Yesterday’s historic UK referendum has delivered a vote to leave the European Union. It will take time to work through the implications. So much is still unknown in terms of how the UK will negotiate its exit and build new trading relationships in the years ahead. But, invariably, uncertainty affects economic and capital market activity – and this feeds market volatility; although governments and central banks also stand ready to react.
This all adds up to a complex picture that we can’t hope to unravel in one sitting. The starting point for us today is how the various forces in play might reshape the capital agenda. It was always the case that companies needed to think in terms of multiple futures– but BREXIT adds another dimension.
It was an uncertain world before this morning, but the vote for BREXIT adds a further complex layer. It’s important to maintain a sense of perspective. Just as they did last Friday, people across the country got up this morning, bought coffee, caught the train, came into the office and planned their weekend. But, this vote has placed the UK economy on a different path. Forecasts based on the UK remaining in the EU – basically everything in the economic mainstream – are no longer valid. The UK’s EU exit and what comes next will be the subject of much debate for a number of years, making it difficult to form new expectations in these early days.
What we can say is that our EY Item Club analysis and our latest UK Attractiveness Survey both point to the potential negative impact of uncertainty on inward investment and the UK economic environment– at least in the short to medium term. The pound, whose strength is underpinned by trade expectations and the UK’s economic stability, will inevitably remain under pressure until there is greater certainty and confidence in the UK’s path. Credit ratings agencies have indicated that the UK’s credit rating will come under review, with broad implications – not least for banks and other organisations tied into this rating.
With so many moving parts, it is impossible to cover the whole gamut of implications and talk in absolute terms. On the other hand, we cannot afford to wait for the dust to settle before we start to think about the possible implications and more immediate reactions. To this end, today’s blog is going to focus on how forces currently in play could shape the capital agenda – with the proviso that this is an exceptionally fluid situation.
Uncertainty has hit global investor confidence and markets are in ‘risk-off’ mode – as we’d expect. What happens next depends on the interplay between investor reaction and any government, EU and central bank responses. This isn’t just a UK problem – the ripples are spreading far and wide.
Raising capital is obviously going to be more difficult in this environment, we just don’t know the extent and duration of any market dislocation. IPO activity was already slow across the UK – and in global markets – due to a wide range of economic and political uncertainties. We expect UK IPO activity to slide further to a near standstill in the next 12 months as investors absorb and process the changes to the UK economic landscape. Corporate debt markets have been marching to the beat of ECB support – which helps to explain their more sanguine reaction in the run into the vote. This sanguinity is now being tested, with spreads widening significantly this morning. Companies in need of finance in the near future will need a plan B.
Central banks could add more support – including bank lending if necessary as the sector comes to terms with the complex impact of EU exit. But even so, it looks like we’ve woken up to a very different world for most companies seeking credit and that word again – uncertainty – will loom large over fund raising processes. Exiting the EU raises questions about the future of a whole range of financial regulation and the ability to raise capital across borders.
UK economic data has been mixed leading into the referendum, but it’s been clear from surveys – and client conversations – that many companies were holding off on major decisions and investment. Our most recent Capital Confidence Barometer shows UK companies recognising that they need to stay on the front foot, making deals and alliances to help them push beyond the current low level of organic growth. But given the uncertainties around trade, sterling and funding, we expect to see a further pause as companies digest the result and work through the possible implications of life outside the EU.
M&A activity won’t stop entirely. Slow growth and disruptive forces will still provide strong imperatives to do deals, But practically, a weaker pound will put UK companies at a disadvantage in terms of outbound acquisitions and financing conversations. Where we might see more activity is from foreign private equity funds looking to acquire assets in the UK, if the cheaper pound offer an attractive valuation. UK mid-market buyout activity held up well in the months leading into the vote. But, any buyers will be mindful of the economic outlook and prospects for trade.
Companies always need to be constantly adapting to changes in their market – this was true before the vote and more so today. Operational and capital fitness have been high up the UK corporate agenda for some time – which should hold companies in good stead – but I don’t think we can emphasise enough the fluidity of the outlook and potential for significant change.
The need to plan for multiple outcomes is epitomised by the outlook for interest rates. Will the Bank of England offer further stimulus or will it be forced to hold its ground – or even raise rates – if it needs to bolster the pound? The falling pound will help exporters, but the benefits could be tempered by uncertainty over future trade deals. More expensive imports will put pressure on input prices – including food – something we really haven’t seen for a while. Companies need to think about how they might pass on any price rises in this environment. Businesses will be thinking about their workforce in the context of any changing employment rules and levels of activity. How will all of this affect household’s spending power?
It’s going to be tough to gage how demand will react, putting a high premium on operational and capital flexibility.
Capital preservation requires that companies continuously assess and reassess their strategies. When we talk about BREXIT, it’s important to put it in the context of global challenges and opportunities. It’s implications aren’t the only challenge in global markets, neither will opportunities entirely dry up. We believe that companies that lead the markets will be those who can prepare for multiple futures by building in strategic, resource and capital flexibility. Effective capital allocation will help companies seize advantages and mobilize against challenges.
It’s inevitable in a period of challenge and change that some companies won’t be able to adapt quick enough. It’s vital that companies engage with their stakeholders quickly and honestly if problems arise.