The British media is alive with excited speculation – though little in terms of hard evidence of the impact – over the possibility of a British exit from the EU. With the 23 June referendum very firmly on the horizon, the posturing is increasing and the debate hotting up. But what does this mean for the private equity industry?
The picture is clear if we stay. UK prime minister David Cameron made only modest headway in renegotiating the terms of Britain’s membership. So it’s safe to say that little will change, at least in the short term, if the public votes ‘no’ to Brexit.
All the unknowns apply solely to the situation if the UK does leave. There has been something of a failure however, to properly articulate the impact of an ‘out’ vote. Most of the commentary around why an ‘out’ vote would not be good for British business is based upon the impact of political instability and regulatory disentanglement. But what does that really mean?
Uncertainty is one of those intangibles not founded in, or necessarily based upon, reason but which can have a huge impact on appetite for risk and willingness to make decisions. Investors typically have a dislike for uncertainty. Notwithstanding the political speculation, the views of economists and political scientists are also hugely varied, with different studies predicting very different effects of an 'out' vote on Britain's GDP.
Perhaps a better approach is to identify the potential practical realities of leaving the EU as they might apply to the private equity market.
Losing the passport
Out of Brexit would of course mean being outside of the EU 'passporting' regime so that UK fund managers would lose their ability to sell financial services into the rest of the EU in the absence of having a branch there.
For private equity houses based in London and fundraising across Europe, would this lead to a reassessment of their location? Perhaps more significantly, would US banks located in the UK, to enable them to sell financial services into the EU, move out? And if so where to?
A move would need to be back in to Europe, which poses the question: would a base in Paris, Madrid or Frankfurt represent a more logical centre of business than London? After all, the UK has held a strong position as a global financial centre since way before the single market and for many reasons: language; time zone; and legal system to name but three. The English legal framework for M&A represents a globally respected and stable foundation for private equity transactions across the world.
Although the private equity industry in the UK was underwhelmed (to put it mildly) by the introduction of the Alternative Investment Fund Managers' Directive (AIFMD), principally because of the added cost, both financially and administratively, those UK-based AIFMs who have gone on to avail themselves of the benefits of the UK's pan-EU passport would lose those benefits if the UK left the EU.
That said, if Britain remained in the European Economic Area (EEA), the AIFMD would continue to apply and the status quo would be maintained. If the UK did not remain in the EEA, it would likely apply for a non-EEA jurisdiction distribution passport, which, given that the UK has adopted the AIFMD into domestic law, the EU authorities might be hard placed to resist granting.
Undoubtedly for some private equity houses, an ‘out’ vote would signal greater freedom outside the confines of EU regulation and greater flexibility within a global, rather than local market. Nevertheless, for assets operating and trading within the EU or with operational supply chains reliant on EU members, there is no doubt that consideration will need to be given to the potential impact from new trading tariffs. So too will those portfolio companies need to consider any potential impact once the UK is outside of the shelter of Europe.
The somewhat controversial Transatlantic Trade and Investment Partnership would not apply to Britain if it stepped out of Europe. However, with key objectives being market access, regulation and co-operation, it’s difficult to see how being part of Europe would place us in a better position.
The movement of human resource and the recruitment and retention of talent is a concern raised on both sides of the Brexit debate. No doubt, skills shortages could be more effectively filled from the global resource market rather than from within the limits of the EU. However, once outside the EU, British workers in Europe (and similarly EU workers in Britain) are likely to find their worker rights eroded or their employers dogged by bureaucracy. This would impact private equity at both the fund and portfolio level.
Delays and deal volume
The issue of deal timing and delays in signing is also a hugely speculative one but nevertheless likely. There is always scope for political uncertainty across a region to create delays. Indeed Dealogic data suggests that that is happening already with the number of private equity acquisitions of UK companies falling drastically in the first quarter of 2016 against the same period in 2015.
But notwithstanding the potential for delays, or temporary abatement, the US continues to scour Europe for funding and assets. Cross border activity into and out of Europe happens and will continue.
In the meantime, it’s far from clear which way the vote will swing.
Amanda Onions is London-based counsel for Hogan Lovells and global coordinator for the private equity group. Click here for Hogan Lovells’ in depth analysis on Brexit and constitutional change.