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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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