Europe – the Final Countdown
04 Mar 2019 - Estimated reading time: 1 minute
Brexit is upon us (or at least it was at time of writing), although what this means for any of us remains uncertain.
From a funding and strategic perspective, our long-term approach eases concerns over the potential of Brexit and English and Wales LGPS valuation dates coinciding. In terms of shorter-term factors, we encourage Funds to consider which sectors are likely to have most sensitivity to the Brexit outcome (the market movements immediately post the EU referendum give a sense of potential sensitivities e.g. sharp sell-off in Sterling, domestically sensitive UK stocks underperforming and a rally in Government bonds). UK Property is another area likely to be highly sensitive to the eventual Brexit outcome (we discuss the UK property market in more detail in our latest Investment Perspectives).
Using this information we have carried out “Stress testing” for a number of Funds to help them understand the potential financial impact of three possible scenarios:
- Soft Brexit – likely to reflect a continuation of the existing agreements with the EU, and the UK’s competitive position is forecast to be more secure. An uplift in UK GDP and interest rates, and stronger Sterling are anticipated in this scenario.
- Hard Brexit – weakening the UK’s competitive position at least in the beginning. Expectations of a ‘soft Brexit’ are reversed here. Modest rise in inflation and Sterling credit spreads might also result, and a markdown in UK property values.
- No deal –greater uncertainty with regards to the UK’s competitive position as well as trade disruptions. With a bigger adjustment to Sterling expected, more significant GDP slowdown, lower interest rates, and a more severe markdown in UK property.
How Funds fared in the different scenarios depended on the nature of the assets in which they are invested. From an LGPS perspective we encourage focus to what these stresses might mean for employers with shorter expected time horizons in the LGPS.
In addition to the above focus on assets, we also encourage Funds to understand potential operational “squeezes” e.g. derivative settlements, potential liquidity needs over the period and consider their exposure to overseas domiciled funds (most notably money market funds).
Those of you of a certain age will recognise the title of the 1980’s hit song. Ironically, given the profession we work in, the song’s writer (Swede, Joey Tempest) said, “who needs a pension when you write song like the Final Countdown”. While I’m sure this is true for him, I’m not sure his royalties will be enough to go round all the LGPS, therefore it is important to consider what Brexit “squeezes” the LGPS might face.