All the British EU referendum seems to have been good for so far is trading insults - as emotions run high in the last few days before the historic 23 June vote, and British politics reels from the murder of MP Jo Cox, it is worth taking the time for a more sober, analytical perspective on the Brexit debate.
It has been repeated countless times that the UK faces the biggest political decision of a generation next week. It is less often mentioned, but no less true, that this is the biggest trade decision of a generation, and will have an impact on all aspects of trade finance.
Predictions run wild over the impact Brexit will have on the markets - indeed the markets’ current turmoil, and sterling’s downward trend in recent weeks, are evidence enough of the heady international speculation on the matter. The uncertainty of polls is foremost in everyone’s minds after the surprising outcome of last year’s general election, and it seems the one thing we can be sure of is we can’t be sure of anything. UK bookmakers do, however, have Bremain as the winner in the saga.
However, it is important to attempt to tease out the potential impact of a UK divorce from the European Union for the trade finance, commodity finance and project finance industries, in order to prepare for the possibility, and simply to understand better the intricate trade and financial relationships tying the UK to the EU.
Equant Analytics, an analysis company which predicts trade finance, has three possible scenarios ranging from worst to best. Thanos Papasavvas, co-founder of Equant, says the most likely is a central scenario, in which both parties will fight to limit the impact of Brexit, and due to the length of negotiations companies and banks will have time to adjust to it without too much volatility. “We think the transition is not going to be that significant in trade,” he tells TXF. “In that case, trade may be the dog that never barked!”
Papasavvas nonetheless believes the UK remaining will be better for Britain and for the sustainability of the European project. He points out that foreign direct investment (FDI) is crucial for the UK because of the current account deficit, and that much of the FDI flowing in is linked to the UK’s participation in Europe. A Brexit would disrupt investment significantly.
A popular Leave argument is that any lost trade with EU states would be compensated by increased trade with the Commonwealth. India is already the third biggest source of FDI to the UK after France and the US, but the Brexit argument is blown apart by Commonwealth and other trading partners’ statements in favour of Britain remaining. Chris Southworth, secretary general of the ICC’s UK branch, tells TXF: “It is a red herring that this is an either-or choice between European markets and spreading out into the Commonwealth. We do both. These are not separate worlds.”
Southworth says: “The international community is overwhelmingly in favour of Britain remaining. We are a leading hub for trade finance worldwide and it’s difficult to separate our relationships from other parts of the world. We are an interconnected part of the ecosystem.” A survey by the ICC of its UK members in April found 86% of respondents believed the UK should remain in the EU.
Beyond simply trade finance, one fifth of global banking activity is booked in the UK, according to figures from Standard & Poor’s. Foreign banks account for 50% of all UK banking assets. Nigerian and Ghanaian banks depend on capital from the city. “This is not a simple decision about us; we have to have a sense of responsibility,” says Southworth.
Access to the ‘passport’ system, which gives UK-based banks the automatic right to sell services across the EU, would be rescinded in the event of Brexit, French finance minister Michel Sapin has said. The passporting system grants the right to sell financial services across the EU bloc under a single set of rules, and is of great benefit to foreign banks who have their EU headquarters in London. Of course negotiations could win the City of London the right to re-enter the passport system, but this would be at the cost of long talks and concessions.
Foreign banks account for 50% of all UK banking assets, so a loss of passporting rights would be a huge blow to the British financial sector and may spur a shift in the European financial centre of to Frankfurt or Paris. The financial services industry is a cornerstone of the British economy, attracting $1.6 trillion of foreign direct investment, the highest FDI into financial services of any advanced economy, according to S&P.
Despite gloomy predictions, Brexit is a known unknown, rather than an unknown unknown, says Thanos Papasavvas of Equant Analytics. This means the shock to the markets will be there, but it won’t create the cataclysmic meltdown of the 2008 financial crisis. Banks and corporates have been hedging against the risk of Brexit in the past few weeks - the Bank of England offered British banks around £2.5 billion extra liquidity to brace against Brexit this week.
The moniker applied to the Remain campaign could just as easily apply to the uncertainties chilling project finance in the event of a Brexit.
The UK has been a hub for project finance in the EU. The European Union’s bank - the European Investment Bank (EIB) has a strong history of supporting projects in the UK, from hospitals to roads and offshore wind farms. Funding from the EIB would almost certainly dry up or be sharply reduced in the event of a Brexit. A project finance consultant tells TXF: “Brexit will make it harder for the UK to win business, and funding costs might go up.”
Access to long-term debt is crucial to the continued development of project finance. The consultant says: “Long-term debt is the stuff that dries up quickly when there is volatility. If you don’t know the future value of sterling it makes it rather difficult.”
The potential knock-on effect on the euro will make it very hard to fix interest costs. Various financial sub-markets are necessary for project finance to work: interest rate swaps, currency swaps - and these tend to fall apart much more quickly than the banking market, says the project finance source.
“If you have a Brexit, there’ll be a bonfire of regulations on employment rights, electricity markets, that might ultimately benefit some companies,” says the consultant, “but you would have to be playing chess in three dimensions to work out what the ultimate outcome is.”
Project finance as we know it coincides with the last big expansion of the European single market, and developed in the 80s and 90s. As such it is unclear what project finance would look like in a Britain outside the EU. Scotland is another concern: it has been a popular destination for project and infrastructure finance, and Brexit would cut its access to this, potentially precipitating a second Scottish independence referendum.
Small and medium enterprises and European regulation
One of the biggest stories at the moment in global trade finance is the drying up of funds available to SMEs, internationally touted as the engine of the economy. The effect a Brexit would have on SMEs in Britain is huge, making it harder for them to access finance and confusing the regulatory environment which is already indirectly putting pressure on their access to liquidity.
Short-term operational challenges for UK corporates include the currency devaluation, rise in interest rates and reduced access to funding in capital markets. The longer-term risk is missing out on capital investment due to uncertainty.
The battle lines are drawn between household British businesses: Rolls Royce has come out in support of Remain, while Dyson, which exports vacuum cleaners and other equipment to EU states, is arguing the case for Leave. Challenged about the rationale behind this British business supporting Brexit, Southworth says: “You have to respect people’s views; I am not going to criticise them for their views. All I can say is that these views are a tiny minority of the business community, that’s a fact.”
Wide-ranging regulatory treaties Basel II and III were agreed in the context of the EU, and would no longer bind the UK in the event of a Brexit. James Sinclair, marketing manager at Trade Finance Global, says the exit from Basel II and III would prompt British regulatory authorities to implement their own regulation, which would likely be even stricter than the European regulations, thus pushing SMEs further into dependence on alternative sources of finance and smaller banks, and deepening the crisis of liquidity.
Southworth says: “The last thing we need, when we already have a trade finance gap and SMEs are finding it tough to access finance, is a Brexit scenario. It doesn’t take Einstein to conclude it would be an extra complication.” The time necessary to negotiate and draft new regulations would have a chilling effect on access to finance for SMEs, which for Southworth and many others in the trade finance community, should be the number one priority.
‘Is it the economy, stupid?’
Regardless of the outcome of next Thursday’s referendum, the political and economic relationship between the UK and the EU will continue to be debated and negotiated for years to come. In the event of a Brexit, much will be determined by the harshness with which France, Germany and other EU heavyweights will treat Britain.
While the accepted wisdom is that ‘it’s the economy, stupid’, in the topsy-turvy world of the Brexit referendum it seems like politics takes the upper hand. While punitive exclusionary trade policies would be in no one’s economic interest, politically they would make the point that defectors from the EU will not be let off lightly. With both France and Germany facing elections next year, domestic politics will pressure leaders to adopt a harsh stance, lest they lose even more ground to the growing extreme right. Harsh remarks from French and German ministers now clearly aim to prevent the Brexit from happening, and the rejection reflex should it occur would likely be disadvantageous to all parties.
“Who do we go to when we have a tough decision to make?” says Southworth, “We go to our friends for advice. Why would we ignore the advice of our trusted friends and trading partners, what would we gain from walking away from them?”
But in a political climate of intense mistrust and anti-establishment feeling (ironically for a campaign led by an Eton and Cambridge graduate), with justice secretary Michael Gove claiming the British people have ‘had enough of experts’, it is clearly unlikely the overwhelming consensus of the UK’s friends and trading partners will shift public opinion.
Southworth speaks of a palpable frustration within the international trade community, of being subject to a Brexit decision they are powerless to influence. Ultimately British voters will have their say, and it will be up to politicians to mitigate the result, and the finance community to manage the consequences.
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