Europeans Selling UK Exposure Ahead of Brexit Vote

Shanny Basar

Spreads for some UK issuers of euro-denominated bonds have widened considerably since confirmation of the date of the Brexit referendum according to Franklin Templeton.

The UK will vote on “Brexit”, whether to leave the European Union, on June 23.

David Zahn, head of European fixed income at Franklin Templeton Fixed Income Group, said in a note: “Since UK Prime Minister David Cameron confirmed the date of the referendum, markets have experienced some volatility focused on UK-specific assets; spreads for some UK issuers of euro-denominated bonds have widened considerably for no apparent reason, which suggests to us that a lot of Europeans are selling their UK exposure.”

Zahn added he was surprised that investors in Continental Europe think the referendum result will only affect the UK.

“We at Franklin Templeton Fixed Income Group think they’re mistaken and that Brexit has significant implications for investment markets in Europe as a whole,” he said. “Moreover, we think the possibility of a vote to leave is underpriced in the market currently.”

As the referendum draws closer, Zahn expects volatility to accelerate and to encompass other European assets, coming to a crescendo the day after the Brexit vote. If the UK votes to stay in the EU, markets will calm down quite quickly and the subsequently rally could lead to some good opportunities to realise value.

“If there is a vote to leave, there should still be some opportunities, but we’d anticipate that there would be more volatility for longer in the wider European market as well as in the UK,” Zahn added. “We’d expect peripheral bonds to sell off quite considerably and anticipate questions about whether Brexit sets a precedent for other countries to consider their future in the EU.”

George Evans, chief investment officer, equities at Oppenheimer Funds, said in a note that Brexit is unlikely. However if the referendum results in a vote to leave the EU then Scotland would likely leave the UK and Northern Ireland would suffer as intra-island trade and labor movement became more cumbersome.

“The pound would likely weaken,” added Evans. “Growth would slow in England and probably other parts of Europe as well, as everyone digests the implications of the change and makes adjustments.”

Evans said that if Brexit does happen, short-term negative sentiment will provide Oppenheimer Funds the opportunity to buy stock in companies at prices the company will be more than happy to pay.

The BlackRock Investment Institute said in a report this week that Brexit offers a lot of risk with little obvious reward.

“We see an EU exit leading to lower UK growth and investment, and potentially higher unemployment and inflation. Any offsetting benefits look more amorphous and less certain, in our view,” added BlackRock.

The fund manager expects volatility in UK and European assets to rise ahead of the referendum.

“Sterling is most vulnerable to Brexit fears as it is the most liquid UK financial asset,” said BlackRock. “A Brexit could pressure the UK’s budget and current account deficits, hurting the currency and potentially triggering credit downgrades. Conversely, we see depressed sterling bouncing back if the UK votes to stay.”

A leave vote is likely increase gilt yields and cut portfolio inflows, pressuring domestic sources of funding for the budget deficit as bank funding costs rise and credit spreads widen.

“The Bank of England would likely cut rates in such a scenario or revive quantitative easing, looking past any temporary rise in inflation caused by a weaker currency, we believe,” added BlackRock.

Brexit would also deal a blow to domestically focussed UK equities and poses risks to the London property market as at least some corporate office demand is based on access to the EU’s single market.

BlackRock said: “Brexit would cut into the financial industry’s outsized contributions to the UK economy, tax revenues and trade balance, we believe, and offset apparent fiscal gains from leaving the EU. We could see the EU pushing hard to harmonise standards for financial services and capital markets – to the detriment of a UK financial industry dependent on single market access.”

The report added that financial services paid £66.5bn (€93bn) in taxes, or 11% of government tax receipts in fiscal 2015 according to a PwC report, including employment taxes of £30bn for 1.1 million workers.

“This adds up to some £27,300 per person. Suppose 10% of these workers lost their jobs after a Brexit? This could cost the government up to £3bn in annual employment taxes alone – especially if higher-paid workers bore the brunt, we calculate,” said BlackRock.

In asset management the UK has a 50% share of the European market, which is contingent on the ability to do business across the continent, as regulations such as Ucits directive and the Alternative Investment Fund Managers Directive allow distribution across the EU.

“To maintain their Ucits or AIF status, UK-based funds might have to move to a European Economic Area jurisdiction,” said BlackRock. “This would likely be a taxable event for investors – a high price to pay.”

In addition the Ucits and AIFMD regimes are recognised in Asia and Latin America so Brexit would also affect global distribution.

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