So what is next?
Imagine the following scenarios:
An exchange rate loss of 5-10% for the British pound, several interest rate hikes by the Bank of England, a change in the reporting process for derivatives, an abrupt change in the core banking strategy, and more. All these scenarios may turn into reality as a result of the UK's unsmooth withdrawal from the European Union. In particular, recent negotiations have been fraught with uncertainty, and at the time of writing this article, it was still completely unclear whether, how and when Brexit will be implemented and what the specific consequences will be. There are two possible scenarios: either a hard Brexit on the 29th of March or a possible extension of the deadline with the hope of clearing up all outstanding issues between the EU and the UK.
But what does Brexit mean for treasurers in particular? What are the implications on the way treasurers do business? How will business relationships be affected?
While far from easy questions, they certainly touch upon some of the issues that treasurers need to consider in order to be prepared for the future. In this article we would like to discuss some of the issues relevant to your treasury.
Financing is one of treasury's core functions. Due to its complexity, financing also has an impact on many other treasury areas, such as cash and liquidity management, foreign exchange and interest rate management or bank relationship management. Financing is often used to meet liquidity needs and is provided either by banks or by capital markets. Both would be severely affected by a no-deal Brexit. This could put treasurers in an undesirable situation where they have a liquidity deficit that cannot be covered. And since we have often seen profitable companies go bankrupt due to liquidity problems, avoiding this situation should be paramount for all treasurers. The following questions can help avoid this situation:
Although it is impossible to provide a one size fits all answer to all of these questions, the following points should nevertheless be considered when searching for a solution:
The company's capital structure in terms of debt, equity and credit portfolios and underlying currencies must be analyzed appropriately. For instance, a situation could arise where the Bank of England and the European Central Bank take two opposing approaches on interest rates, which could then have a significant shock on liquidity, interest expenses and credit prices.
In addition to evaluating the company’s financing and its sources, there should also be a thorough assessment of the usual external providers of financing: the banks. This leads us to Bank Relationship Management.
Brexit will affect banks in a very similar way to companies, which means that banks may also have to change their strategic direction and risk appetite. In such a situation, they tend to re-evaluate their current customer base, much like treasurers could re-evaluate their banks.
In this situation, treasurers may want to ask the following questions:
The following two externally driven questions as a result of a changed banking strategy are also important:
For treasurers, this may mean unwanted changes in business activities and have implications on the company's core banking strategy.
Treasurers can try to counteract legal uncertainty and ambiguity by shifting business from UK banks to continental banks. Before doing that, however, there are specific points that treasurers should consider first:
And last but not least, transferring existing derivative transactions from the UK to continental banks could have undesirable accounting effects. According to IFRS 9, a change of bank means a significant change in business parameters and thus the derecognition of the previous transaction and the recognition of a new transaction. For this reason, the existing hedge accounting would have to be terminated and a new hedging relationship should be designated. This can only be avoided by relocating to a branch of the UK bank which has the same credit risk as the London head office.
Just as banks evaluate their customer base and risk appetite, companies and treasurers must also evaluate their counterparty risk. This is because a changing economic environment may affect creditworthiness. Some investments previously considered attractive will now become riskier and may no longer meet the company's risk policy. The main questions that need to be asked here are therefore:
Treasurers can counteract this in several ways. When assessing the approach, the following aspects should be taken into account:
Brexit will also lead to changes in the regulatory environment, such as in the reporting process for derivatives. The European commercial register Regis-TR has already announced the introduction of a new UK commercial register, which will also serve British companies.
As of today, it is expected that a separate UK register will exist as of the 1st of April 2019. For self-reporting entities, however, this initially only means that the counterparty must be stated as "non-EU" so that the register does not attempt a reconciliation.
The following must therefore be observed:
With a variety of instruments that can be used to hedge risk, the main question should be here:
Many companies use forwards because they do not require premium payments. Options, on the other hand, are a good way to protect against downturns, but given their higher volatility, the cost could be significant. One strategy could be to identify the worst exchange rate your company is willing to accept and then set the strike price accordingly.
Cash managers need to examine the impact of Brexit on their business. As many companies have cross-border activities, this is where international cash management comes in. One of the main questions cash managers need to ask themselves in this context is:
When answering this question the following should be considered:
Whether a hard Brexit or an extension takes place, you should be prepared. Ideally, you should have started and maybe already completed preparations for many possible scenarios, including a "No-Deal Brexit". Are you ready to face a no-deal Brexit scenario? One thing that is clear is that the Brexit will not end on the 29th of March. You should be prepared for a long and complex process.
Source: KPMG Corporate Treasury News, Edition 89, March 2019
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