Corporate finance revenues after Brexit - what will change?

The possible corporate finance financial landscapes after Brexit are just beginning to appear. They were predictable enough, but few seem to have seen it this way. Perhaps because more than 20% of Europe’s 500 largest companies currently have their headquarters in London, where Mayor Sadiq Khan has described a hard Brexit as ‘economic self-sabotage’.

In his view, if the UK does not get full access to the Single European Market by the time of Brexit, assuming there is no postponement, some finance jobs at least are bound to shift to Frankfurt, Dublin and even Paris.

Perhaps not as many as the 35,000 jobs in the financial services sector overall and 17,000 medium term job losses in the wholesale banking area that Oliver Wyman have suggested, but extra required capital of up to €40bn and annual costs of €1bn could cut ROE by up to 2% and push business not just out of the UK, but out of the EU altogether.

Assessing the potential of changes in the market

The problem in assessing the viability of these claims is that there are few reliable studies of the relationship between trade structure and trends on the one hand, and corporate finance activity on the other. What little evidence there is suggests that trade flows, both by country and sector, are a good predictor of M&A activity.  Intuitively, a decline in trade should at least foreshadow or reflect a downturn in general economic activity.

But although EU membership is estimated to have boosted British goods trade with other member states by 55%, there is nothing to suggest that UK trade, and therefore deals, cannot adapt to a lower percentage of exports to and imports from the EU, exactly as happened in reverse after EU entry.

If previous studies are right, we can expect more US, Chinese and Indian trade with the UK, and with them, deals. Europe, on the other hand, is almost certain to turn in on itself, with companies such as Deutsche Telekom and Deutsche Bank already writing down profits, a larger percentage of even German trade flowing to its EU partners, European companies such as the merged chemicals groups Linde and Praxair and Austrian manufacturer RHI rejecting the UK as an HQ or listings location, the failure of deals such as the proposed merger between the London Stock Exchange and Deutsche Boerse, and more inter-EU cross-border transactions as a result.

Finance Training shows the UK losers, too: the real estate sector is another potential loser: there have already been significant falls, albeit from a level that many thought overheated, and investors have even been blocked from cash withdrawals, and airlines, importers and companies with substantial European exposure have all seen valuation falls, liquidity constraints and credit curbs.

UK competitiveness after Brexit

The UK’s competitive position must not, however, be seen exclusively in a European context. The evidence is already mounting, in fact, that deals are being done despite Brexit. Private equity deals are holding up well in the seller’s market that the UK currently represents, which took €5.8bn of Q3 3 PE investment within EMEA, 31% of the total. The predictions by Europe Economics and Oxford Economics, amongst others, that the UK M&A market – and business sentiment generally - would be significantly adversely affected in the short term at least by the uncertainty surrounding a Brexit trade deal has proved illusory. This is for two again quite predictable reasons.

First, because the fall in sterling has made UK assets cheaper for overseas investors, whether technology companies such as ARM Holdings, acquired last year by Japan’s SoftBank or Worldpay Group, being bought by US group Vantiv in a £9.3billion deal, or agribusiness Weetabix, bought by US simulacrum Postholdings this year for £1.4bn. These deals are also being driven by the second positive factor, that they are not primarily focused on EU exports and moreover, even WTO rules would not prevent them from generating at least some European sales, albeit with lower ROEs, at least in 2018. Overall, FTSE 100 companies have beaten the profit forecasts analysts made before the referendum last year, consistently with the optimism expressed by manufacturers such as Dyson and distributors based in the UK, above all Amazon which has continued to put money into UK facilities.

Second, the UK will retain a number of key advantages. One of them is tax. If the EU fixes its €10bn annual budget hole both by harmonising and by raising taxes, whether sales tax levies, customs duties, new energy or environmental taxes such as ETS revenues, or transfers from national budgets, rather than relaxing already stretched borrowing criteria, then the UK’s relatively lower corporate tax rate will stand out and European corporates’ profit levels will fall quite significantly.  

Unless Scottish independence is placed back on the political agenda, which seems unlikely at least in the short term, these arguments apply to all UK assets. It would not be wise to jump to Brexit conclusions about Scotland’s recent prime place amongst transactions, however, as Macquaries European Infrastructure Fund 5 LP and others acquisition of Edinburgh based UK Green Investment Bank for €2bn was a single deal that dominated transactions. Nor on the basis of a single year should we be convinced that financials will continue to dominate deals, but the finance sector will remain the largest source of UK corporate tax revenue for the foreeseable future, FinTech is growing in importance everywhere and the steady rise in regional financial centres such as Bristol and Manchester is a much longer and more reliable trend.  A second is legal structure. English law is frequently chosen as the governing law for international transactions, and it will now develop separately from EU law, to the disadvantage of the EU. And third, regulation.

The UK is already looking at loosening a range of regulations after Brexit, all to the benefit of investors and corporates. There is already a whiff of Dubai about post-Brexit Britain, and deal structures are beginning to reflect it already.

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