In this blog, Jon Wolff shares observations on how Brexit is beginning to impact employer covenants.
If I cast my mind back (more than 21 months now!) to the end of June 2016, there was a huge amount of activity around LCP, with our experts considering how the Brexit vote could impact upon our clients - how would funding levels change, how long would the volatility in equity markets continue and how would employer covenants be affected, given each employer’s specific circumstances?
In the LCP covenant team we considered the hypotheticals and came up with a check list, which we then discussed with a number of our clients, covering things like whether or not there was an overseas parent company, how reliant the companies were on imports and exports, and the extent to which businesses relied upon an EU labour force.
We had lots of good conversations providing valuable insights. However, whenever we came up with the killer question of “can you quantify how the vote may impact upon future trading?”, perhaps understandably, 9 times out of 10 the answer was “it’s just too early to tell”.
This was a common response way beyond Summer 2016, with so many unknowns and variables meaning that it was difficult to really bring any quantifiable analysis onto the table beyond some quite generic sensitivity analysis.
However, it is now becoming more apparent how the impact of the Brexit vote, and the uncertainty of the final outcome for the UK, is having an impact on some clients.
We have seen situations where clients reliant on raw material imports have seen their cost bases sky rocket given the inflationary impact of Sterling weakening. Even where forward currency hedges were in place, as pre-vote contracts have expired, clients have had to renegotiate new arrangements at much less favourable rates.
We have also seen situations where clients have needed to plan for, or actually commit to, relocating in order to ensure the continuity of trade post-March 2019, when the UK is due to formally leave the EU.
Such relocation projects usually require significant amounts of capital, and put a new slant on “investing for sustainable growth.” Normally we would expect an employer to be justifying the need for relatively low deficit contributions to schemes by stating that investment today will lead to a stronger covenant tomorrow. Now the message can be that relocation investment is needed just to survive.
We have been working with clients to consider what the impact of Brexit might be on their funding position and overlaying these with the potential impact on their sponsor covenant, under different Brexit scenarios. Typically different scenarios show very different outcomes. However, the point is that understanding possible outcomes and key drivers enables Trustees to start planning and engaging with the sponsor on what the implications of Brexit might be for that particular scheme.
With the Brexit negotiations moving forward at what seems like glacial speed, there remains a long way to go before we see the full impact of what the UK voted for on 23rd June 2016.
I don’t have a time machine to be able to see exactly how things will pan out, but I do know that pension schemes which have well thought out integrated risk management strategies, and have contingency plans to deal with future uncertainty, Brexit related or otherwise, will be best placed to stay on track to meet their objectives.