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What does Brexit mean for GCC investors?

The European Union accepted Prime Minister May’s Brexit Plan on the 25th of November. After 20 months of talks with EU negotiators and a difficult approval by her cabinet which cost two ministers, May still has to get 320 MPs to vote for her deal on 11 December.

Announced on the 14 November, May’s Brexit deal has been presented as “the best deal possible” by both Downing Street and Brussels, guaranteeing a close partnership between the UK and the EU whilst keeping a positive environment for business and securing British national interests, namely the end of the freedom of movement and a return to constitutional integrity. If approved by Parliament, the terms of Britain’s withdrawal from the EU would therefore be official and the EU would formalise the process with a majority vote from the Council and an early 2019 vote by the European Parliament.

The problem is that the deal has many detractors in the UK and is presented as the only alternative to chaos, thus reviving critiques of “project fear” from opponents. . Jean Claude Juncker, the president of the European Commission asserted that “this is the only deal possible.” A contentious matter is how the Northern Ireland backstop issue has been resolved. If Parliament approves the deal, the UK would leave the EU on 29 March 2019 and have a transition period until the 31 December 2020, during which the Kingdom will follow EU rules, particularly on employment, environment, tax and the European Court of Justice. However, to avoid a hard border between Northern Ireland and the rest of the UK, London agreed to indefinitely stay in the European Customs Union beyond the transition period, until a free trade agreement is reached with the EU. This of course, without having any say in the making of EU laws.

That is why winning Parliament’s vote on 11 December will be far from a walk in the park for May. She will be faced by Labour leader, Jeremy Corbyn, who lately announced his opposition to the deal he called “the worst of all worlds”. May’s deal is also opposed by all 10 Democratic Unionist Party (DUP) MPs and by some Conservatives members, who are either Brexiteers or Europhiles. Bloomberg estimates that a maximum of 368 MPs could vote against the deal, thus invalidating it. Uncertainty is therefore very high, as Jeremy Hunt, Secretary of State for Foreign and Commonwealth Affairs concurred that “nothing could be ruled out”.

Indeed, it would seem irresponsible for British and European officials not to have a Plan B. The latter could either be an extension of negotiations or a new referendum. A hard Brexit remains the least desired option, but its likelihood seems to be higher than either longer negotiations or a new referendum. Indeed, an extension would require a unanimous European vote which might be difficult to achieve considering the reluctance of EU members to drag their feet into yet another round of negotiations. On the referendum side, things get even more difficult as time is running out before the leave deadline and major parties have still not brought the issue forward. Another Parliamentary majority would also be needed for general elections to be called, or a majority vote from Tory MPs to replace Theresa May, something which remains as difficult to achieve than passing the Brexit deal. Therefore, a hard Brexit with all its negative repercussions, including an uncertain legal and business environment remain something to take into account for anyone interested in investing in the UK.

The costs of “Brexits”

Researchers overwhelmingly agree that Brexit’s economic impact will be negative. Between a soft and a hard Brexit, only the damage range differs. The latest research from LSE, King’s College and the Institute for Fiscal Studies hold that, depending on its staying in the Customs Union, the UK’s economy will be around 1.9-5.8% smaller in 2030 than what it could have been if it stayed in the EU. The relative recession would amount to 3.5-8.7% in the case of a hard Brexit.

The distance between such numbers is high because we don’t know yet which of the many “Brexits” the UK is going to take. Despite the near 600 pages in May’s deal, little is known of the UK’s future economic partnership with the EU, including its effect on migration, trade barriers and the service industry. This uncertainty has already claimed £22 billion in held-up business investments since 2016 and the worst-case scenario, from Cambridge Econometrics, holds that nearly half-a-million UK jobs could be lost by 2030. If uncertainty continues and economic conditions worsen, this could impact GCC countries, particularly the UAE. Indeed, there are 120,000 Britons in the country who in 2015 represented the second largest investment group in Dubai’s crucial property market, and more than 1.2 million visitors from the UK, who could suffer from the Sterling’s depreciation.

Gradually, London might lose its status as the world’s financial capital and the currently depreciated assets like equity and property might not have the return on investment rates that were once usual for an economy like the UK. Because of this, the London Stock Exchange might lose Initial Public Offering opportunities from Gulf companies but also listings from companies like DP World which left the Stock Exchange in 2014. Moreover, the global economy seems to be exiting a period characterised by high liquidity and the Bank of England is set to raise interest rates, which are already at 0.75%. This is why it is less reasonable to expect UK shares to rise and outperform European competitors as soon as Brexit is settled. Real estate regulation might also have a negative impact for investors as there are higher stamp duty charges when buying property and higher capital gains tax when selling one.

The new Annual Investment Allowance (AIA) announced by Chancellor of the Exchequer Hammond is unlikely to positively affect Gulf investors, as their investments largely exceed the new £1 million threshold. The current uncertainty surrounding the Brexit deal is likely to slow investments coming from the GCC, especially considering the small albeit non-negligible risk of having a general election in which Jeremy Corbyn replaces Prime Minister May. Manuel Almeida, partner at a geopolitical risk firm says that “the ideological baggage of a Corbyn-led government could be enough to deter many GCC investors. Among planned measures of heavy state intervention in the economy is a programme of nationalisations of everything from transportation and mail to water and energy”.

Almeida added that “pushing those plans through may become a quagmire of legal battles with investors. However, it would send all the wrong signals, could have all sorts of negative repercussions in the wider economy and would certainly deter many of investing in such a climate”. Even without having Labour in power, the extent to which the British government is ready to go to strike deals remains uncertain. While a low Pound welcomes the purchase of shares into British companies, one should expect higher scrutiny from the government if foreign acquisitions start to skyrocket after Brexit, particularly for strategic national industries in which GCC countries are interested: artificial intelligence, financial technology and creative industries.

In the case of a no-deal Brexit, the situation becomes even trickier for Gulf investors. Although the economic impact of a hard Brexit can lead to even more depreciated assets and a lower Pound, there is little indication showing strong appetite among Gulf investors for volatility. Even if Mark Carney, the Bank of England’s chief, is right about house prices decreasing by 35% in the case of a hard Brexit, the medium-term volatility surrounding the UK market will certainly hinder GCC flows to the UK. Indeed, it will be hard for investors to gauge when the market correction will end after a hard Brexit, meaning that investors will wait until prices start to rise again. Uncertainty is therefore likely to surpass the higher discount offered on UK assets, as GCC investors invest in the UK for its being a safe choice, not a risky bet.

The benefits of Brexit for GCC investors

Nevertheless, GCC investors should not overlook opportunities in the UK, especially in the case of a soft Brexit where political and economic stability is back, and the market correction over asset prices over. The UK has been a second home for Gulf Arab investors since the 1950s, and their perception of London as a long-term safe-haven is unlikely to change as a result of Britain leaving the EU. Indeed, the UK has in and of itself been an investment destination for Gulf investors, regardless of its EU membership. According to the World Bank, the UK remains the fifth largest economy in the world and is ranked 7th in the Ease of Doing Business ranking. This is why a smooth Brexit deal could lead Gulf investors to deploy their capital into the UK. However, the window of opportunity created by Brexit, in terms of a cheaper pound and depreciated assets, could but they will have to be quick to use the short window of opportunity created by Brexit, namely a cheaper pound and depreciated assets.

First of all, four out of six GCC economies peg their currency to the dollar, which has consistently gained value over the Pound Sterling since the referendum. From $1.50 in 2016, £1 is now only worth $1.27, which is a worthwhile win for Gulf investors if one takes into account depreciated assets in the UK. The property market is a perfect example as high-end houses are now cheaper in London, where price decreases averaged 5.8% in the last 12 months and even went down by 20% in the affluent neighbourhood of Belgravia. Other cities like Manchester, Birmingham and Edinburgh should also become more attractive in the eyes of Gulf investors. Assets in the UK are currently discounted; they are likely to rise with a soft Brexit and are an opportunity not to be missed.

Same thing for investing in companies. The FTSE has lost 8% of its value since the beginning of the year, which means that there are plenty of cheaply valued companies in which to invest in. Currently, Gulf investors are more likely to benefit from investments in companies with revenues from outside the UK, like mining, pharmaceuticals, commodities and consumer staples companies. On the other hand, companies tied to the UK market like property developers, retailers and commercial banks might not be considered for immediate investments, but could represent a great opportunity once stability comes back to the market. There will however be a short window for deploying capital. These days, the environment is yet too uncertain. But if May manages to pass her bill in Parliament, the market could already respond positively to regained political certainty and it would be sound to start deploying capital in the UK.

A surge in UK investments in the GCC?

Finally, Brexit also creates some opportunities for UK investors in the Gulf. As the UK seeks to find and reinforce non-EU trade partners as part of its “Global Britain” strategy, the region is set to attract UK investors, especially considering its rising economic growth. The UK already exports around £30 billion annually to the region. It expects to increase such numbers by reaching an additional $100 billion trade and investment into Saudi Arabia until 2030 and $25 billion of annual bilateral trade with the UAE by 2025.

The UAE in particular is going to reap the benefits of having a liberal business environment and attractive opportunities. The UK Export Finance department has set up an office in Dubai in March 2018, and has started a fund of £9 billion for the Emirates. Dubai’s Multi-Commodities Centre has also recorded from July 2016 to February 2018, a 29% increase in UK companies operating in the free zone, a number which is far greater than any other European country. Fintech, AI, professional and financial services, clean growth and creative industries should all be sectors in which UK companies will invest in the Emirates.

Takeaways:

  • Current high levels of uncertainty are likely to deter GCC investors.
  • Yet, if the 11th of December Parliament vote ends in a surprise approval of May’s deal, then the likelihood of a soft Brexit would increase and stability would regain the markets. Britain’s withdrawal from the EU would be sealed and negotiations would potentially lead to better clarity on the future EU-UK economic relationship, thus raising investor confidence.
  • GCC investors are then likely to enjoy a short window opportunity to deploy capital and benefit from the cheap company valuations, lower property prices and devalued Pound Sterling, before the market correction ends completely and the window of opportunity closes.
  • However, if a hard Brexit ensues, the picture becomes much more complex for GCC investors, who might not risk the high volatility created by a no-deal Brexit, despite the discount created on British assets and Pound Sterling.

Our publications do not offer investment advice and nothing in them should be construed as investment advice. Our publications provide information and education for investors who can make their investment decisions without advice.

Sources:

Albawaba, 26 March 2018, “Dubai perfect destination for UK businesses after Brexit”.

Arab News, Manuel Almeida, 20 September 2018, “Brexit’s economic and political effects a puzzle for the GCC too”.

Arab News, Richard Wachman, 27 September 2018, “Wall of Gulf money heading for post-Brexit Britain”.

Financial Times, 24/25 November, FT Weekend House&Home, “Follow the money”.

Gulfnews, Siddesh Suresh Mayenkar, 19 November 2018, “Hard Brexit? This time its different for UAE investors”.

TheEconomist, 17 October 2018, “Why the risk of a no-deal Brexit is increasing”.

Wall Street Journal, 18 October 2018, “Brexit Britain’s Broken Politics Leave Investors Few Bargains”.

Photo Copyright © 2018 Bank of England.

 

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