Morrison & Foerster Discusses What Global Investors Think About Brexit

Amid the uncertainty Brexit has created, foreign investors are assessing their existing and prospective investments in the UK, with particular focus on Brexit’s potential impact on EU-UK trade and labor mobility. No one has a crystal ball but our MoFo attorneys around the world have, through conversations with our clients and contacts, gained a picture of the views of smart and successful businesses and professionals about what they expect from Brexit. We have spoken to companies, from the very largest to startups, around the globe. This article sets out this crowd-sourced thinking from a wide variety of thoughtful contacts, and provides a gauge of sentiment and outlook among investors.

The current view among some foreign investors is that the lower value of the UK’s currency, the pound sterling, has increased interest in British real estate and corporate assets. But, as a result of the prospect of the UK sitting outside the EU single market after Brexit, more than one-quarter of UK-based companies plan to send some staff overseas or undertake a review of their corporate domiciles. When it comes to planning for the long-term, there are differing views as to the impact of Brexit, depending on the domicile of the investor and the industry sector.

In this article, the term “hard Brexit” (which has never been strictly defined) means a Brexit with no compromise on issues, including the free movement of people, the UK’s departure from the EU single market, and a trade relationship defined by the UK being outside the EU – i.e., the UK will revert to World Trade Organization (WTO) rules related to trade. Alternatively, a “soft Brexit” would involve some form of closer ties, perhaps through conditional access to the EU single market, and some degree of labor mobility.

China’s Investors Remain Interested in the UK Market Amid Brexit 

Since 2015, China has represented 33.5% of total global investment into the UK. Since the beginning of 2016 alone, China’s investment in the UK totals $14 billion. And while these figures represent a decrease from those of prior years due to China’s recently enacted capital controls, investment figures rebounded in the second quarter of 2017 and are predicted to increase, reflecting China’s continued interest in the UK market notwithstanding Brexit. In particular, China is now seen to be looking to access British industries, having made recent acquisitions in the UK tech sector.

The UK may have benefited from limitations on Chinese investment into the United States as a result of scrutiny by the Committee on Foreign Investment in the United States (CFIUS), a U.S. interagency committee that reviews transactions that could result in foreign control of a U.S. business. But a recent UK government green paper on proposed rules to regulate foreign investment (FDI) implies that Chinese investment into Britain may also be constrained on national security grounds.

Beijing is very focused on Brexit, both politically and in terms of its impact on the global economy. There’s some concern that there will be a hit on growth in the UK economy as a result of Brexit and some knock-on effects because of instability. But in particular sectors, and in the UK and some EU Member States, there is seen to be opportunity. For example, trophy-asset acquisitions by Chinese companies may have slowed down because of capital controls, but hard-asset acquisitions by wealthy individuals are still going to occur because they can pick up significant assets at a discount. The financial sector, banks, and insurance companies are of particular interest to Chinese investors because they see London as a hub to the EU. But this will continue to hinge on what happens with Brexit.

Hong Kong investors are taking a “wait and see how the negotiations go” approach to Brexit and its impact. But in the meantime, they will be opportunistically looking at targets in the UK, irrespective of the status of Brexit. As they see it, the trade status between the UK and the EU is critical in terms of what rights will exist for investors going forward. Chinese insurance-sector clients who are currently making acquisitions in the UK say what is driving the transactions is their interest in the sector and the current exchange rate, which has seen the UK pound depreciate against the Chinese renminbi.

Over the last few years, China has viewed London as an important renminbi offshore center.  This role may now be in jeopardy. Many Chinese banks are in talks about alternative centers, including Dublin and Frankfurt. And because the German and French relationships with the Chinese government are strong, China’s outbound investment into Germany is noteworthy.  How the governments vying to become new financial services hubs for China in Europe negotiate with China will be highly influential on the outcome.

Japan Is Heavily Invested in the UK and Does Not Want a Hard Brexit

Japan is heavily invested in the UK, and has been public about its urging the UK to avoid a hard Brexit to protect Japanese companies that are based in the UK and do business within the EU.  In 2015, nearly half of Japanese investment into the EU went to the UK.

In September 2016, Japan published a message to the UK and the EU that detailed the potential economic damage Japan saw stemming from Brexit. That message also contained a list of specific concerns about Japan’s substantial investment into the UK, which Japan noted had created 440,000 UK jobs. In particular, Japan explained that if its banks cannot maintain their single-passport access to EU markets, they would face challenges to their EU business operations and would possibly need to acquire EU corporate status or consider potential relocations to the EU. Japan also encouraged the UK to maintain a flexible immigration policy to support business hiring needs.

And Japan has already begun to act on those warnings. For example, one of Japan’s biggest banks is looking at relocating its UK investment banking operations to Amsterdam. Other banks are planning to move their operations for EU clients to Frankfurt.  Japanese automakers, which manufacture thousands of vehicles a year in the UK, are also considering relocating some UK operations.

Japanese financial institutions are discussing Brexit almost every day, although it is seen as less important for companies that do not rely on a UK presence for their EU operations. We are told that a prevailing view inside Japanese financial institutions is that current EU regulations will apply to the UK, with the UK benefiting from passporting, during the two-year Brexit transition period that the UK government has been seeking in its negotiations. Japan sees it as troublesome that negotiations seem to be proceeding very slowly and with the prospect that there will be no deal and a hard Brexit. Consequently, Japanese companies are said to be making contingency plans, as they do not know what the regulatory relationship will be between the EU and UK following Brexit, including what UK legislation will be passed to regulate the areas that are then no longer subject to EU regulation.

On the other hand, Japanese manufacturers in the UK say that, so far, they have made no specific plans for Brexit because they do not rely on the EU license or EU passport. They do, however, see potential problems with post-Brexit customs duties and clearance procedures if the UK is outside the EU Customs Union, which may compel an increase in inventories because of customs holdups.  But if increased costs are limited to these issues, they say, they are not likely to move their UK factories.

Overall, the significantly larger population of, and scale of business in, London over continental cities is regarded as important. Even if some financial institutions suffer losses due to Brexit, London is seen as likely to remain an attractive market compared to other EU cities.

Singapore and Southeast Asia Are Closely Monitoring Brexit for Opportunities

Singapore overall is not too worried about Brexit and sees some of its consequences as potentially positive. While financial services firms may be looking to relocate and re-domicile, the impact on real estate appears to be negligible. The majority of Singaporean investments into the UK have been in the real estate sector. Many wealthy Singaporeans, and the Singapore Sovereign Wealth Fund, invest in real estate and there seems to be few concerns about continuing to invest in the real estate sector in the UK. Indeed, UK real estate is seen to be potentially even more attractive to Southeast Asian investors post-Brexit.

Singapore and Southeast Asian investors do have concerns, however, about Brexit’s impact on investments in financial services and manufacturing. But the impact on the financial services industry in the UK is also seen as potentially providing opportunities for Singapore. Some smaller businesses, including FinTech startups, are observed eyeing Singapore as an alternative place to London. 

Brexit is also seen to be part of a broader trend away from globalization. Viewed alone, Brexit is not seen as having a major impact on trade flows to Southeast Asia, but rather as part of a bigger trend. In combination with the impact of the Trump administration, Brexit’s impact in the longer term is seen to potentially be more negative for Singapore and Southeast Asia. 

The EU is a major trading partner of Singapore, more so than China, and the yet-to-be-agreed

Singapore-EU free trade agreement may now need renegotiation in light of Brexit. In particular, Singapore wants continued access to UK financial markets, which may not remain part of the deal when the UK leaves the EU.

There is also a view that if a hard Brexit occurs, Asian companies will likely need to seek out alternative financial centers in Europe. However, some kind of Brexit transition deal with the EU may be probable.

The U.S. and UK Appear Poised to Work Through any Issues that May Result from Brexit

Longtime allies and trade and investment partners, the United States and UK are seen to be, ultimately, capable of working through any bilateral issues that may result from Brexit, including forging new trade agreements. American companies and exporters utilize London as a base for EU-wide operations, so some are seen as likely to be looking to establish European operations to avoid any new barriers to business across the continent as a consequence of Brexit. A number of major U.S. investment banks, for example, are said to be planning to move some operations to Continental Europe to reduce their risk, while others are said to be expanding London operations.

Companies in the Washington, D.C. Metropolitan Area are likewise monitoring Brexit and its impact, and are increasingly likely to move some operations to other parts of Europe to ameliorate risk. Investors are said to be unlikely to deploy capital into the UK before Brexit is finalized because of the current uncertainty. Paris, Frankfurt, even Milan are seen as potential alternative financial centers. There’s also uncertainty about whether London will remain a conduit for Western investment into Africa, particularly Southern and East Africa.

Wall Street harbors worries about the implications of a hard Brexit – in particular, the potential regulatory arrangements of a future EU-UK financial services relationship. Some in New York see Brexit as a challenge to London’s primacy as a major center for corporate restructuring. And there appears to be great uncertainty about whether, post-Brexit, EU jurisdictions will recognize schemes of arrangement sanctioned in the UK to restructure companies. There also appears to be growing competition among major European cities to become the next hub for cross-border insolvency filings. Dublin is seen to be emerging as a potentially hot insolvency destination.

In San Francisco, Brexit does not stand out as an issue amid a mix of other global issues, including the implications of the Trump administration and the developments around CFIUS and Chinese investment. Brexit is seen as a bigger issue for the financial services sector than for the tech sector. The UK is viewed as remaining a good focus for M&A activity, particularly if it can maintain employee mobility and the cross-border transfer of goods and services as part of a post-Brexit agreement. It is too early to tell if Brexit will make M&A more difficult.

There is also a sense that Europe is emerging from slower growth, making European assets attractive. The UK is seen to have a very attractive tax regime worth emulating. There is significant interest in whether a Brexit deal will create an environment that is attractive to a talented labor pool and permit the free movement of goods and services.

Risk Seen for German Companies Scaling Out of the UK Market

Brexit negotiations are seen as having created an uncertain change of course for German companies with international operations, resulting in a worsening business outlook. German companies remain very interested in doing business in the UK but, since Brexit, one in 10 is said to be moving operations out of the UK. The view from Germany is that if you do business on a global scale, you will need to find a new place for your hub outside the UK. Pre-Brexit, non-European investors already had this issue on their radar. With FinTech, if you cannot do business on an EU scale, you are seen as likely to need to find another place for your hub in the EU. The German view is that the UK will now try to make its economy more attractive by reducing taxes and regulatory hurdles in a bid to limit Brexit’s impact.

A hard Brexit is seen as unlikely, as it would mean there would be no transition period and the UK likely lose all benefits of the single market, carrying huge implications. The period for negotiation with the EU ending in March 2019 is not considered sufficient time for full negotiations of a new relationship with the EU. An interim agreement, giving the UK the practical option of a transitional arrangement of a new relationship with the EU with a succession of two-year extensions, is seen as more likely. Some of the implications of a hard Brexit are seen to potentially include the UK having no data or environmental protections, and UK companies facing tax and customs duties in order to do business in the EU. Exported goods are seen to face the possibility of being stuck at borders the day after Brexit, with no one knowing how to apply the WTO rules. British retirees in Spain face the risk of needing visas and perhaps owing Spanish inheritance taxes. Europeans working in the UK may need to return home. And issues are seen to potentially exist around the Open Skies Agreement, which governs EU-U.S. commercial air travel. In pending antitrust litigation, concerns exist about what will happen to London as a venue for litigation if findings of cartel-like behavior by a UK court will not be applicable in the EU.

Frankfurt is seen as likely to take a lot of London banking business. In investment banking, thousands of bankers’ jobs are moving to new locations throughout the EU, including Frankfurt, Ireland, and the Netherlands. While Germany is seen to be strict on employment regulations for the benefit of employees, and France more so, the Netherlands is seen as more relaxed.  Outside of financial services, it is interesting to note that German companies see potential in Barcelona as a tech hub and Munich as a biotech and pharma hub.

Belgium Sees More Contingencies Needed the Longer Brexit Takes

The view from Belgium is that Brexit may disrupt its close trade and investment links with the UK. Belgian exporters based in the UK have been advised to have a contingency plan in place for the possibility of a hard Brexit. For manufacturing, there has already been a pre-Brexit shift away from more expensive countries like Germany, the UK, and France to the newer EU members. Brexit is seen to be accelerating this shift. In one case, the EU sales director of a European pharmaceutical company considering the UK for its headquarters changed plans following the Brexit referendum.

For corporate relocations, different countries are seen as offering different benefits; Ireland in particular is seen as likely to attract some investments that would have gone to the UK for those seeking an English-speaking country. Ireland’s tax regime, while seen by the corporate sector as benign, has, however, been questioned by the EU Commission. 

Impact on Financial Services and Other Sectors in the UK

Brexit remains a divisive issue within the UK, and there is little consensus about how it will impact the economy. In general, companies are seen to want to retain as close a trading arrangement with the EU to the current situation as possible, with continued access to skilled workers from the whole of the EU.

Post-Brexit, UK financial services companies are seen as not likely to have the same easy access to EU financial markets they have currently, with some aspects of existing operations needing to be relocated to other EU jurisdictions as a consequence. Frankfurt, Amsterdam, and Dublin have been mentioned as potentially good options. And Paris has been chosen as the new home of the European Banking Authority. Italy, Spain, Austria, and Eastern Europe seem unlikely alternative financial services locales due to what is perceived as a less sophisticated technical legal infrastructure and the attendant challenges of moving outside a major city, including the ability to receive an EU regulatory passport. That said, with the UK’s dominance in financial services having lasted for more than 150 years, some question how much impact Brexit will truly have in the long term.

Outside of financial services, if companies are based in the UK and performing services in the EU, they are being told they will likely need to establish operations in the EU. Foreign investors are being advised to consider how Brexit might impact their business prospects if they come to the UK. Investing in the UK now is seen as potentially advantageous, as the UK government is currently seeking investments. But investors have been cautious about considering which Brexit scenarios are most likely, because the situation is in considerable flux. Simply waiting and seeing, however, is not seen as an advisable strategy.

Interestingly, tech investor sentiments about the UK post-Brexit are positive, with many confident London will remain an important tech hub. And while an EU presence is now seen as important in order to scale regionally, the UK government has taken notice and plans to expand the number of visas for highly skilled tech workers.

The biggest question for business leaders is whether there will be a transition deal. Some believe there will be a long transition period. The consensus among investors is that the EU also needs a sensible free trade agreement with the UK. Hence, companies think that, perhaps, it is not a good idea to switch investments until the position is clear. Some of the UK’s leading business organizations, including the Confederation of British Industry (CBI), are lobbying for some degree of labor mobility to ease business hiring post-Brexit. Companies want to know whether the EU and UK will continue to enable the movement of people, a policy seen as helpful in attracting highly skilled employees.

Looking Forward

In this article we have summarized the insights of contacts and clients from across our network in Asia, the United States, and Europe about how Brexit is perceived today.

While some see Brexit as disastrous, others see it more as a cumbersome change in political arrangements that an economically attractive UK will ably manage. Where some have ceased to view Britain as a place to invest and grow, others see a great opportunity to acquire real estate and business assets at discounted rates, with the assumption they will be very well positioned for the future ascendance of Britain post-Brexit.

Now that the initial shock of Brexit has worn off and the EU and UK are involved in protracted negotiations over its terms, foreign companies doing business in the UK and Europe face important issues. Among them are whether to locate operations in the UK, the prospect of London no longer being the center of European financial services, the opportunities for technology businesses in London and Continental Europe, and many more, often fluctuating, issues. Whether you view Brexit as a negative or a positive, the scope and scale of change it entails is enormous. It poses both challenges and opportunities for businesses and clients, who will carefully prepare to protect and enhance their vital interests

REFERENCES

Executive Summary

China

Japan

Singapore

Germany

Belgium

UK

United States

This post comes to us from Morrison and Foerster LLP. It is based on the firm’s client alert, “International Investor Sentiment Toward Brexit — Views From Major Tech And Financial Centers,” which is dated December 18, 2017, and available, along with the firm’s Brexit research center, here.