Hedge funds and a potential Brexit

It was a catchy story that the FT reported on Tuesday. According to the piece, hedge funds are commissioning their own exit polls for the 23rd of June in order for them to place their bets accordingly. Ideally, a vote for Brexit will be a stunner for an industry that has seen its profits decline quite significantly since the start of the year. The “hedgies” are now expected to gamble on the pound and on pound-derivatives, amongst other financial products.

For their private polls, the hedge funds are making use of the framework set out by the Electoral Commission. It states that polling is allowed unless the results are published before the closure of the polling stations at 10 PM on the 23rd of June. Not only hedge funds but also banks will be interested in getting an early impression of the possible result of the referendum, as it is very likely that it might affect their business, both in the short and in the long run.

The market currently foresees a drop in sterling in the magnitude of around ten percent, should there be a vote for Brexit. Some experts go further than that, predicting an even sharper decline. Last week, the rating agency Standard & Poor’s made big headlines with a prognosis that a vote for leave could cost the pound its reserve currency status. “A decision by Britain in favour of leaving the EU in the June 23 referendum could jeopardize the British pound sterling’s position as a reserve currency and the associated benefits to the credit rating, in our view”, the analysts wrote in their report.

In case of a Brexit-vote, central bank reserve managers “might prefer to reallocate toward assets with less headline risk than the GBP”, they concluded. With sterling having lost more than seven percent against the euro during the last six months, the route of travel in case of a decision for Brexit is obvious. This became clear again on Tuesday when an ICM phone poll which saw the leave campaign in front led to a surprise fall in sterling, after a nearly month-long recovery in May.

Hedge funds, wealth managers and stock traders will try to benefit from swings in the pound before and after the election. Mike Amey for example, Managing Director and Portfolio Manager at Pimco, tries to prepare for all possible outcomes on June 23rd: “We believe that portfolios can be structured in a way so that they will benefit from a vote for remain and that they are hedged, should there be a different decision”, Amey commented. For that reason, Pimco is buying bank bonds and gilts with five- and ten year maturities and sells British pounds for US-dollars. You can be pretty sure that Mike Amey is not the only one preparing his portfolios for referendum day. But not many are as willing as he is to talk about it.

So far, the hedge fund industry is perceived as being in favour of Brexit, whereas the big banks are seen in favour of remaining in the EU. There are prominent bankers who have spoken out in favour of Bremain, e.g. Jes Staley (Barclays), Gary Cohn (Goldman Sachs) and John Cryan (Deutsche Bank). Equally, you have prominent fund managers that are publicly in favour of Brexit, e.g. Jon Moulton (Better Capital), Savvas Savouri (Toscafund) or Crispin Blunt (Crispin Odey). A letter in favour of Brexit signed by more than 100 City grandees seems to underline the thesis that “hedgies” and other financial service providers are for leaving.

However, according to the industry body AIMA, this is more perception than reality. I recently spoke to their deputy CEO Jiri Krol and asked him whether it was true that the hedge fund industry was primarily for Brexit. He disagreed. “I don’t think you can draw the picture in black and white – banks for remain, hedge funds for exit”, he said. In his opinion, the lines are much more blurred than they appear to be.

Interestingly, he addressed one of the core points that I had been thinking about that day. Is it true that a vote for Brexit could free the financial industry from existing regulation? Given that financial markets these days are becoming more, not less regulated, not just in the UK and the EU but also in the US and in China, I reacted quite sceptically when I first heard that argument.

Krol, as one of the leading representatives of the industry, seems to be thinking similarly. “For some reasons, people think regulation would change dramatically for hedge funds if the UK was to exit the EU”, he explained. That, according to him, is a false conclusion: “Nobody really thinks that the UK government will dismantle the existing framework”, Krol said. In some areas, for example the issue of dealing commissions for financial advice, the British Financial Conduct Authority actually made recommendations that went further than those of its European counterpart. “In this stance, the UK was at the more hawkish end of the spectrum, not at the more liberal”, Krol concluded.

In his opinion, arbitraging between different legal frameworks will not make a lot of sense. “The dream of sailing the seas in an independently designed and separate framework is not a serious possibility”, he said. In any heavily regulated industry, there would be continued heavy regulation. Not only the UK’s adoption of financial standards like Mifid 2 and the FSB´ stability mechanism but also events like the Anti-Corruption Summit that took place in London earlier this month should remind hedge fund managers who advocate for Brexit that it is very likely that we will see more, not less regulation of financial markets in the years to come.

And, by the way, if they want to continue advertising in the EU, they also need to follow the existing framework that applies to funds that do business in the EU. “There isn’t really a case for a freer, less regulated financial industry”, Jiri Krol stated.






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