Brexit concerns hover over capital markets

UK-based accountants could well gain a greater degree of influence in corporate finance decision-making once the UK leaves the EU, if some assessments of the post-Brexit landscape turn out to be accurate. This could prove particularly true with regard to the raising of funds in European bond markets by the country’s midsize companies. On the other hand, they might not.

It is impossible to forecast the impact of Brexit with any confidence, given the chaotic uncertainty that has come to characterise the project since the UK electorate voted to leave the EU.

It is, though, perfectly possible to point to a number of areas that will present challenges in one way or another. As the solutions being considered will lead to the development of additional operational processes and an inevitable increase in corporate costs, accountants will face additional responsibilities and tasks. These will extend beyond the counting and interpreting of numbers.

Steve Lamarque is a founding partner of Hilbert Investment Solutions, a distributor of structured financial products to institutional and retail investors. He identified one nonfinancial issue with which companies will need to engage. “What will be the legal jurisdiction under which UK companies will raise capital in Europe’s bond markets?” he asked.

As most issuer documents are governed by English law, this will be an immediate legal and regulatory issue. “What will happen to investors?” Lamarque said. “How will they claim their money back if something goes wrong? Will a UK borrower even be able to borrow directly under European laws, or will they have to access EU markets via another route?”

Settlement of financial obligations is an area of concern. Investors who have become comfortable with the settlement services provided by Euroclear are already asking whether the UK & Ireland CREST (Certificateless Registry for Electronic Share Transfer) settlement system, which forms part of Euroclear, will be able to continue operating under existing rules.

Regulation will potentially be a further challenge, raising the question of whether bond issuers will be legally able to sell their paper. Institutions that are regulated by the UK’s Financial Conduct Authority can currently sell under Markets in Financial Instruments Directive II rules, but it is unclear whether they will be able to continue doing so after Brexit. As things stand, no one can say.

If the pool of potential lenders and investors shrinks, the lack of competition could push rates even higher on top of the Brexit premium. The duration for which takers of paper are prepared to invest or lend could shorten, requiring companies to come to market more often. Paradoxically, this could have longer-term benefits, in that the more often a company comes to market, the better it is known and, all other things being equal, the easier and cheaper it can be to raise funds.

Andrew Boyle, CEO of corporate finance and investment specialist LGB & Co., is almost sanguine in his assessment of the situation. “My understanding is that there are concerns among EU companies, banks, agencies, and governments about their ability to continue to access London’s eurobond and syndicated credit markets and that there is less concern among UK borrowers about their ability to access local continental European markets,” he said. “This is based on the relative depth and lending capacity of the markets.”

“In November the European Commission pledged to allow EU companies and individuals to continue using UK clearing houses to settle euro-denominated contracts, ending fears that Brexit might create a cliff edge for trillions of euros of financial derivatives,” said Boyle. “There are likely to be further moves to facilitate EU borrowers’ access to London’s capital markets.”

So, in the short term, Brexit is unlikely to have a significant impact on the level of funding available to UK companies. In the longer term, there might be changes reflecting the amounts of bank capital and investment funds allocated to transactions being originated in London and local continental European centres.

Allocation decisions might be influenced by regulatory factors such as the ability to offer securities to investors across Europe and any requirements to impose withholding tax on bilateral loans after the UK leaves the EU.

UK companies might have to organise a greater proportion of finance at a subsidiary level. However, compromises can be made, and so any obstacles to cross-border funding are likely to be political rather than a reflection of a fundamental dislocation in the capital markets.

Chris McHugh, a lecturer at the London Institute of Banking & Finance, said that all other things being equal, if the UK is economically worse off after Brexit, then lending to UK companies — whether via bonds or loans — by international lenders should decrease and the marginal cost of funding with either debt or equity should increase. He thinks that this could only be measured post-Brexit.

“It is a sweeping generalisation, but many of the larger firms are already geographically diversified, and if they already fund internationally, I see no reason why this should change. Brexit ought not to create any new legal or tax hurdles to issuing bonds in the US or elsewhere,” he said.

“UK mid-caps are most likely to fund with bank loans either bilateral or via syndicates,” he added. “The notional threshold for issuing bonds internationally is quite high.”

One possible solution, the creation of a new corporate entity in an EU country, will inevitably increase operational costs for additional office space, staff, and professional advice. However, many UK companies that are active in the EU will already have such a presence.

Jeremy Leach, CEO of Managing Partners Group, a mutual fund manager and specialist in the asset-backed securities (ABS) market, takes a more positive view of the post-Brexit landscape than most. “I am frustrated by the negative and outlandish doom and gloom being spouted by politicians in the EU, elsewhere in continental Europe, and in the UK,” he said.

“Brexit will have no immediate impact on existing borrowings, and the European Securities and Markets Authority regulatory regime under which bond issues fall extends beyond the EU. Pension funds, insurance and reinsurance companies, and other liability-driven investors will continue to mop up new bonds. They have more cash to invest than they have suitable investment opportunities and will not stop doing business through London,” he said.

He stressed that a UK institution wishing to raise capital by issuing a listed ABS or bond does not need to do so in the UK. Pursuant to the European Prospectus Directive, the ABS would be a completely separate corporate entity to the institution wishing to raise the money, with orphaned ownership and bankruptcy remoteness being requisite.

Leach explained that if the ABS were to be listed in Luxembourg, for example, it would typically follow that the discrete vehicle (ie, the corporate entity created for the purpose of issuing the security) would be a Luxembourg-registered company as well, which would produce a prospectus and seek approval from the Luxembourg regulator prior to listing on the Luxembourg Stock Exchange, a regulated market.

“This prospectus can quite easily be written under English law and would ordinarily be expected to be,” Leach said. “And the issue would have been fully placed with credit investors before the prospectus is even submitted to the Luxembourg regulator for approval.

“In this scenario it really does not matter whether the borrower is a UK corporate entity raising capital or a French one. The currency is of no relevance either, so quite why there would be an expectation of a capital market meltdown as a result of Brexit is beyond me.

“What is clear is that inflation and interest rates will be on the rise in 2019, and this will push the cost of debt up. But equities on both sides of the Atlantic are in line for a tough year, so borrowers are likely to remain more comfortable with the rising cost of debt, as it may well remain more attractive than raising capital by issuing more shares at a time when equity markets will be under pressure.”

Having said all of the above, Leach’s overarching message to CFOs fretting about the post-Brexit world is short and sweet. Keep calm and carry on, he advises.

— Brian Bollen is a freelance writer based in the UK. To comment on this article or to suggest an idea for another article, contact Drew Adamek, an FM magazine senior editor, at Andrew.Adamek@aicpa-cima.com.