A vote to exit would likely hurt business sentiment and investment immediately. The big problem is the uncertainty surrounding the United Kingdom’s commercial relationship with the EU. The U.K. is the center of Europe’s financial system, but the regulatory treatment of its financial operations on the continent may change. The uncertainty surrounding this new relationship could take years to sort out.
If the “leave” camp were to win, certainly the foreign exchange markets would be in turmoil, with the pound probably making new lows below 1.39 against the dollar and the euro would follow lower as well. Stocks also would be under considerable pressure as investors try to figure out the effects on trade and the resultant hit to economic growth. There would most certainly be a flight to quality across the bond markets globally, driving 10 year interest rates for Germany and Japan into further negative territory. The yield on the 10 year U.S. Treasury note would most probably drop below 1.5 percent. And gold would continue its recent surge.
At a recent AFP Treasury Advisory Group meeting where the Brexit was discussed, one treasurer of a large global private equity firm noted that her primary concern is currency volatility that will undoubtedly continue if the U.K. leaves the Eurozone. To further prepare for a Brexit, treasurers should work diligently to fully understand their companies’ cash position, gain an even better understanding of the facilities utilized, and gather all the facts together before it happens. Post-Brexit, cash flows from export and import activities could be interrupted and they would certainly be more volatile as a result.
Consequently, companies might face short-term liquidity problems especially shortly after the Brexit negotiations start. While liquidity was king during the financial crisis, it remains so today as evidenced by many studies conducted by AFP. Treasurers also should review whether financial contracts with different counterparties would be affected by Brexit. Treasury should create a liquidity and risk management strategy and be able to point the risks out to the CFO and the board.
To help on the currency hedging front, check out the CTC Executive Perspective, “Five Ways Treasurers Can Protect Earnings from FX Swings.”
Whatever the result, questions will likely cloud the U.K. outlook for the time being. Even if the U.K. does choose to stay, domestic politics is likely to remain challenging, and markets will be looking to ascertain whether the referendum-related slowdown in the first half of the year is something more permanent.
Craig Martin is Executive Director, Corporate Treasurers Council.