Apocalypse now as no-deal Brexit looms

Private debt managers are being forced to consider the consequences of what once seemed unthinkable – the UK crashing out of the EU with no trade agreement.

“The probability of no deal is increasing by the day,” UK Foreign Secretary Jeremy Hunt told the Evening Standard this week, on the same day that fellow newspaper the Independent predicted what day one of a no-deal Brexit could look like. Transport chaos, financial panic and medical meltdown are apparently among the appetising prospects to look forward to.

At a presentation by Intermediate Capital Group last week by its head of economic and investment research, Nick Brooks – “Macro and Market Outlook: Global Economy in Transition” – there was no great sense of alarm. ICG recently announced it had collected a healthy €3.7 billion for its latest Europe fund and the presentation – while acknowledging the lateness of the cycle – fell well short of predicting collapse any time soon.

However, among four political risk factors – the others being trade war rhetoric, Italian populism and wrangling within the German coalition government – was the Brexit negotiations which, in the words of ICG’s presentation, “remain stagnant as key deadlines approach”.

Weighing up the likely scenario post-March 2019, Brooks said he thought a transition deal over trade was likely, which would avert any aggressive moves to pull money out of the UK. Uncertainty would ensue, but extra time would be bought – during which time, hope would be invested in the possibility of a long-term arrangement being put in place.

However, in the event of the UK crashing out of the EU without a deal, Brooks was every bit as apocalyptic in his assessment as the Independent. His own prediction involved recession brought about by huge disruption to supply chains, a sharp rise in import prices and inflation, a slump in sterling, falling income and decline in personal consumption. The effects would be similar in nature to those seen in the aftermath of the 2016 referendum result, but greatly amplified.

In our discussions with the market about the possibility of a no-deal Brexit, concerns are expressed about what it will mean for sterling-denominated funds given the expected currency slump – and the consequent increase in the price of hedging. Larger, pan-European funds are expected to escape the worst of hard Brexit consequences through their ability to target other markets; but many think UK-focused funds will be hit hard.

Meanwhile, fund structuring lawyers tell us of their concerns over UK regulated funds that do not have regulated offices overseas and, in the words of one lawyer, “could be paralysed if there is a hard Brexit and there are no co-operation agreements in place”. Particularly concerning is that – under AIFMD – you can’t delegate portfolio management to a country (such as the UK) that doesn’t have a co-operation agreement in place with EU regulators.

The same legal sources say they have seen a big uptick in client concern about a no-deal Brexit over the last few weeks. While many believe such a fate will ultimately be avoided, confidence in the inevitably of a UK/EU compromise is weakening. For private debt, as for other asset classes, that’s a sobering thought.

Contact the author at andy.t@peimedia.com