Viewpoints

Op-Ed: Should fund boards pay attention to Brexit?

October 9, 2017

By Gerald Malone, Aberdeen Funds

Brexit: “A quarrel in a far-away country between people of whom we know nothing.”

 

Well, that was Neville Chamberlain’s view of Hitler’s land-grab of Czechoslovakia in 1938—and he was dead wrong. Brexit may not threaten the peace of nations, but it does have the potential to disrupt established trading arrangements, destabilize financial markets, provoke erratic currency fluctuations, and result in fundamental regulatory change, especially impacting financial services regulation.

 

In global markets there are no longer any countries “of which we know nothing.” So as Britain’s negotiations with the European Union about disengagement terms get under way, it’s time for U.S. mutual fund boards to recognize that Brexit is another risk to be added to their burgeoning Rolodex and kept under review as the shape of the eventual settlement emerges; this may stretch beyond the March 2019 deadline when the United Kingdom formally leaves the European Union.

 

First order of business: Brexit will not go away.

 

No Exit from Brexit

I’ve been surprised that in every U.S. webinar in which I’ve participated and seminar in which I’ve been involved, the first question inevitably is: “But surely down the road, the U.K. will see sense and the decision to leave the E.U. will be reversed?” This genie will not be returned to its lamp.

 

Firstly, other E.U. members—especially France and Germany—would not welcome the U.K. troublemaker back into their club. They already face problems with Poland and Hungary challenging E.U. authority on immigration, and reintroducing the U.K. as a powerful catalyst around which “dissenters” might group is anathema to Brussels dealmakers. When the U.K. walked out the door of its E.U. marriage, there was no going back. 

 

Secondly, although the vote to leave was narrow, in the U.K. there is now widespread acceptance—demonstrated in recent polling—that reversal is not an option, even among erstwhile “remainers” like me. The ridiculous posturing of E.U. grandees like E.U. President Jean-Claude Juncker (unelected) and Chief Brexit negotiator Michel Barnier (a member of the European Parliament) has, if anything, driven the middle ground of U.K. opinion into the “Brexit is inevitable” camp.

 

The E.U. may have a track record of browbeating member nations into holding repeat referendums until people come up with the right answer (viz., Ireland and the Lisbon Treaty), but that won’t happen with the U.K.

 

What are the Risks?

So, pre-occupied as U.S. mutual fund managers and directors may be by the familiar, evolving, domestic risk agenda, the constantly changing scenario in Europe will find them confronting fresh, unfamiliar hazards. Following the U.K.’s referendum vote, around 400 U.S. Securities and Exchange Commission-registered entities disclosed Brexit-related risk factors in their quarterly reports, as did at least 35 companies in registration statements with the SEC.

 

What makes the need for constant awareness imperative is that there is no “safe” roadmap to follow, and the daily unfolding of the ups and downs of negotiations will provoke turbulence—especially as negotiations move toward the nitty-gritty of future trade relations in 2018. Since the Brexit vote, a flight to safe haven markets, currency turbulence, and the increasing intervention of the European Central Bank as risk premiums rise have been the order of the day.

 

Already, “smart” predictions have been proved wrong. The consensus at the outset was that sterling would “tank.” But here is one of last month’s headlines: “Sterling RISES as Brexit fears calmed by economic data.” Traders who bet on “tanking” have had their fingers burnt, demonstrating that following the herd does not work here.

 

I have to own up to having a dog in this fight. I offer consultancy services to mutual fund managers and independent trustees/directors on monitoring the Brexit process. Wearing my other hat as an independent fund director, though, I think that as with any other observable risk, it’s a responsibility for boards to be regularly informed as the risks Brexit poses—or indeed the opportunities it provides—unfold in different ways. Keeping up to date, building a board record of due diligence in assessing the risks, and ensuring managers are on top of the situation are matters all fund directors will want to keep in mind.

 

Already a turf war is brewing about who can grab what slice of London’s markets, and fund boards should consider asking:

 

  • Who will run euro clearing?
  • Will there be passporting of investment products?
  • Do managers need to change their structure to comply with Brussels regulation and set up E.U. entities to continue to trade?

 

Readers with an appetite for detail might care to read a discussion paper on exchange-traded funds published by the Central Bank of Ireland in May. It’s a well-crafted opening shot in Ireland’s campaign to become the location of first resort for those who feel they may be prejudiced by potential Brexit outcomes.

 

Where are the Vulnerabilities?

Which sectors are most vulnerable to the risk of trade dislocation? The financial services industry is a front-runner. So, too, is the pharmaceutical industry. The E.U. pharma regulator, the European Medicines Agency (EMA), is based in London’s Canary Wharf and will surely move. But what’s not widely appreciated is that it operates on the basis of close links with the U.K.’s Medicines and Healthcare products Regulatory Agency (MHRA), which undertakes much of the regulatory “grunt work” for the EMA. Failure to secure a seamless transition of responsibilities could have significant temporary impact on pharma markets across the E.U. and the U.K., including the approval of new products.

 

European trade, including trade with Britain, is a complex web depending on highly regulated transport networks. “Hard” Brexit—simply leaving the E.U. and trading on World Trade Organization terms—begs the question about what happens to all those legacy E.U. arrangements. On the day after a hard Brexit, whose planes will be allowed to fly out of Heathrow, and where will they be allowed to land? You can bet that in the boardrooms of Amazon, DHL, and FedEx there’s a lot of head scratching going on.

 

No End in Sight

Theresa May’s government is negotiating from a weakened position following the May election debacle, which deprived her government of its majority. The debate in Britain now is whether she can survive a lame duck premiership, or will she be ousted in a backbench coup. Who would want her job?

 

My prediction is that she will stagger on—politically wounded—and the job of negotiating sensible Brexit terms will be harder as negotiators in Europe smell blood and toughen their negotiating stance. Mrs. May has already hinted at a two-year interim phase beyond the 2019 Brexit drop-dead date. This show is set to run and run.


Gerald Malone is the independent chairman of Aberdeen Funds and recently founded the consultancy brexRisk. A Scottish lawyer and former U.K. politician, he served as a Member of Parliament in both Margaret Thatcher’s and John Major’s governments and was deputy chairman of the U.K.’s Conservative Party from 1992 to 1994.