On Friday 29 March 2019, the UK will formally leave the European Union (EU). Although a transition period should apply from that date until Thursday 31 December 2020, it is not yet clear what the UK’s relationship with the EU will look like after that, especially as a trade deal between the two has not been agreed. The uncertainty is causing concern for UK corporates who are forecasting hypothetical scenarios. In fact, it is possible that there will be no transition period at all, if a withdrawal agreement has not been signed by the date of the UK’s departure.
Assuming that the transition period does happen, the UK would remain in the single market and the customs union for a further 21 months. As such, the free flow of goods, capital, services and people between the UK and EU member states would continue. But after that or in the event of a withdrawal agreement not being signed? It’s anyone’s guess.
Although politicians continue to make optimistic noises about a deal being struck, UK businesses are bracing themselves for the unthinkable: a ‘no-deal’ Brexit where the UK crashes out of the single market, losing its privileged access to the world’s largest free trade bloc. Dechra Pharmaceuticals, a UK-listed supplier of veterinary products, is a good example of a company that is preparing for the worst. Although it expects the financial impact of Brexit to be immaterial, it is nevertheless planning for an EU-based product testing facility and the transfer of product registrations to an EU-domiciled entity. It also anticipates that EU batch testing and increased customs duty may potentially impact on its operating costs.
The possibility of a ‘no deal’ or ‘hard’ Brexit is piling further pain on UK companies that are already under pressure due to the volatility of sterling and cancelled contracts. Research by the Chartered Institute of Procurement and Supply (CIPS) earlier this year found that 60% of UK businesses with EU suppliers had found their supply chains more expensive to manage after the Referendum vote, 23% planned to reduce the size of their workforce to offset Brexit-related costs and 9% had lost or had contracts cancelled as a direct result of Brexit. Furthermore, around one in seven (14%) EU businesses with UK suppliers had already moved parts of their business out of the UK in order to reduce their exposure to Brexit-related complications.
Spotlight on cash
However Brexit pans out in the long term, it is almost inevitable that it will entail some upheaval for UK companies that have customers, suppliers or operations in EU member states. The possibility of unexpected costs arising in the form of duties, currency fluctuations, visa fees to secure and retain talent, and taxes is a significant concern, so is the threat of supply chain disruption and the risk that a UK-based company may no longer be able to access critical EU lending facilities and payment infrastructure.
Cash will be more important than ever in what is likely to be a turbulent time for UK companies since cash is the basis of working capital, the lifeblood of a company’s day-to-day operations. It is cash that enables businesses to pay their employees and suppliers, ride out temporary shortfalls in funding and buffer themselves against currency fluctuations.
So what are the key cash considerations that CFOs need to factor in while overseeing their treasury’s response to Brexit?
Having the right amount of cash in the right place, at the right time is fundamental to working capital management. Therefore full cash visibility can make a major difference to how a business navigates turbulent times. It allows the business to optimize its use of working capital, make effective financial decisions, maximize the return on its cash and avoid exposing its cash flows to unnecessary counterparty or financial risks. Cash visibility also supports more effective forecasting, empowering the CFO to make robust long-term plans.
Historically the UK has been an attractive place to run cash pools from because of its ability to handle numerous different currencies, but this could change as a result of Brexit. A company that is used to moving money between its UK headquarters and subsidiaries in EU member states could face tax implications in the future. On the other hand, the UK may become a more attractive base for notional pooling depending on how it implements certain EU regulations going forward.
Short-term debt facilities
Companies will want to ensure that they have sufficient short-term debt facilities to be able to accommodate a temporary strain on their working capital or disruption to their supply chain. For some, this might entail having a conversation with their bank about extending credit lines. Others might choose to stockpile cash reserves instead.
According to KPMG, Brexit could result in the UK no longer being party to both the EU’s Parent-Subsidiary Directive and the Interest and Royalties Directive. These directives provide relief from withholding taxes on dividends, royalties and interest payments made between EU companies that are in the same group. Even more broadly, there may be an impact on the availability of relief under certain EU-US double tax treaties.
Companies may face disruption in this area if banks based in London lose their ‘passporting’ rights to sell their services right across the EU. Although a number of leading banks have already begun the process of setting up European subsidiaries, businesses could find that maintaining their banking relationships becomes more expensive and more complicated as greater numbers of banking staff are deployed to the continent. They also need to ensure that they maintain connectivity with their banking providers and have enterprise resource planning and treasury management systems that can integrate with multiple banking partners, allowing them to switch between partners if necessary.
FX has presented a major risk ever since the Referendum took place. While many UK companies that earn revenues overseas have benefitted from the fall in the pound, others have found that the depreciation of sterling has eaten into their profit margins. With sterling set to remain volatile against the other major currencies for the foreseeable future, it may be appropriate for some businesses to use hedging to mitigate all or part of their FX risk. Other Brexit-related risks for CFOs to monitor include the counterparty risk of working with new financial institutions and potential disruption to the supply chain.
Access to EU payment systems
It is possible, post Brexit, that UK financial institutions could have restricted access to the EU’s payment infrastructure, including the Single Euro Payments Area (SEPA) schemes. As a result, companies might want to review their bank account arrangements to ensure they have bank accounts domiciled in EU member states, allowing them to continue their participation in EU payment schemes.
All round, Brexit is world of unknowns, both from a treasury perspective and from a broader business perspective. The critical cash issues that it raises do, however, illustrate the vital strategic role that treasury can play in helping the business to weather the storm. According to the 2018 Business of Treasury survey, published by the Association of Corporate Treasurers, 92% of corporate treasuries are now preparing information for their boards, with 58% presenting reports to the majority of board meetings. What’s more, the research found that two-thirds of treasuries are helping their organizations to address geopolitical uncertainty, including Brexit. So when it comes to planning for the UK’s departure from the EU, CFOs should find that excellent support is close at hand in the form of their committed and knowledgeable treasury team.