Following the Conservative party’s pledge in its last general election manifesto, the UK will decide whether to stay in the European Union in a referendum on 23 June. The forthcoming vote is causing huge divisions even within political parties, with David Cameron and Boris Johnson key figures on opposing sides of the debate. Domestic, European and global markets are all bracing themselves, and political posturing will only increase over the coming weeks as the possibility of the UK becoming the first country to leave the EU looms ever larger.
The impact on the future economy, although uncertain, is likely to be enormous. Those who want to exit argue the decision is about freedom and democracy – to regain control of UK borders and funnel the cost of membership (estimated at £8.5bn net in 2015, according to a House of Commons briefing paper) to more beneficial ventures. But those in the ‘stay’ camp suggest that any vote to leave is merely grounded in nostalgia and that the sensible outcome is to retain our relationship with the continent.
But what impact should the nation’s decision have on the financial services industry and markets in the long and short-term?
Hard or soft?
“There is widespread support for an exit among Conservative MPs, many of whom would prefer that the UK jumped into a time machine and went back 150 years,” says Tim Stevenson, director of European specialist equities at Henderson, who adds that an exit could have a detrimental effect on the UK economy. “There is a very real risk that the UK could vote to leave, in which case the UK economy would undoubtedly suffer,” he says.
“The outs maintain that a short transition will ensue, before the UK economy returns to sunnier climes. However, the uncertainty caused may hinder any signs of real progress for markets for the time being,” he adds.
Ed Smith, asset allocation strategist at Rathbones, feels the future impact could depend on the manner of departure. He says, “The economic and financial implications are much more finely balanced and multi-faceted than the campaign rhetoric would imply. The long-term consequences depend on the terms – will it be soft, where we come out of the EU but retain access to the single market? Or will it be hard, where we cede all special terms of access?”
Investment markets throughout the first few months of 2016 have been extremely volatile. After breaking through the 7,000 points barrier in May 2015, the FTSE 100 plummeted to under 5,500 points in February 2016, as global economic uncertainty grew. The market rebounded to over 6,400 points in April 2016 but has since dropped back further with the exit vote looming.
John Bennett, head of European equities at Henderson, says that a leave vote that results in panic could weaken sterling, but he is optimistic about the opportunities this could present for investment. “This would be helpful in a world that is threatened by deflation. In this situation we would turn our attention to the potential beneficiaries of that currency weakness. For example, I would expect some immediate stock-specific opportunities within UK exporters,” Mr Bennett says.
Regulation
EU directives are deeply ingrained in UK financial services regulations. The Undertakings for Collective Investments in Transferable Securities Benefits (Ucits) was introduced in December 1985 and is still in force today after further amendments, in particular Ucits IV in 2009. The directive provides fund managers with a ‘European Passport’ to enable collective investment vehicles to be marketed at retail investors across the EU.
The Markets in Financial Instruments Directive (Mifid) was applied in the UK from November 2007 and aimed to integrate the EU’s financial markets and stimulate cross-border investment. Further amendments to this, known as Mifid II, must be adapted by EU members in domestic laws by 3 July 2016.
Michael McLintock, independent financial adviser at Adelp Financial Solutions in Lanark, says these regulations could be tailored if the UK were to leave. “It’s more likely to be adapted than disappear altogether,” he says. “The good thing is that it might be more adapted to the way British financial services work rather than being a broad-brush approach across the whole continent.”
According to Dean Mullaly, managing director at London-based Mark Dean Wealth Management, UK advisers could lose passporting rights and have to apply to each individual country where they wanted to give advice. He adds the terms of exit are also more complicated than a clean severance. “We wouldn’t actually get a seat at the negotiating table for how we pull out,” he says. “That would all be done by Europe, so the old saying ‘keep your friends close but keep your enemies closer’ – it’s a bit like that.”
For non-Ucits investments such as hedge funds, the Alternative Investment Fund Managers Directive (AIFMD), ensures that a single fund manager is responsible for compliance. This contains an anti-letterbox provision, which prevents an Alternative Investment Fund Manager (AIFM) from delegating investment management functions to an extent that exceeds “by a substantial margin” those it retains. Therefore it can no longer be considered to be the manager of the alternative investment fund. Mr Smith does not see this as an issue for buying European investments, but the cost of passporting into these regimes is likely to increase. “It’s got to be more than just a letterbox on the Boulevard Royale,” he says.
Opportunity
The future of UK financial services would be hugely uncertain in the event of a vote to leave. According to research by Rathbones, between 2010 and 2014, financial services dominated the UK’s inward investment flows. They represent 27 per cent of the total stock of foreign investment and 42 per cent of the inward flow over the past five years. The next highest source, ‘professional, scientific and technical services’, generated only 16 per cent.
Mr Smith says because of this, the financial services industry is rife with risks that would increase by leaving. “It does seem to be more and more difficult to do business in Europe from outside of its borders and [this] is only likely to intensify.” However, he adds that this may open up opportunities to transact business globally that could prove highly beneficial for the UK. “We have historic and currently good ties to Asian financial centres such as Shanghai and Hong-Kong,” he says. “If we are free to capitalise and strengthen those ties by being unshackled by the EU’s trade treaties, then the financial services industry could be better off.”
