UK Investment Banks Report Worst Quarter in 8 Years Ahead of Brexit Vote

© REUTERS / Neil HallA branded balloon and mug are seen in the office of pro-Brexit group pressure group "Leave.eu" in London, Britain.
A branded balloon and mug are seen in the office of pro-Brexit group pressure group Leave.eu in London, Britain. - Sputnik International
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The UK's banking sector's performance was affected by the Brexit referendum outlook, with earnings and deal making declining in Q1, providing an outlook on crisis sustainability to the nation's entire financial system.

Kristian Rouz — Anxiety has taken its toll on the most prominent segment of the UK's financial services sector, investment banking, in the first quarter of 2016 as the total amount of deals concluded slumped amidst concerns of Britain possibly leaving the European Union in June. The amount of merger and acquisition (M&A) deals declined to least since 2010, whilst overall deal making sank to its eight-year bottom in Q1: investors and money managers have either postponed their activities till after the Brexit vote on 23 June, or opted for holding on to their money.

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Corporate M&A spending dropped an annualized 39% in Q1 in the UK, according to Bloomberg calculations, as managers have become increasingly cautious amidst anticipations of economic turmoil in the Albion should the Brits vote ‘Out' on 23 June. Revocation of trade and immigration agreements is projected to weigh on the overall UK economic performance, resulting in slower growth, lower demand for credit and lower capital turnover, meaning the financial services sector is poised for a squeeze of an unknown scale in case of Brexit. Subsequently, the banking hub in the City of London is going through a period of calm in business activity, affecting its performance.

The total value of investment deals concluded in London in Q1 amounted at $50 bln, its eight year lowest, compared to $80 bln a year ago. Frustration is even greater in quarterly estimates, as in Q4 2015 the total volume of deals hit its multi-year highest at $230 bln.

Uncertainty of Downing Street policies toward the financial sector in case of Brexit is also putting investors and enterprises off deal making until after the vote. Currently, the UK's governmental regulation of the corporate sector is similar to that of the entire EU, yet, should Britain leave the bloc, changes in regulative policies are likely, meaning an extended period of rules adjustment, harmful for business activity.

"Because a lot of our regulation originates in Brussels, it is unclear what will be renegotiated if the U.K. were to leave the EU, but we expect a long period of reworking a number of treaties," Ben Higson of London-based Hogan Lovells said.

Aside of Brexit concerns, the broader international decline in M&A activity affected Britain as part of a prevailing global tendency. Stock market fluctuations, bond meltdowns, and currency swings that have accompanied the global economy throughout most of 2015 resulted in international M&A deal making declining by 10% in Q1 this year to $623 bln.

Meanwhile, the UK's banking sector has fallen on hard times. Profits of top British banks collapsed 40% in 2015, the steepest on the record, due to their excessive exposure to international headwinds, according to KPMG research. The combined earnings of Barclays, HSBC, Standard Chartered, Royal Bank of Scotland, and Lloyd's dropped to 12.4 bln pounds, to their 2013 levels, with Barclays, RBS, and Standard Chartered having posted net yearly losses in 2015.

"There is definitely not much news to cheer investors. Compensation is high, costs are not coming down as fast as expected, and there is a lot of project change over the next four years with ringfencing. There is more redress still to come out. So investors will have to be in it for the long run," Tim Howarth of KPMG said.

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Meanwhile, investors from mainland China ignored Britain in Q1, concluding 59% of their deals in mainland Europe, 26% in North America, and only a negligible 0.07% in the UK. Chinese investors find the Brexit perspective menacing to their businesses, seeking greater and more certain returns per dollar invested.

Deal making activity is, however, expected to increase after the Brexit vote, no matter the outcome. Should Britain leave the EU, the Albion's relations with the mainland would be subject to reformatting, but the changes would hardly be dramatic or unpredictable. In case of an ‘In' vote, business activity in Canary Wharf might even exceed its pre-referendum scale.

"We are likely to see a busier than usual summer, both in terms of equity capital markets and M&A activity as companies try to get deals done in what may prove to be a politically more stable environment, ahead of the US elections later in the year," Gareth McCartney of UBS Group AG said.

Most of the UK's governmental and monetary officials are explicitly favoring the ‘In' vote perspective, warning of dire economic consequences of a Brexit, thus effectively keeping investors out for the time being. That said, the two remaining months ahead of the referendum will likely be an extended period of slack for the UK's financial sector, meaning the GDP results from first two quarter of the year are likely to be lower, reflecting mostly the real economy's performance, a stress test for the entire system or sorts. Eventually, the current uncertainty will show the actual capability of the UK's economy to withstand certain political challenges.

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