As the June 23 referendum to decide the UK’s future relationship with the European Union approaches, the potential for a close vote is forcing businesses to consider a range of potential scenarios.
With just over a month to go, until Britain’s voters decide in the June 23 referendum whether the country’s future lies within or outside the European Union (EU), campaigning is heating up. As the decision hangs in the balance, with polls indicating a close result, businesses are battling through a period of uncertainty. What can they do to mitigate the risks associated with the in/out vote?
Unsurprisingly, sterling has been significantly impacted by the looming referendum – particularly as a so-called ‘Brexit’ has started to become a very real possibility. Following the tragic attacks on Paris in November, the polling agency ORB International reported last month that sentiment had swung in favour of an ‘out’ vote for the first time to-date, with 52% of Britons canvassed who definitely intend to go to the polls claiming they would support leaving the EU.
The reaction in the markets may provide some indication of the response in the event of a Brexit – sterling dropped by up to 10% against the US dollar and 16% against the euro between December 2015 and March. The decline, which continued until late March, was such that had not been experienced since 2008, following the Lehman Brothers collapse and the subsequent financial crisis. Thankfully the pound has since recovered some ground; however many fear that the recovery would not be so rapid in reality should the ‘Leave’ campaign convince enough voters.
In the event of a Brexit, it is widely held that there are three basic potential outcomes:
The good: In the ‘best case’ scenario of a Brexit, the UK would maintain most of its trade agreements with the EU, without having to abide by EU regulation – leaving the UK free to set its own agreements with other countries such as China and the US. To top off this perfect picture of UK’s future, we would experience a stabilised pound.
The bad: While the Utopian image in the ‘best case’ scenario might be appealing, it seems far more likely that the transition would prove more of a bumpy ride in the event of a Brexit. The EU seems unlikely to let the UK both have its cake and eat it. Discussions around new deals will be long and drawn out, creating a further period of uncertainty. In this scenario, we would expect to see sterling drop sharply against other key currencies.
The ugly: In the ‘worst case’ scenario, the break from the EU would be disastrous. If the EU decided to restrict access to the region’s markets UK exports would suffer massively, leading to lower potential economic growth and widening the trade deficit. The pound would take a significant hit should post-referendum negotiations between the UK and EU turn nasty.
But what if it’s an ‘in’ vote?
Even if the UK electorate opts to remain in the EU, corporations could find themselves suffering from the impact of pound volatility.
If Brits vote to remain in the EU, the pound could appreciate quickly – as speculators close their short pound positions – and the currency could rise by 6% to 10%. Exporters could also feel the strain when they convert international profits back to the pound and suffer an unfavourable exchange rate.
In the event of a Brexit and a difficult transition, which sends the pound’s value plummeting, businesses with branches in foreign countries will experience rising costs when paying staff salaries and for office space overseas. A sharp decline by the pound might also force UK businesses to downsize or even close, if their costs on foreign currency experience a 20% increase.
To avoid this, risk management techniques must be put into place, with input from the entire C-level team: this is a strategic business decision, which should take into account the company’s exposure, margins, profitability and risk tolerance. The CFO must put tools in place to review live market rates in real-time and to inform the team of when to hedge against this FX risk.
Those who are benefitting from the pound’s weak position at present would be wise to hedge, as a short, sharp sterling recovery might hurt their profit margins.
We can’t be sure of which way the vote will swing on June 23 and it is precisely this uncertainty that the markets struggle to tolerate. Companies with international operations would be wise to prepare for their individual worst case scenario and follow their own strategic FX plan. In the absence of a crystal ball, this is their best opportunity to ensure stability – whichever way the vote swings.
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