Exit plan – what does Brexit mean for CFOs?


29 November 2016


As of 2015, the UK was ranked third globally in direct foreign investment. However, since its citizens voted to leave the European Union in June, significant questions have been raised as to whether that position is sustainable. Greg Noone talks to Thomas Sampson of the London School of Economics about whether Brexit is set to permanently change the way in which multinationals will perceive the UK as an investment destination.


In October, Carlos Ghosn left 10 Downing Street looking – although perhaps not feeling – quietly confident. Flanked by aides, the CEO of Nissan-Renault had just met with UK Prime Minister Theresa May for talks on the future production of its new Qashqai SUV model. In normal times, this would be an internal company matter, a question of assessing whether or not it was affordable to make room for a new assembly line at its factory in Sunderland.

For Ghosn and the board, however, these were hardly normal times. Over the past decade, the Sunderland factory had acquired a reputation as having one of the most efficient assembly lines in the region, eventually making close to one in three of all the cars manufactured in the UK. Brexit put that status in jeopardy. Car plants are not self-sufficient; they often need to source integral components from abroad – in Sunderland’s case, from Europe – and in most places around the world that means factoring in the costs of tariffs into production.

Nissan-Renault hadn’t needed to worry when the UK was part of the single market, but since the vote to leave, Ghosn and the board had been shaken by the government’s apparent willingness to sacrifice that position in exchange for the full restitution of border controls. And so, the company announced that it required clarity from the government in the run-up to negotiations. Not receiving it could mean Nissan-Renault moving production to one of its other factories inside the single market, and perhaps reconsider any expansion of the Sunderland plant and even its future.

Publicly, Ghosn said he was satisfied with the results of his meeting with the prime minister, although it remains unclear precisely what assurances were made by the government to Nissan-Renault in those few hours. What is clear is that the concerns raised by the company about the course of Brexit are bigger than one factory in the north of England. At the very least, the wait between now and the eventual divorce settlement – as well as the probable secrecy surrounding the back and forth between the negotiating parties – will breed uncertainty among businesses. At most, the process may serve to profoundly alter the way in which multinationals view the UK as a place to invest.

Keeping promises

For Thomas Sampson, an assistant professor in economics at the London School of Economics and the co-author of the report ‘The impact of Brexit on foreign investment in the UK’, this will be almost entirely dependent on what kind of settlement is eventually reached. A ‘soft Brexit’, wherein access to the single market is retained would, in his view, constitute the ideal scenario for investment conditions. Anything less than that, though, is another matter.

“There’d be some interesting differences across some sectors, but I certainly think if we follow a hard Brexit, it’s not going to make the UK a more attractive place to invest,” Sampson explains.

If this were to occur, the professor and his colleagues predict a 22% fall in FDI for the UK, which amounts to an overall drop in £2,000 in GDP for each household. Even, as Sampson acknowledges, this area of economics is not an exact science – the literature charting the links between growth and trade, for example, is much more expansive – even a slightly smaller drop than this would cause residual damage to the UK economy. Multinationals, after all, are among the most productive types of companies, devising and deploying technology and institutional knowledge that falls beyond the reach of smaller firms. They also tend to employ a highly skilled workforce and, on average, pay them a greater salary than their domestic rivals.

Even if there’s a hard Brexit, my expectation would be at least in the medium-term that London would continue to be Europe’s leading financial centre.

The report underscores this case by focusing on two sectors that remain heavily dependent on the activities of multinationals – the car industry and the financial services sector. The implications for the former, as stated above, remain relatively gloomy. When it comes to financial services, however, the available outcomes are not as clear-cut.

Certainly, the persistent uncertainty surrounding ‘passporting’ – the ability of banks based outside of the eurozone to mount transactions within the single market – has led to industry bodies calling on the government to be clearer in how it will approach this issue during the exit negotiations. While the ability of multinational institutions like UBS or Goldman Sachs to straddle the UK’s favourable regulatory environment while freely operating throughout the EU isn’t all that keeps them in London, it does form a sizeable slice of their current operations. And if passporting is lost in the final settlement, that may be enough to put off other banks from making the same kind of commitment to the UK in the future.

Despite this, Sampson remains hopeful for the city’s prospects; although, at this stage, he doesn’t have a strong opinion as to which other financial hub – Dublin, Frankfurt and Paris have all been cited as possibilities – will emerge as its eventual successor. “Even if there’s a hard Brexit, my expectation would be at least in the medium-term that [London] would continue to be Europe’s leading financial centre,” he says. Overall, Sampson believes, there is much besides passporting – such as plentiful office space, supporting infrastructure and the difficulty of moving institutions wholesale from one financial centre to another – that keeps major banks headquartered in the UK’s capital. “It wouldn’t be that all the businesses operating there would be moving out of London but just some aspects that couldn’t be done outside the EU.”

Prognostication

Assuming the UK will not continue to enjoy access to the single market, several options do remain for the government in making sure the country continues to remain attractive to foreign investors. One is to manipulate the rate of corporation tax so as to attract more multinationals to headquarter their operations there, although Sampson acknowledges that such a policy carries its own levels of risk.

“I don’t think that’s a good policy to follow for the country as a whole,” he says. “On a global level, it’s a sort of ‘beggar-my-neighbour’ policy where you risk a race to the bottom. Eventually, you’ll end up with no-one charging corporate tax and governments being unable to fund certain services. You’d also hope that the UK could compete along dimensions other than simply charging the least tax.”

What may be more fruitful could be a long-term and sustained investment in sector-specific infrastructure, which is better for supporting the kind of nimble national economy that could compete successfully with the likes of the single market. “That’s going to differ on what type of investor you are,” explains Sampson. “For the car industry, you need good transport links to ports and shipping facilities to provide low-cost trade routes. When it comes to the financial services industry, it could mean enhancing the kind of payments infrastructure and network that helps support banks and similar institutions.”

This would also have to be matched by a commensurate investment in education, so as to create the kind of highly skilled workforce that would make the UK a natural fit for roving multinationals looking to invest in Europe. “Foreign multinationals tend to employ more skilled workers than domestic firms, so they particularly value having access to highly skilled workers,” adds Sampson. “It’s obviously another reason why potential immigration restrictions after Brexit would be bad for FDI.”

There’d be some interesting differences across some sectors, but I certainly think if we follow a hard Brexit, it’s not going to make the UK a more attractive place to invest.

While the prognosis for FDI inflows into the UK made by Sampson and his colleagues is, on balance, negative, the professor nevertheless remains hopeful about the country’s prospects in this area in the long term. While a hard Brexit may initially result in the country’s reversion to WTO rules when it comes to trading with the single market, he predicts that, over time, a free-trade agreement similar to that recently reached between Canada and the EU will probably be attained.

In the meantime, what remains is uncertainty. A survey conducted by Deloitte in mid-November found that almost 88% of CFOs in the UK believe that Brexit will see the country’s business environment become harsher in the long term. Just over a third of European CFOs felt the same way.

“Businesses across Europe have contended with a number of political shocks over the summer, reflected in high levels of uncertainty,” said David Sproul, Deloitte’s chief executive in the UK. “Concerns around regulatory change are the biggest concern, but curbs on workforce mobility and export opportunities are also cited as risks to European businesses.”

Ultimately, Sampson says, it’s helpful to remember that the negotiations – when they do start – will be a two-way street: “The government [politicians] are going to have to negotiate with the rest of the EU, and they can’t just decide that type of Brexit they want on their own. It may be that, when they see what the potential costs of a hard Brexit would be, that they pursue a less extreme policy. Nevertheless, I don’t think we really know at this point.”

Thomas Sampson of the London School of Economics.