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BrexitThe Implications for Ireland
Referendum on 23 June – The question . . .
Remain a member of the European Union
Leave the European Union
“Should the United Kingdom remain a member of the
European Union or leave the European Union?”
The European Union by currency
Two-thirds of Irish goods exports go to non-Eurozone members
14% of Irish goods exports go to the UK
UK14%
Eurozone35%
USA22%
Canada1%
Switzerland5%
RoW23%
Irish Goods Exports' Destinations
Merchandise exports to the UK performed strongly last year
Currencies were a big tailwind in 2015
13,500
14,000
14,500
15,000
15,500
16,000
17,500
20,000
22,500
25,000
2010 2011 2012 2013 2014 2015
Exports to the UK and US (€m)
US UK (RHS)
0.60
0.65
0.70
0.75
0.80
0.85
0.90
0.95
1.00800
900
1,000
1,100
1,200
1,300
1,400
1,500
1,600
1,700
1,800
Jan-03 Jan-05 Jan-07 Jan-09 Jan-11 Jan-13 Jan-15
€m
Exports to UK and €/£ rate
Exports (€m) EURGBP
Trade weighted sterling has retreated over 8% from its recent high
Recent sterling weakness is therefore concerning
75
80
85
90
95
100
105
110
Jan-06 Jan-08 Jan-10 Jan-12 Jan-14 Jan-16
Trade Weighted Sterling
Exports would be hit by further sterling weakness
This would likely widen in the case of a Brexit…
-2.5%
-2.0%
-1.5%
-1.0%
-0.5%
0.0%
0.5%
1.0%
1.5%
2.0%
2000 2003 2006 2009 2012 2015
Trade Balance with the UK (% of GDP)
CSO data show some sectors are heavily GB dependent
…with a number of sectors particularly vulnerable
0.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
GB share of Irish Goods Exports
The country punches above its weight in attracting FDI
Could Ireland benefit from Brexit?
0
75,000
150,000
225,000
300,000
375,000
UK
BE
DE
LU IE ES
FR
NL IT PT
SE
AT
MT
HU
PL
CZ FI
RO
BG
CY
HR
EL
SK
EE
DK
LV
LT SI
Total FDI ($m) 2009-2014 inclusive
The impact would be more pronounced in the short - term
The long-term effect of Brexit on Ireland is modest
Estimates of the impact of ‘Brexit’ on the Irish economy
IFO Institute 0.8-2.7% Hit to per-capita GDP in 2030
Oxford Economics 0.9-2.2% Hit to real GDP in 2030
LSE/CEP 1.0-2.4% Permanent reduction in incomes
What would happen if the UK votes “leave”
• UK invokes Article 50 of the Lisbon Treaty.
• UK and European Council assign negotiating teams to work out withdrawalarrangements and separate post-exit arrangements.
Process
• Negotiating period/remaining EU membership set at two years.
• Can only be extended indefinitely by unanimous ‘EU28’ vote.
• Agreement within two years looks highly optimistic, Swiss bilateral tradeagreement (I) took 6 years.
Time frame
• UK would no longer be part of EU single market.
• EU trade agreements would cease to exist after two years, if no deal reached-WTO terms would apply instead.
• Agreements via the EU with 53 other third party areas would also cease.
Trade
• UK would drop out of the EU customs union.
• Exports would have to comply with EU Rules of Origin.
Customs union
Different types of trade deals – Swiss, Norway, WTO
• Bilateral trade agreements.
• Tariff free access.
• Limited access to single market for financial services.
• No customs union.
• Adherence to EU principles, inc free movement of labour (safeguard clause-applies).
• Ability to negotiate its own trade policies.
• No vote on EU legislation, but accepts most.
• Full access to (EEA).
• Access to single Market for goods and services (ex-fisheries & agriculture).
• Accepts free movement of people, labour market rules, banking & climate change regulation.
• No customs union.
• Significant contributions to the EU budget.
• No vote on EU legislation, but accepts most.
• Trade conducted on a ‘Most Favoured Nation’ basis. Tariffs would apply and vary greatly across products.
• 4% average EU import tariff.
• Not bound by EU financial regulation, but may mirror in order to “passport”
• No obligation to free movement, but concessions possible in any agreements.
Detailed trade / access framework
Free trade agreements come at a price . . .
• This may force UK negotiations towards adopting WTO (Most Favoured Nation) status.
Can the UK abandon EU budget contributions (£10.5bn net in 2015) and impose migration limits and still enjoy single market access???
A ‘leave vote’: possible market and economic effects
• A sharp fall in sterling (10%?, 20%??) – significant volatility post-Brexit?
• A fall in other asset prices (FTSE, house prices?)
• Higher UK bank funding costs and tighter credit?
• Heightened economic uncertainty - household & business spending?
• Reduced inward investment?
• The start of an exodus from the City?
• Bank rate: lower for longer?
• Renewed calls for Scottish independence?
Possible effects include….
Economy likely to be weaker in coming months/years (despite competitiveness boost from a weaker pound). A price worth paying???
What to expect until 23 June
• Lots of political noise
• Uncertainty-related drag on activity?
• Volatility and weakness in sterling
0
5
10
15
20
25
2007 2008 2009 2010 2011 2012 2013 2014 2015 2016Sterling implied 3-month volatility
1.38
1.43
1.48
1.53
1.58
1.63
1.68
1.73
1.78
-0.5
-0.3
-0.1
0.1
0.3
0.5
0.7
0.9
Jan-14 Jul-14 Jan-15 Jul-15 Jan-16Spread (UK 3-m libor - US 3-m eurodollar future) (lhs)USD/GBP (rhs)
% $
GBP implied 3-month (at the money)
volatility
GBP:USD and expected rate differential
Our expectations for Sterling
Leave
• Sharp fall in sterling: 10%? 20%?
• Volatility to remain high –hedging costs?
• Possibly a fall in EUR:USD on Brexit contagion fears?
• Outlook depends on central bank action and the to’s and fro’s of negotiations.
Stay
• Cable immediately rises to $1.48 and EUR:GBP falls to 73.5p (currently $1.4050 and 81p).
• Volatility falls back.
• “Back to normal”, with sterling outlook based central bank action.
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BrexitHedging the FX Risk
Hedging - Brexit
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Corporate Treasurer with no sterling exposure Euro at risk from Brexit?
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Forecast – ‘Common Theme’
Jump Risk Assumption
Event Risk of Brexit – Binary Outcome?
Investec Bank
Stay Leave
0.7350 end of Q2 10% to 20% weakness
Investment Banks
Stay Leave
73p Parity
71p Mid 90’s
15% appreciation 15%-20% weakness
0.65
0.70
0.75
0.80
0.85
0.90
0.95
EURGBP Spot
EURGBP Spot 0.7890 "Stay" Win
Brexit Vote "Leave" Win
Strategy 1
Do nothing ! - Wait and covert post Referendum
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Strategy 1
Do nothing . . . Convert at spot post Referendum
If outcome is positive • Get all the benefit of a favourable move with no cost of
hedging.
Mitigating factors against a negative outcome• Can you pass on the cost of a negative outcome to your
customers?
• Will your competitors employ a similar strategy?
• Are there natural hedging techniques that you can
deploy?
• UK only a small portion of overall sales of purchases
• Are you a foreign exchange dealing Sage? – Beware of
Outcome Bias.
0.65
0.70
0.75
0.80
0.85
0.90
0.95
EURGBP SpotA Credible Strategy
EURGBP Spot 0.7890 "Stay" Win
Brexit Vote "Leave" Win
Strategy 2
Hedge Everything – Using Forwards
Pro’s
• Lock in rate and take out risk of negative outcome.
• Gives you certainty to price/budget from.
• Lock in expected margin
• Forward Contracts are more attractive when pricing to
clients is ‘stickier’ or long term contracts exist with client
Con’s
• Customers may expect price improvements on
favourable currency move
• Locked into contracts at unfavourable rates if outcome
moves currency your favour
• Competitors may not have hedged allowing them a
competitive advantage of favourable currency move.
• Margin Calls
• Cost of hedging
0.65
0.70
0.75
0.80
0.85
0.90
0.95
EURGBP + Forward
EURGBP Spot
Brexit Vote
Forward Rate 0.7916
EURGBP Spot 0.7890
Brexit Vote
Forward Rate 0.7916
Strategy 3
Buy Vanilla Options !!
Indisposition to Options
• Inappropriate for your business
• Complexity
• Lack of familiarity
• Accounting treatment of hedging.
• Premium/Cost
Specific Strategy for Event ‘jump’ Risk
• Buying a EURGBP Vanilla Call Option
What is a Vanilla FX Option?
• An FX Option is the right
but not the obligation to buy
or sell a specified amount of
a currency on a fixed date
at a fixed rate.
• You pay a premium for this
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Photo of the room
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Strategy 3
An example – GBP seller against EUR
Strategy 3 - Buying a vanilla EURGBP Call Option
Strategy Deployed
• Todays Spot Rate = .7890p
• Worried about possibility EURGBP will be trading
above 95p in the event of a ‘Leave’ referendum win.
• This would have a material negative impact on your
business
• Don’t want to use forwards as ‘stay’ more likely
outcome and you expect EURGBP will trade below 73p
in such an event.
• You buy a EURGBP Vanilla Call Option
• Protection at same level as forward 0.7916
• Decision date on the 27/07/2016
Strategy 3
An example – GBP seller against EUR
Buying an EURGBP Call Option
Best of both Strategy 1 and Strategy 2
• All the benefits of doing nothing (spot strategy) if the referendum is favourable.
• All the benefits of having booked forwards if the referendum is not favourable.
‘Having your cake and eating it’
No free lunch
• Premium Cost is 3.5% of amount you are hedging
• Assume hedging amount of £1m Cost = £35,000
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Strategy 3
An example – GBP seller against EUR
Buying an ‘Out of the Money’ EURGBP Call Option
Reducing the cost
Change the protecting Rate
Example
• Instead of protecting 0.7916 (forward rate)
• Protect 0.82 (Pinch Point)
• Buying ‘An Out of the Money’ Option
• Cost now reduced to 2.5% of amount hedge.
• On £1m = £25,000
Strategy 3
Pro’s and cons of options
Buying an EURGBP Call Option
Advantages: Disadvantages:
• Know ‘worst case’ EUR/GBP rate allowing
contracts to be budgeted with greater certainty
• Protection from GBP weakening beyond the
Strike Rate
• Full participation if EURGBP moves lower post
Referendum
• Can be a good tool to hedge Event risk where
outcome may lead to large FX movement.
• Need to pay Premium upfront
• For longer dated options with higher volatility,
option premium can be significant.
• No benefit in range bound market.
Strategy 4
Portfolio Approach
Forwards
Vanilla Options
Spot
Key things to consider:
• Know the risks.
• Know the tools at your disposal.
• Know what your competitors are doing.
• Do a scenario analysis.(Worst case scenario)
• Talk to your FX Provider.
• Know what works for your business.
• Make sure your Hedging Strategy is appropriate.
Final Thoughts
David Cameron’s concessions
• Not very wide-ranging. e.g. nothing on migration.
• Knew what he could achieve with EU?
What deal could be struck post-
Brexit?
• Free trade comes at a price. Something has to give!!
• Long period of uncertainty. EU and non-EU trade deals (53 of them) need to be struck.
• Migration/contribution ‘red lines’ may lead to WTO ‘MFN’ status.
Remain or leave? • Our forecasts are based on ‘remain’.
• Cannot rule out ‘Brexident’ e.g. if government popularity falls.
Markets?
• Sterling would fall on ‘leave’ vote, but would remain volatile – little point in specifying targets.
• Market reaction may depend on negotiating stance and who is negotiating e.g. would Cameron resign???
Brexit Coverage
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