Comment: The Battle of Britain

Six months ago, £1 was worth roughly €1.42. Three months out from the 23 June poll on the UK’s membership of the European Union, that has fallen to less than €1.28.

The exchange rate is influenced by a variety of factors and the European Central Bank’s recent acceleration of its quantitative easing programme is certainly responsible for part of the rise in the value in the euro. Equally though, the decision by David Cameron, the UK prime minister, to call the EU referendum has pushed the value of sterling down.

The forecast for UK growth has been cut to 2 percent from a 2.4 percent estimate by independent government department, the Office for Budget Responsibility. In anaemic European terms, that’s still not bad, but while the rest of Europe is in recovery mode, the UK is on a different path – politically and economically.

The referendum was well flagged. Cameron promised the ‘out’ camp in his party a vote before the last election. What most commentators, especially in financial and business sectors, did not see coming was the momentum of the Leave campaign.

Polls are close, but show those backing the ‘out’ campaign are ahead when undecideds are excluded – and the pro-exit side is more likely to get out and vote. 

Meanwhile, most business leaders are in favour of the status quo. Guaranteed access to the single market outweighs most other questions for the corporate world. But a combination of bad experiences and complacency has kept a lot of business and financial leaders quiet on the issue. Burned by taking sides in the Scottish independence referendum and comforted by a general belief among financial specialists that the UK would never vote against its own interests, business has not strongly backed the Remain campaign.

The biggest international banks have been making Brexit contingency plans for some time. Should UK voters choose to leave the European Union this summer, Deutsche Bank may withdraw staff, possibly to Germany, while Dublin is said to be the destination of choice for other international lenders (and PDI’s editor).

Private debt funds, on the other hand, seem content to wait and see, taking comfort from a London-centric view that people will be too afraid to vote to leave. Several of the managers PDI has raised the question of Brexit with have swept it aside, arguing either that it won’t happen or that they will not be affected.

There’s little doubt that the majority of people working in private equity are in favour of the UK remaining part of the EU. A poll by PDI’s sister title, Private Equity International, showed a majority of 75 percent were in favour of the UK remaining in the EU.

But most private debt providers now acknowledge that the Leave momentum is stronger than anticipated when it was merely an academic exercise. As one market player said of the vote: “It’s going to be a lot tighter than anyone thought.”

Are the unconcerned managers correct?

At around 60 percent of the market, the UK is still a major source of dealflow for non-bank lenders. A contingency plan that involves not lending in Britain just isn’t feasible.

More to the point, UK companies will still need finance after an EU exit, if anything, they could be more in need of it. So it’s pretty easy to string yourself a narrative that it doesn’t matter.

As long-lock structures – many of which are domiciled in Ireland, the Netherlands or other EU jurisdictions – and a global investor base, private debt funds have to be comfortable with cross-border structures. There are questions around how an exit would have an impact on their ability to fundraise in Europe, but those issues would likely be resolved gradually post-exit.

That said, while Brexit may not pose an immediate threat to their business models, debt managers should be more concerned, especially considering those most active on a pan-European basis are mainly headquartered in London. 

Any exit could seriously undermine the progress made by private debt in Europe.

How would a non-EU member Britain fit into the Capital Markets Union? It wouldn’t, at least not without agreeing to the kind of EU rules that the Leave campaign rails against.

The free movement of capital, without which modern market lending is unthinkable, is a core tenet of the EU. It’s not something they are obliged to extend to a non-member without some sacrifice on Britain’s part (cf. Norway and Switzerland).

Worse for private debt – and the continent as a whole – is the worry that the aftershocks of a British exit would include strengthened pushes towards the exit elsewhere.

The Netherlands – whose regulatory regime plays host to many alternative lenders – is high on that list. 

For now, though, European private debt will continue in its current state of limbo, wondering what kind of new world it will wake up to on 24 June.

A Brexit vote won’t stop alternative lenders working across borders, but the financial fall-out of a reset in the relationship between the UK and the EU could be calamitous for alternative lenders when it comes to access to the single market, free movement of capital and regulations governing funds. 

Consider, for example, Securus Group’s £25 million ($36 million; €32 million) unitranche deal with Muzinich & Co in February.

Muzinich, in common with many other direct lenders in Europe, is part of a wider US-headquartered group. It has offices and specific funds in each European country it focuses on (France, Italy and Spain).

Its unitranche for the UK security services firm was arranged alongside a £5 million revolving working capital facility provided by Royal Bank of Scotland. The £30 million package will refinance the company’s existing senior and mezzanine credit facilities as well as provide the firm with extra firepower for growth and acquisitions.

The £25 million unitranche is split between a £20 million six-year bullet loan and a £5 million accordion facility, which will allow the company to increase the loan should it wish to draw on extra capital. The new financing leaves Securus 4-5x levered.