Priorities for businesses in wake of Brexit vote


By Alex Stojanovic

After more than 40 years of EU membership, UK businesses are presented with a radically new situation.

The unexpected and unprecedented nature of the decision meant that few UK-based businesses or those dealing with the UK had made detailed contingency plans. So, assessing the immediate impact of the Brexit on their business is the obvious thing any senior management team should be doing now.

Here are a few key considerations in this radically new context:

What is the short-term impact of the referendum decision on our business?

The focus on, and damage limitation, if any, of immediate impacts (e.g., potential supply-chain disruption or low consumer confidence leading to delayed purchasing decisions) or short-term risks are bound to be prioritised over any upside potential or opportunity cost of not investing in operations or capacity.

Risk assessment and risk management provide the framework companies need to identify the impacts on their business and assess which are the most important factors, as well as determining their optimal response.

The principal considerations would depend on whether a business conducts significant levels of trade with the EU and whether it imports or exports goods or services.

Once the impacts have been assessed, companies can prioritise any decisions that must be taken immediately. Although some, such as international investment banks, have already begun to assess the future of their operations in Britain, most businesses will want to wait until they have greater clarity about the government’s post-Brexit road map, macroeconomic policy, and the possible outcome of any UK negotiations with the EU.

What are the main financial risks, and how can we manage them?

Questions to ask include: Can we tolerate a short-term fall in the value of the pound? Will we benefit, or do we need to hedge for it? What is our overall leverage and structure of financing, and how will a potential rise in interest rates due to inflation, or a fall in interest rates due to recession, or changes to the UK’s credit rating affect us?

The response would depend on the assessed levels of threat and impact, but in the short term, whilst the level of uncertainty is high, it is probably going to lean towards caution and hedging of financial risks.

What about planned investments and projects, and do we need to change our medium- to long-term plans?

The likely response of most companies to major uncertainty around the UK economic environment is to put UK investments or long-term expansion plans on hold. Even if the company’s cost and income structure is “EU neutral”—in that it neither buys from nor sells to the EU, meaning there is no direct impact on costs or revenues—the decision needs to be based on the long-term prospects of the UK economy and the likely effects on your company or industry.

Another factor to consider is the potential impact on the workforce and talent management. Does the company have EU nationals amongst its employees, and will the particular skills, support, and business network the company depends on still be accessible?

Further down the road, UK businesses will reassess their strategy and competitive advantage, and foreign and multinational businesses will take a view on the long-term prospects of their UK operations. If the UK itself is the target market, they may expand those operations. If the UK is simply a base for access to the wider EU market, they may contract.

Where should we start our risk analysis?
 
Risk appetite is the starting point of any analysis—whether of upside or downside risk, and risk management. The risk averse (particularly among non-UK businesses) may hedge and/or limit their UK exposure, depending on which is the cheaper option.

The risk loving can opt to gear up their UK operations (UK market-focused businesses or exporters) or make an immediate decision to seek opportunities elsewhere (e.g., some financial services firms that depend on the EU financial passport).

However, risk management is less adept at dealing with uncertainty (unknown distribution of outcomes, new events), and businesses would eventually need to answer more fundamental questions on their medium- to long-term UK strategy. Nonetheless, the risk-management context still provides a useful framework for the analysis.

The analysis would need to consider two main issues concurrently: Firstly, what type and size of UK business operations are we going to retain, and what risk are we going to tolerate? Conversely, what operations are we going to terminate, and what risks are we going to avoid? These are strategic-level decisions.

Secondly, what do we need to do in terms of risk control, reduction, or transfer? This is the domain of the financial management, accounting, and risk-management function, and has an influence on the first issue.

Finally, if I was asked to advise a business, my finance specialism bias would prompt me to consider the whole situation as a “real” or “financial” option. Unless there are immediate changes in demand or cost, you don’t want to limit the UK business opportunity as it is costly to sever or move any developed business operation.

On the other hand, you want an opportunity to cut losses, i.e., create an option to change, reduce, or cut operations before it’s too late. This means managing risk in the short term (e.g., hedging with derivatives) and deciding whether to exercise the option (to change, reduce, or cut) or let it expire after a year or two.

Clarity, confidence, and a considered approach

Get into the granular detail of how Brexit might affect your business, advised David Lancefield, partner in PwC’s Strategy&. In a PwC webinar on Friday, he recommended businesses look at the impact that the fall in the value of the pound could have on their finance arrangements and their liquidity, and explore what they can do about that in practical terms.

Other questions to ask include: What does it mean for your supply chain across Europe and beyond? And what are the contractual implications of that? If you are in the middle of a deal process, is there a Brexit clause?

Lancefield also noted the importance of an inclusive approach. The risk of Brexit “has often been the preserve of an individual in an organisation, and it’s been a technical topic.

“Whereas now, we need the whole organisation to come together, whether it’s an exec board or exec committee, to work through this in quite a systematic way, making sure that all the angles are covered and making sure that all the people in their organisation are able to express their views and fears,” he said.

People often overlook the fundamentals after a shock. When considering strategic options, Lancefield advised that leaders focus back on the core of what they do really well, both as an individual and as an organisation.

“Confidence is really critical here, because for the UK and many businesses, the fundamentals are strong.”

Carolyn Rand, FCMA, CGMA, non-executive finance consultant and former chief executive of Cambridge Biotech company Isogenica, agrees that the UK’s underlying economic position is strong.

“We need strong leadership from boards to keep a clear head and deal with the headwinds as they hit us, but not to cause them.”

Beyond the immediate shock to the markets, the next move companies need to make depends on the terms of the agreement under which the UK leaves the EU. This will become apparent over the next two years, Rand said. Knee-jerk decisions, such as reducing knowledge capital, may hurt companies’ long- term outlook.

As a non-executive finance consultant, Rand will be recommending to her boards that they avoid making drastic decisions they may regret later. “Be considered and consistent,” she said. “And keep hedging FX contracts so we can know our future cash flows with certainty.”

Alex Stojanovic is a director of the Centre for Governance, Risk & Accountability and head of the department of accounting and finance at the University of Greenwich. CGMA Magazine Senior Editor Samantha White (swhite@aicpa.org) contributed to this article.