Are we looking forward to 2017 or just to put 2016 behind us?
By Bruce Stephen
Posted: 20th January 2017 08:15
Are we looking forward to 2017 or just to put 2016 behind us? Activity levels in H2 of 2016 have increased, including US and Chinese M&A investment activity in Scotland (in deals such the acquisition of Skyscanner), showing that there are deals to be done. The Brexit effect, at least to date, appears to have been short-lived with the weakness of sterling allowing foreign investors to pick up a bargain. The underlying businesses must, of course, be strong and we have been involved in some interesting deals in the last six months in particular.
With changes to Chinese rules on foreign investment, there may be fewer instances of investment in UK assets. However, the strengthening of the dollar following Donald Trump’s victory and tightening of monetary policy in the US with the Fed having increased rates to 0.75% in December (with further, more gradual increases, anticipated) means that it is likely that sterling-valued assets will be looking attractive to outside investors whether or not we are part of the EU.
There is, of course, no question that Brexit has affected some investment decisions but given the time that it is likely to take for Britain to leave the EU many clients have to date decided to take a longer term view and are continuing the ‘business as usual’ approach. There appears to have been a softening from the hard Brexit stance, with certain politicians (including Dr Liam Fox, Secretary of State for International Trade, and David Davis, Secretary of State for Exiting the European Union) testing the public’s appetite for paying for access to the European market (with Boris Johnson, the Foreign Secretary, of course indicating we can pay, but not too much). This may be good news from a financial services perspective if it leads to a Brexit outcome that maintains access to the Single Market and preserves passporting arrangements for financial services firms operating in EU countries and regulated in the UK.
The cost of finance in 2017 is likely to increase. Underlying rates may need to increase to cover additional costs of funds for banks, particularly with increased regulatory requirements around first loss capital and MREL (minimum own funds and eligible liabilities) funding. This is likely to have a knock-on effect on market interest rates and although the Bank of England is predicting a lower inflation figure for 2017, the impact of a rapidly-expanding US economy may feed through to an increase in Bank of England repo rate. Margins may also increase from their current level over the coming months as funders look for return. Rates are relatively low in historic terms but even small increases in the current rates will have a significant impact on debt service costs.
Traditional sources of finance continue, with the UK relying predominantly on bank debt. However, we have seen a marked increase in funds activity in 2016, with funds financings showing a significant jump since the summer. Capital market funding has continued to be important to certain sectors in Scotland, in particular the securitisation of loan book interests or local authorities meeting the financing requirements for capital projects such as the recent landmark £370 million listed bond issue by Aberdeen City Council to finance part of its £1 billion capital expenditure programme, on which Brodies advised.
Predictions for 2017
- Article 50 notification debated in the UK Parliament before notice is given to the European Commission in March 2017. We expect a huge amount of media coverage around this time. Activity levels may be affected, although much will depend upon the likely mood or anticipated outcome of the Brexit discussions.
- A Brexit agreement that maintains access to the single market should be easier to negotiate than multiple trade deals with different countries, with the magnitude of the latter task having become increasingly apparent. UK access to the European Economic Area for goods and services would require compliance or at least equivalence to certain EU legislation and requirements. Key negotiating points will be the price of access and which provisions need to maintain equivalence to ensure financial services passporting is maintained. The free movement of people, one of the four pillars on which the Single Market stands, may require some compromises, again this is an area for discussion. Politically the immigration question for some in Government appears to be one of ‘control’ rather than restrictions. With a customs union, the requirement (and ability) to negotiate independent trade deals with the rest of the world will be restricted.
- There will be lot of politicking around Brexit in each of the general elections in German, French and Netherlands.
- The full impact of the US presidential result has yet to be seen. Market sentiment suggests a period of strong growth for the US economy, partly fuelled by significant public spending on infrastructure projects in the US.
- Certain areas of the UK economy should hold up well against some of the turbulence associated with the Brexit negotiations. [Highlight some in Scotland in particular]
- With the cost of finance potentially increasing in 2017, it is worth considering funding deals that take your business through the medium term. It is also advisable to consider putting in place appropriate risk mitigation in relation to interest rates, exchange rates and, for some, commodity hedging.
So are we looking forward to 2017 or just to put 2016 behind us? Although there are plenty of challenges ahead in 2017, some of the events of 2016 have the potential to create opportunities for the year ahead. Some action can be taken now to ensure a stable footing and a better understanding of the moving political landscape around Brexit will assist in deciding whether to take advantage of those opportunities.
Bruce Stephen is a Head of Banking & Finance at Brodies LLP, Scotland’s premier corporate and commercial law firm. With over 20 years’ experience in banking and finance, Bruce is a recognised expert in the UK legal directories and is a member of the Brodies Brexit Advisory Group, helping clients deal with the implications of Brexit for their business.
Bruce can be contacted on +44 (0)131 656 0260 or by email email@example.com