Could Brexit uncertainty make it harder to borrow? Joe Cassidy explains why funding to the real economy may be fragile.
Ten years after its fall, what lessons does Lehman Brothers offer businesses as they seek to manage Brexit? On the face of it they are contrasting cases with very different roots. Yet they share one clear similarity: in 2018 – as in 2008 – businesses are having to manage significant risks generated by huge levels of uncertainty. A key question is therefore whether uncertainty created by Brexit will squeeze funding to the real economy, just as it did a decade ago.
We are likely to be living with this uncertainty for some time. The EU’s rejection of key parts of the prime minister’s Chequers plan in Salzburg on Thursday only served to underline that point and looking at the complexity and hurdles still to overcome, I don’t think we will see a deal this side of Christmas. Investors and businesses across all sectors want clarity from the EU summit in late October, but I think that’s a long shot.
Working for a global bank back in 2008, I remember there were two things that gave us some comfort as the world changed around us. The first was the collateral we held to secure risks taken with counterparties. The second was knowing that our contracts were written under English law, with its familiarity, inherent certainty and relative ease of enforcement. These two comforts – plus the fact that we had secured alternative sources of funding early – helped us emerge from that period stronger than some of our competitors.
Are we about to go ‘risk off’?
A decade later my team are I are again assessing the threats to funding and contractual and certainty around counterparties. Rather than trying to predict the outcome of political negotiations and speculating on the chances of ‘no deal’ or ‘cliff edge’, our focus is on how businesses can emerge from inevitable market volatility in a solvent state and ready to take advantage of opportunities as they appear.
If I’m right, I can see this uncertainty starting to weigh on investors’ risk appetite for cross border financing. A risk premium could emerge, with higher haircuts, wider spreads and shorter durations on bonds and other forms of lending, as banks and other institutions start to consider the full impact that “no deal” would have on business models, market access, contract certainty and the cost of doing business.
This lack of appetite would then be compounded by the traditional ‘risk on-risk off’ cycle: the way in which investors normally start reducing their risk appetite around Thanksgiving and tapering towards Christmas and year end – before coming back into the market in early January.
If we haven’t had a deal by the New Year, and we’ve still got no contract certainty on existing financing and funding structures, then we start to ask ourselves: who will write new cross border business in this area?
What can you do about it?
There are several things we need to see to avert this risk to the economy.
A certain amount of good housekeeping needs to take place. Banks need to look at their relationships with counterparties; asset managers need to examine their contracts; and pension fund managers need to model access to liquidity.
But this is clearly not only a challenge for financial services – it’s also one for corporates and the real economy. Good housekeeping therefore is about looking at the more immediate time frame of the next nine months and looking at:
These actions, along with clear understanding of our dependency on others in the supply chain (in its broadest sense), and their state of readiness, offer some comfort that we have done what we can.
We cannot predict right now how and where we will land, but we can at least ensure that we will survive the journey, and emerge into the post-Brexit landscape, solvent.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK. You can register for the email subscription list of this column and expert views from our Brexit leaders.