Uncertainty following the Brexit vote will lead to high volatility in the short-medium term and put further pressure on the fragile economic recovery
The initial shock of the Brexit vote has created turmoil in the markets for FX, equities, debt and commodities. With mounting concerns on the political side, from David Cameron stepping down to questions on the quality of future trade agreements, the outcome for the future of the UK and the EU remains uncertain, stoking volatility. The likely downgrade of UK’s credit ratings will negatively impact the risk perception of UK-based companies and those that work closely with them.
Within the UK, questions abound on the nature of potential trade agreements and the extent to which growth, which is expected to decline, will be impacted. The consequent spill over to the EU risks the fragile recovery amid limited options for the ECB. Yields for southern EU countries, Spain and Italy, have already gone up. At the same time, demand within other countries for separating from the EU is going to raise further concerns over the Union’s prospects.
In response to this changed environment, corporates would put investments on hold and move to use financial products that minimise the risks undertaken
The short term uncertainties would discourage corporates from undertaking large investments, reducing their need for Medium and Long Term credits and structured finance projects. At the same time, there is likely to be an increase in demand for short term credit products to tide over the tough times.
Additionally, the associated volatility in the markets is expected to drive up demand for risk mitigating derivatives such as FX and IR hedges. The higher risk profile of UK companies and sterling depreciation would increase the need for trade finance products, for both imports (to provide assurances to sellers following a higher risk profile) and exports (to ensure timely payments). A shift towards more secure financing products, such as factoring, that help reduce risk profile and costs along the entire corporate’s value chain can also be expected.
Multinational corporations currently based in the UK are expected to relocate a part of their operations to the EU depending on the trade agreements negotiated. This would imply greater emphasis on quality of service and international banking products (e.g. transaction banking, cross-border funding) to meet the demands of Treasuries of same corporation in multiple locations.
Banks will be required to review their commercial approach to ensure profitability
In light of the changes, both expected and unexpected, how quickly banks are able to react and adjust their commercial strategy is going to be key in profitably navigating the Brexit shock and the new setup.
- Commercial planning: the change in circumstances calls into review which financial products to push and on which client segments to focus on.
- Segmentation: existing clients will have to be segmented based on the new environment, by understanding their changed needs and evaluating their revenue potential.
- Pricing: with a shift in product use and different competitive landscape, pricing strategy and implementation need to be adapted to make use of the opportunities present.
- Capital allocation: greater attention to resource allocation will require differentiating clients based on whether the relationship is worth investing, maintaining or divesting.
By proactively working on these topics, banks can make use of the crisis to carve out a better position for themselves amid a likely retreat of certain competitors.