The situation today
The UK private equity industry is the largest in Europe and an important component of the UK’s financial services sector. Like banks and other asset managers, most PE firms maintain their European HQ (or else a significant presence) in London. The firms’ UK regulatory authorisations are valid across the EEA and they can also access ‘passporting’ rights under MiFID and AIFMD to market their funds and services on a cross-border basis, rather than under 31 separate regulatory regimes. Those same directives (and assorted other EU laws) also impose a growing welter of compliance obligations on them. All of this and more will be up in the air if Britain votes on June 23 to leave the EU.
Loss of passporting rights
To begin with, nothing would officially change, because EU law mandates a two-year transition period after a country serves notice to quit. But at the end of those two years, unless an extension is agreed, the UK would automatically cease to be a member and would tumble out of the single market.
UK-based firms’ MiFID and AIFMD passports would then be void and they would require a new EU operational base in order to obtain passports for cross-border services. Similarly, EU firms would need a UK base to deal with UK clients. It would become more costly in resources and time for firms to set up, staff and operate parallel establishments in the UK and EU. Moreover, many foreign firms pick the UK as their ‘home state’ in the EU for AIFMD purposes, because the FCA is internationally respected and widely believed to be fairer and more accommodating than other regulators. Those firms would now have to relocate back into the EU.
British access to the European single market may be restored on a “third country” basis if it is granted ‘equivalence’. Since its current regime is EU-compliant, one would think this would not be contentious. But third country delays are common; the AIFMD third country regime isn’t even operational yet.
International trade politics could also get in the way. Granting equivalence would likely get bound up in a new UK/EU trade deal covering at least financial services. The timing, scope and details of a deal are inherently uncertain. Indeed, some member states may seize the opportunity to take a bite out of the City’s lunch by blocking a deal on equivalence. Nor is equivalence fixed – Britain would have to keep up to date with evolving EU legislation in order to maintain equivalence, but it would no longer have a vote. Without Britain’s free-market advocacy inside the tent, the EU rulebook could acquire a more dirigiste flavour over time.
A new deal
It’s in Britain’s national interest to negotiate a post-Brexit trade deal with the EU. Several post-Brexit ideas have been floated by the Leave camp, including staying within the EEA (the Norway model), or inking a set of deals on an industry-by-industry basis for ad hoc single market access (the Swiss model – although it’s worth noting that Switzerland doesn’t have a deal covering financial services).
Both models would almost certainly require contributions to the EU budget and voluntary compliance with most EU regulations in order to maintain ‘equivalence’ between the UK and EU. But contributions and regulation are two big reasons the Leavers want to quit the EU in the first place, so it’s hard to see a cabinet of Brexiteers taking that road. Even within the Leave camp, there is currently no consensus on the shape of the future arrangements.
The UK is the EU’s second largest economy and the City of London is the world’s biggest international financial centre. The loss of both may persuade EU leaders to be reasonable at the negotiating table. But they will also be under pressure not to give Britain a better deal than it currently gets inside the club, lest they incentivize other members to quit. Even at the best of times, trade negotiations are notoriously time-consuming and complicated, as every industry lobbies for preferment. In an era of rising nationalism, jingoistic tub-thumping on both sides raises the risk of a lousy deal or no deal at all.
Domestic political uncertainty is another problem. If the Remain campaign loses on June 23, it is widely believed that David Cameron will have no choice but to resign as prime minister, triggering a party leadership election that might not be concluded until later in the summer. The new PM and cabinet would then have to negotiate on multiple fronts at once – with the EU27 and the major European political institutions, and also with all of the countries that currently have trade deals with the EU, which Britain will cease to be party to after Brexit. This is literally unprecedented, no country having left the EU before. To complicate matters further, SNP politicians say they may renew their push for Scottish independence. A breakup of the UK as a consequence of a divorce from the EU cannot be ruled out.
Nearly all of the independent economic analysis on Brexit indicates a negative outcome – certainly in the short term, and probably in the medium and long term as well. If Brexit occurs, the IMF states that it would have “pretty bad, to very, very bad” consequences. An influential report published by BlackRock sums up the conclusions of the world’s largest asset manager in its title: “Brexit: Big Risk, Little Reward”. The Bank of England forecasts a sharp downturn. Indeed, there is evidence that the Brexit debate is in and of itself damaging Britain’s economy: since the start of 2016, sterling has weakened and economic growth has sputtered.
Impact on deals
Private Equity News reported in April that the value of UK private equity deals had already tumbled to its lowest level since the world financial crisis. If the naysayers are correct about a Brexit-induced recession, then this will get worse. As in the last recession, PE funds will find it harder to raise new money and fewer profitable opportunities into which to deploy capital. In a politically tense international environment, some asset prices might fall to attractively cheap levels for buyers; but, from a seller’s perspective, declining asset prices will also hit fund returns.
There are certainly some alt asset managers who believe that Brexit would allow Britain to craft a more business-friendly environment than may be possible inside the EU. And, to be fair, EU market access isn’t the only reason PE firms and funds do business in Britain. It has the English language and legal system, a comparatively lightly regulated economy that incentivizes business, and a critical mass in essential services like banking, law, accountancy and insurance. It also offers access to a pool of talent drawn from all over the world, although this last advantage may well be imperilled by Brexit.
Leaving the EU would be a genuinely revolutionary act, for a country that has historically been sceptical of revolution. Several things make this referendum more unpredictable than a general election: opinions on the EU cut across traditional class and party lines; much of the British press is hostile to the EU; and a prime minister from the political Right will need a high turnout from voters on the Left – Labour, SNP, Lib Dems – to help him carry the day and, in effect, save his leadership of the Conservative Party. Even though the opinion polls are close, data from bookmakers imply that there is a 75% chance of a vote to Remain. But betting odds aren’t destiny – after all, the 5000-to-1 longshots of Leicester City ran away with this year’s English Premier League title. So it isn’t over yet. And if the vote is only narrowly to Remain, it may not be over for a long time to come.