WM Market Reports

UK Poised To Start Formal Exit From EU - Wealth Managers' Comments

Tom Burroughes Group Editor 29 March 2017

UK Poised To Start Formal Exit From EU - Wealth Managers' Comments

The UK government is due this week to formally start the process of leaving the European Union. Wealth managers comment on the economic, legal and industry implications of this momentous event.

The UK government is due, after much parliamentary wrangling, to trigger Article 50 – starting a two-year exit process from the European Union. Despite protests from disappointed Remain supporters, the departure from the EU, in whatever form it takes, is now a reality. In the months ahead, as details clarify on the exact nature of how the UK will be positioned going forward, this news service will gather views from wealth management sector practitioners on the most suitable strategy to adopt. 

On the eve of this momentous decision, here is a collection of opinions from the sector. These commentaries range from the macroeconomic side through to industry structural issues. For those who wish to add their own, they can email the editor at tom.burroughes@wealthbriefing.com.

UBS Wealth Management 
While the UK’s existing trade agreement with the single market will not change over the next few years, the behaviour of firms and households might; business investment is already slowing. If negotiations look to be proceeding in the direction where a trade deal looks unlikely, firms who use the UK as a base to export to the EU to begin to look elsewhere, causing a further slump in business investment. But Brexit presents opportunities as well as threats to the UK's potential growth rate. If the UK fails to strike a trade deal with the EU, the government will use all of its newfound freedoms to make the UK a competitive place to invest.

The ongoing uncertainty around negotiations, together with additional uncertainty about whether Scotland holds a second independence referendum, are likely to keep market volatility elevated. The act of triggering Article 50 is unlikely to create much volatility in the markets in the short term as it is widely expected by markets. Economic and earnings growth will likely be the key driver of stock returns over the medium term. But markets have to be braced for the very real possibility that any deal is only agreed at the last possible moment given the potential wealth of diverging opinions around the negotiating table.

The pound is currently cheap relative to fair value. How the forthcoming negotiations unfold will be crucial to seeing if sterling can unlock some of this valuation discount. If the negotiations proceed in a broadly constructive manner, then we expect the pound to reach £1.36 against the dollar over the next 12 months. If the negotiations do not unfold this way, then the pound could suffer some weakness until greater clarity on a deal - if there is one – emerges.

Jeremy Leach, chief executive, Managing Partners Group
Malta will be the biggest beneficiary following Brexit. After London, it should be the first choice for a financial firm to establish a branch or secondary office because its residents speak English and are well-educated, it provides easy access to the EU and it has an efficient regulatory process. It is politically stable, which is not so easy to say with regards to Italy and even France, while it also has a great financial rating, unlike Greece. 

Dublin is good and it offers English but it is more expensive and less tax-efficient than Malta while all the other options in Europe such as Luxembourg, Liechtenstein, Norway, Switzerland or Gibraltar have one or more flaws that weaken their case. Malta also has a number of advantages that are supporting its emergence as one of the world’s most important financial jurisdictions. These include its membership of the European Union and the Commonwealth, its tax framework, both domestically and internationally with 65 tax treaties with other countries and the legislation it has put in place around securitsations means it is the only EU jurisdiction outside of Luxembourg that has the legislation in place to offer these flexible tools.

Nick Leung, research analyst for WisdomTree, the investment firm
The pursuit of [Prime Minister Theresa] May’s Brexit ideology will intensify macroeconomic pressures for the UK over the near term. Further sterling weakness arising from trade uncertainty will weigh on the safe haven status of UK gilts. A strong push for Scottish independence could also present an additional source of concern for UK gilt investors. Against this vulnerable macro backdrop, investors may consider diversifying their UK equity allocations. In particular, baskets of UK dividend payers with high exposures to UK multinationals could provide better opportunities, with the fall in the pound boosting overseas earnings.

In light of the upcoming political risk, the economic risks facing the UK economy in coming years are also skewed to the downside. The Office for Budget Responsibility forecasts UK GDP to slow in 2017, primarily as a result of falling domestic demand (comprised of household consumption, private investment and government spending) with total quarterly contributions to GDP expected to drop by 0.1 per cent in 2017, equivalent to over 0.4 per cent a year on an annualised basis.

Facing a slowing economy, the chancellor has given little away with respect to upcoming economic strategy, with the Spring budget offering no hints of a pre-Brexit boost in spending. By contrast, the government reaffirmed its commitment to austerity, pledging to maintain deficit reduction targets well over the course of current parliament. I think this suggests that no adjustment to fiscal policy is planned, and austerity is set to continue amidst Brexit uncertainty.

However, the OBR’s base scenario implies a soft Brexit scenario where trade deteriorates gradually over 10 years and with no consideration for a final Brexit bill. This therefore represents a more upbeat scenario for the UK with milder economic consequences. Since the potential for a hard Brexit cannot be ruled out, the risk of significant disruptions to the UK economy remain. Against such a backdrop, the possibility for austerity to be relaxed could increase.

Diala Minott, corporate finance partner at law firm Paul Hastings
Many asset managers are ready to migrate funds into Europe and have worked for some time to get their AIFMs [alternative investment fund managers] ready and approved. This will likely be a slow migration, however.

Most have chosen the jurisdiction where they will migrate their funds and the main jurisdictions we have seen selected are Luxembourg, the Netherlands and Ireland. Some regulators are providing a transitional arrangement for firms which allows them to increase AuM over a period of time and accordingly increase the presence in that jurisdiction. 

The main concern for asset managers is whether they can convince their key staff to move. We have seen some regulatory arbitrage ‎occurring in the industry with managers worrying about how they will convince their best talent to move way from London. In most cases, the decision will come down to personal preferences as well as what historical infrastructure asset managers have in certain European jurisdictions.

Paul Hatfield, global chief investment officer at Alcentra, part of BNY Mellon
Although the triggering of Article 50 shouldn’t come as a surprise to anyone, we believe it will still send a slight shockwave to the market as people focus on the reality of the task ahead and the implications of exiting the EU. Sterling is likely to drop another level. This will have implications for sterling loans and bonds which could trade off and we expect to see less issuance of these as things play out. 

Year to date, sterling high yield bonds have performed well, outperforming euro and dollar high-yield returns, so it wouldn’t be surprising to see a pullback from investors after Theresa May makes the announcement. As has been the case for some time now, there is plenty of cash in the wings with buyers waiting to pick up what they see as bargains on any dips, so I don’t see a cataclysmic fall in markets, particularly as headline economic news has been fairly robust of late. 

With weaker sterling, inflationary pressures are likely to continue to build and if the UK consumer continues to withdraw from retail spending, we may see some pain in that sector. Against that, tourist spending has been very strong and with a lower pound, is likely to stay that way.

Jon Day, fixed income portfolio manager at Newton Investment Management, part of BNY Mellon
While there are some genuine investor concerns on Europe, we do see signs the regional economy is picking up. Ironically, without some of the current background political uncertainty, most investors would probably be quite comfortable with the latest European economic outlook.

Despite some fairly gloomy predictions it could be argued that, with the exception of bond markets, a lot of the European assets currently being affected by political risk actually look quite cheap. And while Europe remains politically volatile, volatility itself can also provide opportunities - because the underlying risks which drive it often turn out to be less extreme than markets initially fear.

In early March the euro rose 0.7 per cent, hitting a weekly high of $1.0615, while the German Bund reached its highest level since February on news European Central Bank president Mario Draghi had declared victory on deflation. The ECB no longer had a “sense of urgency” on doing more to bolster eurozone growth and inflation via its quantitative easing programme. Against this improving economic backdrop, the political risk inherent in upcoming elections in France and Germany is also less stark than in the 2016 UK referendum and the US election, though it is important to caution that further political upset cannot be entirely ruled out.

While upsets can happen I’m more relaxed about political risk in 2017 than last year because the two major political events of 2016 - the Brexit vote and the Trump election in the US - were very much binary 50:50 decisions and, as we saw in the Dutch election, the European elections are much less clear cut. Given improving economic data, the euro looks safe for the foreseeable future but it is what happens in the next recession that is likely to be decisive, given the underlying structural issues some eurozone members face. Recent history suggests we will probably see a recession in Europe at some point within the next 10 years and without real economic improvement the eurozone could face that from a very weak position, particularly if unemployment were to rise substantially.

Julian Korek, global head of compliance and regulatory consulting at Duff & Phelps
It’s true that some US managers are looking at Ireland and Luxembourg and the opportunities afforded by ManCo structures. These structures are a tried and tested means by which fund managers can access Europe. The local ManCo is based in the European Union and handles the regulatory burden, while the US or UK domiciled manager markets the product and manages the portfolio. In fact, we have already started to see this trend emerge. Because of this structure, however, there is no real need for managers to move wholesale operations abroad.

Fund managers are now looking at the opportunities presented by Brexit. Britain has an opportunity to create a new funds regime to challenge the rest of the world. Brexit also allows firms to create other products that can be distributed to non-EU financial centres. I would therefore expect stronger trading flows to develop with Hong Kong, Singapore, Canada and India soon.

Gary Baker managing director, EMEA, CFA Institute
The most recent member survey from CFA Institute shows that, as Article 50 is triggered on Wednesday, investment professionals are increasingly concerned with the potential effects that the process and final deal could have on the industry, as well as the wider picture of geopolitical risk of which Brexit forms a significant part. The survey showed that 70 per cent of the global member base believe the UK market’s competitiveness has already deteriorated as a result of the vote to leave the European Union and that the risks of wholesale fragmentation, further exits and a new Scottish independence referendum have increased considerably since last year, when a survey was conducted following the EU referendum. 

The current state of political uncertainty is a challenge to the investment industry which simultaneously needs to respond to faltering trust, negative perceptions, a lack of engagement by long-term investors and an apathetic millennial generation.




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