On June 23, 2016 the United Kingdom voted to leave the European Union. On March 29, 2017 UK Prime Minister Theresa May triggered Article 50 of the Lisbon Treaty to begin the two-year negotiation process for Britain's withdrawal from the EU. The UK leaves the EU on 29th March 2019, most likely without agreement on the terms of its future relationship with the EU. This seismic disruption of markets has large and lasting implications for mutual funds invested in areas vulnerable to the resulting turbulence.
The risk of turbulence is clear and present. A leading New York law firm has estimated that "thousands of financial contracts, collectively valued at $2.7 trillion, give or take a few hundred billion, could be affected".
"There is nothing to win in this process and I am talking about both sides. In essence, this is about damage control."
Donald Tusk, European Council President
Milestone terms of exit were concluded in December 2017, paving the way to substantive negotiations about Britain's future relationship with the EU. The "Chequers Deal" that followed was debated in the House of Commons in early December, but a vote was postponed by Prime Minister, Theresa May, as the government faced certain defeat.
On Wednesday 5th December Mrs. May survived a vote of no confidence in her leadership as Conservative party leader with less than 50% support from backbench MPs.
The deadline for leaving the EU is 29th March 2019 and no agreement is in place. Mrs. May has been rebuffed by EU leaders over changing the terms of their negotiated deal to make it acceptable to a fractured House of Commons.
"My personal view is that the potential impact of Brexit has been understated."
Jay Clayton, Chairman of the US securities and Exchange Commission
There are many variations of Brexit being debated, but leaving the EU on 29th March is the only solid feature on the political landscape. The date is established by statute. It is unlikely that in the short time left the Commons will pass amending legislation. Preparations in Whitehall for a "hard" Brexit have been minimal, but have now been sanctioned by the Cabinet. £5bn has been allocated to the process.
In this kaleidoscope of constantly changing scenarios, managers and directors of mutual funds will inevitably find themselves confronting unfamiliar hazards - and, on occasion, unexpected opportunities.
Following the referendum vote, around 400 SEC-registered public companies disclosed Brexit-related risk factors in their quarterly reports and at least 35 companies disclosed Brexit-related risk factors in registration statements filed with the SEC. Recently, that figure mushroomed. The 225 filings since November alone represented more than 50 per cent of the figure for all of 2016.
At a recent Current Financial Reporting Issues Conference in New York, SEC Chairman, Jay Clayton, commented: "I would expect companies to be looking at this closely and sharing their views with the investment community."
SEC staff continue to encourage companies to consider disclosing the risks Brexit poses to their businesses. Such disclosures typically include continuous evaluation of exposure to UK and EU markets and to currency movements relating to the pound sterling and euro; monitoring any guidance that may be provided by the SEC on Brexit disclosure; monitoring the economic and political situation as Brexit negotiations proceed and the "leave" date of 29th March 2019 draws near; regularly updating assessments of Brexit-related risk factors to ensure disclosure is not outdated, misleading or excessively generic.
The impact of Brexit and any new regime that will govern the UK's relationship with the EU will be felt over many years and all reporting companies that may be affected should prudentially consider disclosure of Brexit-related risks in public filings.
There is no roadmap to follow, or precedent to cite as a guide or pattern for how the ebb and flow of negotiations and the disruption caused by a likely "hard" Brexit will influence markets in the months and years to come. Even before the formal negotiations began the Brexit decision had already moved markets and currencies in unpredictable ways.
A flight to safe haven markets, currency fluctuations and the increasing intervention of the European Central Bank as risk premiums across the Eurozone rise, have characterized the period of Brexit negotiations. Turbulence will persist as the Brexit terms of trade continue to be hammered out and the consequences of an exit without agreed future trading terms are evaluated.
In this ebb and flow of changing risk, directors and trustees, in fulfilling their fiduciary responsibilities, will wish to keep themselves informed and regularly updated on developments resulting from emerging Brexit settlements creating a novel landscape for mutual fund portfolio risk.
brexRisk® supplies such a service, tailored to the specific concerns of individual clients.