after all, their markets currently operate under the same rules. But Voigt points out that it is only granted as part of a larger negotiation. ‘The EU is always very clear on using equivalency as a bargaining chip,’ he says. ‘Equivalence is something that is not obtained, but given. It is not a purely technical assessment. The decision will always have political considerations, too.’
The current negotiations between the EU and Switzerland over a bilateral treaty are illustrative. The two sides have been locked in talks for years without success and, to up the pressure on Switzerland, the EU recently threatened to remove its equivalency status. That would prevent EU funds from trading on the Swiss Stock Exchange, which would cause a big drop in revenues for the bourse.
‘If you look at the Swiss situation, no one is arguing that the Swiss exchange follows different rules – it’s a much wider debate,’ says Voigt. ‘What we shouldn’t forget is that from a politician’s perspective, financial services is just one of many industries to be concerned about. So what might not make sense to finance industry experts might make sense to a politician looking at the bigger picture.’
While the politicians debate the next steps, the financial markets continue to go about their business. Despite the uncertainty around Brexit, European companies continue to head to London in the same numbers to meet investors, says Robinson.
‘It’s all carrying on,’ he observes. ‘You don’t need to convince companies to come to London because, ultimately, it’s the biggest capital markets center in Europe, so people want to come here and [present] their company for further investment, and I think that will always continue. There may just be some additional hurdles for investors, depending on the deal we get.’
The future of listings in Europe The exchange map of Europe has also seen an overhaul thanks to Brexit. Last year, the Irish Stock Exchange (ISE) sold itself to Euronext, with ISE chief executive Deirdre Somers saying it was time to ‘pivot’ toward Europe. Both parties hope the sale will cement Dublin’s position as a listing venue of choice for debt, funds and ETFs post-Brexit.
But a recent study highlights that the London Stock Exchange (LSE) is expected to remain the region’s dominant market for new listings. PwC conducted a survey of 400 business executives, asking where they would consider for an IPO in 2030 outside of their home market. Respondents name the LSE as the third-most desirable venue, behind only Nasdaq and the NYSE. Despite Brexit, London’s ‘resilience and liquidity’ mean it will remain a top IPO destination over the next decade, says PwC.
European regulators have long held opposing views on unbundling, the process of separating the costs of research and trading. The UK’s Financial Conduct Authority (FCA) successfully pushed for strict unbundling rules to appear in Mifid II, against the wishes of French financial regulator the Autorité des marchés financiers (AMF). Now, with the UK set to leave the EU, could some of those rules be pared back?
There’s ‘definitely talk about Mifid III’ and it could be used to ‘unwind some of the more draconian unbundling capabilities, or at least make modifications to them,’ says Sandy Bragg, principal at Integrity Research Associates, an advisory firm focused on the global investment research industry. ‘I think there are definitely concerns within the UK industry that Mifid III will end up deregulating relative to where the UK is.’
The rules around unbundling may be ‘modified in some way,’ says Patterson. But she is betting against wholesale changes to the current system. ‘It’s not immediately clear that, when the UK leaves, those rules are suddenly going to disappear. A number of regulators like the general concept of more transparency and more governance over the process.’
Under Mifid II, which came into effect at the start of 2018, investors must pay for research out of their own pockets or via separate accounts agreed with their client. The new regime has led buy-side firms to re-evaluate their use of external research and, often, cut back. With less money flowing to research providers, there are fears that small and mid-cap companies could see a drop in coverage – an issue highlighted by the AMF last November when it called for reforms.
Robert Ophèle, chairman of the AMF, said in an interview with the Financial Times that some aspects of Mifid II would need to be reviewed in light of Brexit. ‘Even without Brexit we would have had to look at it again because there are very detrimental effects on research, especially for mid-caps, that’s absolutely clear,’ he commented.
Around the same time, Cliff, the French investor relations association, released a study that found coverage of French firms with a market capitalization between €150 mn and €1 bn ($170 mn and $1.31 bn) fell from five analysts to three over the previous three years.
The FCA has also watched for changes to coverage of smaller companies. Its preliminary conclusions differ markedly from those of the AMF, however. ‘I think the evidence is, so far, inconclusive and does not suggest the dramatically negative impact that some predicted,’ said Andrew Bailey, the regulator’s chairman, in a February speech to the European Independent Research Providers Association.
Data shows that analyst coverage on the LSE’s Main Market and Aim remained ‘broadly consistent’ between 2015 and 2018, he added.
Hard, soft or no Mifid? Disagreements between the FCA and AMF over unbundling date back to at least 2014, says Bragg. ‘It’s a long-standing debate between the two and it really caught our attention because rarely do you see regulators publicly disagreeing,’ he observes.
Many Brexiteers – those strongly in favor of Brexit – view the UK leaving the EU as a chance to deregulate the economy, so they may be surprised to find that it is actually regulators in mainland Europe that plan to cut red tape. ‘It is quite an irony, given that the hard-core Brexiteers are chomping about throwing off the yoke of European regulation,’ says Bragg. The FCA and AMF, plus the European Securities and Markets Authority, are all conducting reviews into Mifid II’s unbundling rules, so plenty more evidence should emerge about the impact on small and mid-cap coverage.
The changes add further pressure to an industry already in decline. The total number of research analysts working at investment banks fell by 10 percent between 2012 and 2017, according to figures from Coalition, a data provider.
‘Small companies have been suffering from limited research for some time, but still manage to get covered either through a brokerage contract or as an add-on to a bigger sector,’ says Marina Zakharova de Calero, director of IR at communications consultancy Powerscourt and head of IR at McCarthy & Stone. ‘With the commercial reality of unbundling being so brutal, the stock or story has to be unique to still justify the time spent on research.’
Any plans by national regulators to pare back unbundling will be complicated by the global spread of Mifid II’s research-payment rules. A number of asset managers, including AllianceBernstein, MFS, Baillie Gifford and Capital, have decided to adopt the European approach across their operations worldwide.
That has created an issue in the US, where banks and brokers are barred from receiving cash payments for research unless they register as investment advisers, which then increases their compliance obligations. This situation prompted the SEC to issue a 30-month no-action letter, allowing US companies to comply with Mifid II regulations.
Could the US market decide to adopt unbundling rules more broadly? Bragg doesn’t see that happening, at least not for the time being.
‘There doesn’t appear to be any broad groundswell [among US investors] to adopt the hard-core Mifid II approach of absorbing research costs,’ he points out. ‘It further isolates the UK in that US regulators clearly aren’t buying into the UK perspective on unbundling and there is push back from the continent.’
Data protection post-Brexit Brexit also has implications for another major piece of European legislation: the General Data Protection Regulation (GDPR). As things currently stand, under a no-deal scenario, data transfers from the EU to the UK would not automatically comply with European data protection rules.
GDPR, which came into effect in May 2018, made sweeping changes to the rules around data collection and storage. Companies deemed non-compliant face fines of up to 4 percent of global annual revenue or €20 mn ($22.6 mn), whichever is higher. During the first eight months of GDPR, authorities received close to 100,000 complaints about breaches, according to figures released by the European Data Protection Board. Early victims of the new regime include Google, which was fined €50 mn in January for issues related to its Android operating system.
The first step many UK companies have taken is to put in place legal clauses they can attach to data transfers in the event of a no-deal Brexit, says Jane Shvets, partner at law firm Debevoise & Plimpton. After that, companies should review the consent they have received from EU-based individuals on databases, including IR contact lists, she adds. It may be necessary to send out notices or ask for consent again, depending on the permissions that were originally granted.
IR teams wondering why their firm’s data protection officer hasn’t yet implemented changes should be aware that many are waiting to see how Brexit plays out before they take any ‘heavy-lifting steps like the re-permissioning of databases,’ explains Shvets.
Data transfers from the UK to the EU, by contrast, will not require changes because the UK regulator has said it views the EU market as having ‘equivalent’ data protection. At some point, the UK should expect similar recognition from the EU, but it is not clear how quickly that would happen in the event of a no-deal Brexit.
