The financial services industry has been left reeling following the UK’s shock vote to leave the European Union.
As politicians, regulators and policymakers grapple with the looming question of “what next?”, financial services firms have been among those seeing dramatic falls in their share price as the markets digest the outcome of the referendum.
Providers, fund groups and banks have all been hammered. But as we make our way through the first working week post-Brexit, it is emerging that some financial firms may be better positioned to withstand market volatility than others.
Here we examine the potential winners and losers in the wake of the vote and how the decision to leave the EU will impact their business strategy, at a time when all markets know is uncertainty.
Set to struggle
Analysts are already scrutinising which financial firms could take the pain of recent market volatility.
An analyst note issued by JP Morgan Cazenove put St James’s Place, Standard Life and Aviva on top, thanks to a strong capital position and their track record on paying dividends.
Prudential, Legal & General, and the Just Retirement Partnership group were earmarked as the insurers most likely to struggle if volatility continues, due to a capital position described as “not very impressive”.
Shore Capital director Eamonn Flanagan agrees there may be trouble ahead for providers, but believes the uncertainty around Brexit will prove problematic to different firms for different reasons.
He says: “Clearly the backdrop is equity markets are falling, and there are a number of implications for the ‘asset gatherer’ or asset management type of businesses, such as Standard Life, Old Mutual Wealth or SJP. When revenues are linked to assets, in a falling market those revenues are clearly diminishing.”
Flanagan says those firms represent a concern around annual management charges and ultimately future profits. But he argues providers such as Aviva, Legal & General, JRP and Pru represent a balance sheet risk, in terms of the liabilities they are carrying with the size of their annuity books.
EY insurance director Jason Whyte sees things differently. He says asset managers who have been used to passporting in much of their business into Europe may be looking at their strategic options.
He argues for life and pensions companies the impact of the vote may be less dramatic, as many of them have pulled back in recent years and already have a much clearer geographic focus for their business they did a few years ago.
He says:“Although theoretically it is possible to operate from a base in one EU country and distribute through the rest, in practice the markets and the distribution are sufficiently different that in most cases it makes sense to have a subsidiary in the relevant country. It may lead some organisations to look at what are their strategic plans for the countries they are in, and with the uncertainty hanging over them they might decide to act more swiftly if they have a clear strategy.”
EY was already forecasting a wave of activity on mergers and acquisitions activity ahead of the referendum. Whyte expects this to be less concerned with one company buying another, but more in the vein of Axa selling off Elevate to Standard Life, and the possible deal to sell off Cofunds.
He says: “It may well be that the waiting period crystallises firms’ determination to tidy up a business, particularly if by selling a subsidiary they can realise a reasonable price and save themselves from a lot of the transitional impact. If you have one or two European subsidiaries that are sub-scale, you might think about not hanging onto them.”
Hargreaves Lansdown senior analyst Laith Khalaf is wary of recent research from the Institute of Directors that suggested a large proportion of businesses plan to delay investment and hiring, and to put off making strategic business decisions.
He says: “That survey took place very close to the decision on Brexit. There were probably a lot of knee-jerk reactions, both in the market but also understandably among businesses as well. I wonder whether in the fullness of time that knee-jerk effect becomes a bit more moderated.
“Ultimately companies adjust to new economic circumstances in their attempts to continue to make a profit. The unsettling thing is we do not know what those circumstances are going to be as yet and we are not going to know for some time.”
What about the banks?
Bank have also been burned by the EU fallout, with trading in Barclays and Royal Bank of Scotland shares temporarily suspended after they each saw their share price fall by more than 10 per cent on 27 June.
Flanagan says: “Banks have a lot more gearing than the life insurance companies would have, meaning the liabilities divided by the shareholder funds will be materially higher. There are specific concerns about property and housing market exposure [following the vote], and banks are highly geared toward that market.”
Khalaf notes Henderson’s decision to cut the price on its UK Property fund by 5 per cent based on uncertain property valuations following the Leave vote.
He says: “This is interesting, because it is basically saying now that the Brexit vote has taken place, it is really difficult to price property. There is a lack of commercial property transactions, but obviously something very significant has happened, and this is valuers saying we don’t know what effect this is going to have on the market. You could probably make the same case for a lot of the stocks on the stockmarket, but they are traded every second.”
Cazalet Consulting chief executive chief executive Ned Cazalet says this is not just a problem for the banks.
He says: “As a banker you want to have something known as the ‘endowment effect’, where you take money in, pay Mrs Miggins 1 per cent and lend it out at 3 per cent. If rates continue to be low or negative, there is no gap between the two. “So why the leap from insurance companies to pension providers to banks? Insurers, particularly those in continental Europe, are investing their money in government bonds. They then switch to corporates except most of these corporate bonds are actually issued by financial institutions, other insurance companies and banks. This creates a contagion risk.”
Not a crisis re-run
However, analysts are keen to stress that should the recent falls in markets prove to be sustained, banks and providers are in a much better place to cope with these headwinds.
Flanagan says: “The comments made by Bank of England governor Mark Carney have been quite instructive. He has referenced the fact that Basle III, the new regulatory regime impacting the banks, is doing what it says on the tin. It is providing that extra cushion for shareholder, and that should be recognised to a greater extent than the markets have given credit for.
“The market is saying: ‘This is a re-run of the credit crunch – hit the banks as hard as you can. But their balance sheet positions are materially different to what they were eight or nine years ago.”
Cazalet agrees banks and providers are better equipped to deal with market turmoil thanks to higher capital requirements.
But he adds: “For the banks, they may have capital, but the question is if rates are low, can they make money?”
Whyte says: “As long as it’s just volatility, we shouldn’t see anything dramatic happen. The real danger is if the market concludes this is going to be a long, drawn-out period of uncertainty and it starts pushing the economy back into recession. That is going to be unpleasant.
“But firms have been through this in the recent past and have put measures in place so that although it won’t be comfortable, it will not have the same catastrophic impact the financial crisis did.”
Khalaf adds: “Potentially this is going to take a long time to work through. It may dawn on people that we may not be talking weeks and months until we get some certainty about what the plan for withdrawal looks like. When that happens, markets and businesses might conclude they have to move on from this issue. But they might not.”