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Capital Investment Paralysis Is The Main Brexit Risk For European And U.K. Corporates

With Britain’s EU membership referendum approaching, S&P Global Ratings recently published an article offering a detailed analysis of near-term and the long-term consequences of a potential Brexit on U.K. and European corporates.

The immediate impact of the U.K’s decision to leave the EU, will lead to a spike in inflation owing to the devaluation of the currency. Shorter term challenges relate mostly to the dislocation that would be caused by increased financial market volatility, including a potential sharp depreciation of the British pound sterling. This could result from the lack of any blueprint as to how in practical terms the U.K. could transition smoothly out of the EU, and would not be helped by the almost inevitable sovereign downgrade that would result.

This could hurt Britain’s consumer-confidence, thereby having an adverse impact on highly cyclical sectors such as airlines and other U.K.-based tourism companies. In addition, capital markets would experience volatility and demand for U.K. assets will remain muted until greater clarity about the exit-settlement emerges. In the midst of the prevailing uncertainty, sterling issuance has dried-up, while lately new-issue premiums paid by U.K. issuers has risen.

In the long-term, the biggest impact would be felt in capital-investment flows – both domestic and foreign direct investment. This could mark a significant break from the past, as the U.K. has historically been one of the world's largest beneficiaries of FDI. The table below lists the industries according to the degree of impact from a reduction in investment.

Relative Medium-Term Reduction in Capex Investment Impact

The report also discusses some industry-specific problems that could arise if the U.K. leaves EU.

  • The U.K. and EU are closely linked in traded goods such as motor vehicles, machinery, commodities, and many food products. For U.K.-based food retailers, a Brexit could push companies to source more local produce. Nevertheless, the large companies in this sector already have a renewed focus on supporting local farmers and suppliers, and therefore don't see this as an insurmountable problem. As for EU-based consumer product suppliers to U.K. retailers, the cost bases for these companies are all in Europe. One of these companies, Belgium-based hygienic disposables manufacturer Ontex, which also produces generic products for U.K. retailers, has fixed prices and fixed contracts. Should Britain leave the EU, these contracts may need to be renegotiated, so they have told us that the longer-term impact is difficult to quantify.
  • Telecommunications is one example in which regulatory policy in the event of a Brexit could affect M&A: there is a significant difference between the U.K. and European regulators' views regarding further consolidation, which the telecom industry has pursued to moderate competition and reduce costs.
  • For European low-cost airlines, U.K.-headquartered easyJet PLC has joined Ireland-headquartered Ryanair Holdings PLC in its public support of the Remain campaign, warning that a Brexit would likely have a materially adverse effect on their operating and financial performance. They say that consumers have benefited from EU membership through deregulation, lower prices, and route expansions, and that the U.K.'s access to the single market has been a key factor in the rise of low-cost carriers.

Swiss corporate sector and a few Norwegian firms offer examples of companies that are able to thrive on the European and the global scene while their head office is located outside the EU. Though the event of U.K. leaving the EU will be largely detrimental for Britain’s economy, the report says many industries, however, would likely be more insulated from much of the disruption, either due to their lower capital intensity--such as media and business services companies, technology, and forest products and packaging--or to their very local and regulated nature, such as U.K. bus and rail. We believe even affected industries could also have the capacity to adapt, or even benefit, over time.

These reports and more are available via S&P Global Market Intelligence’s RatingsDirect®, the official web-based source for access to credit ratings and research from S&P Global Ratings.

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Aug 09, 2016