On 29 March 2017, the UK triggered Article 50 of the Treaty of the European Union, meaning that the UK will be leaving the EU by March next year. In a brief overview provided by the Treasury earlier this year, it was stated that, “as set out under the treaty, the UK has two years to negotiate a Withdrawal Agreement and framework for a future relationship with the EU before the point of the UK’s exit.”

Following on from the Treasury and the Bank of England (BoE) releasing their latest Brexit economic forecasts, KPMG’s Restructuring practice has revealed that there has been a “flurry of enquiries” from organisations looking to mitigate the significant ‘working capital crunch’ that could be the result of a ‘no deal’ Brexit.

In a speech delivered by Mark Carney – the governor of the BoE – at the Society of Professional Economists earlier this year, he highlighted how the UK economy “has been subject to a series of major supply shocks over the past five years, creating tensions between short-term output and inflation stabilisations. Brexit is the latest and potentially largest example.”

Fast forward seven months and the future looks just as uncertain, despite there now being a draft agreement in the works.

Prime minister Theresa May has, in recent weeks, negotiated a draft Withdrawal Agreement that has been approved by the EU27; it is set to be put before parliament on 11 December.

“Businesses around the country have been contingency planning for some time now, but the recent forecasts from both the Treasury and the Bank of England regarding the impact to the British economy of the various Brexit scenarios currently in play appear to have prompted companies to take more direct action,” Blair Nimmo, head of restructuring for KPMG in the UK, said.

Carney, in his speech at the Society of Professional Economists earlier this year, said: “Brexit is a regime shift that has markedly increased the range of possible outcomes for the UK economy, and therefore the potential paths of monetary policy. […] The actual path for policy will depend very much on how the Brexit negotiations evolve.”

It remains uncertain whether May’s Withdrawal Agreement will provide businesses with the stability they require, or the support to establish new trading links.

What has been said before?

According to UK Government’s Preparations for a ‘No Deal’ Scenario from 2018, “it has always been the case that, as we get nearer to March 2019, preparations for a ‘no deal’ scenario would have to be accelerated. Such an acceleration does not reflect an increased likelihood of a ‘no deal’ outcome. Rather it is about ensuring our plans are in place in the unlikely scenario that they need to be relied upon.”

This could explain the increased tensions and worries industries are sharing in recent months, but it has yet to be fully established how these concerns will be alleviated. Banks have their own worries about Brexit. Although Carney has stated that all large banks will be able to handle a “cliff-edge” Brexit, Nimmo has cited there are still prevalent worries in this sector of the financial industry.

Nimmo said: “We know from our conversations with banks that they are increasingly concerned about how to support their customers’ working capital requirements in a ‘no deal’ scenario. This has seen some rapidly trying to segment and prioritise their portfolios in order to form views on credit risk appetite and how to respond to what may be tens of thousands of requests for new credit facilities or extensions to existing lines. Indeed, we’ve already seen a number of banks confirm they have set aside extra cash for exactly this purpose.

“Meanwhile, businesses are ramping up their own contingency planning. Clearly there are numerous complex issues to contend with. However, we’re now seeing a shortlist of ‘critical path’ items that, for a significant number of UK businesses, are considered a priority – that is, those which could have the most direct and immediate impact on day-to-day liquidity, access to capital and bottom line profitability.”

Although the government has continuously reassured UK businesses that their interests will be protected during this unstable period, companies are still holding back and being far more cautious, thus having an impact on the economy.

When Mark Carney delivered his speech to the Society of Professional Economists in May 2018, he outlined how the Monetary Policy Committee’s (MPC) role is to alter their decisions according to what is most beneficiary for households and businesses in the UK.

He said: “The MPC’s guidance speaks first and foremost to UK households and businesses. This is particularly important during large structural or regime shifts when uncertainty is high. In the wake of financial crises or advance of wholesale changes to trading relationships, people’s expectations for monetary policy can understandably diverge from its most likely path to the detriment of the economy’s performance. Guidance is most useful at such turning points.”

However, according to this article by The Guardian, predictions such as GDP falling by as much as 8% in 2019, house prices falling by 30%, and unemployment rates increasing from 4.1% to 7.5% have been deemed as “too severe” by respected economists like Paul Krugman and Andrew Sentence.

BoE predicts May’s Brexit deal has potential to encourage economic growth over the next five years (relative to the current forecast), but only if Britain maintains close EU trading ties going forward. Should a bad deal or ‘no deal’ be established, BoE could raise interest rates as high as 5.5%.

What did KPMG UK have to say about recent forecasts?

Head of restructuring at KPMG UK, Blair Nimmo, shared concerns the firm has identified through industry insights and their clients: “First, the impact that tighter border restrictions may have on working capital and cash conversion cycles, should import and export lead times be slowed. At the same time, many companies are running the slide rule over what further significant currency volatility would do to their margins, in addition to evaluating the operational impact of migration measures affecting lower-skilled workers.

“We are also seeing clients assess and respond to the potential risk of problems emerging in their supply chains, from a basic modelling of the impact of import cost rises to, for some, a total restructure of their supply chain to avoid product outages.

“Finally, in recent weeks, we have seen more and more large organisations confirm their intentions to stockpile goods, with typical buffers ranging from one to two months upwards of incremental stock being put aside.”

The findings from the Decision Maker Panel (DMP) Survey

The Treasury Committee (TC) revealed in a hearing on 20 November 2018 that the Bank’s Agents had conducted a survey using their business contacts regarding their preparedness for Brexit. On Tuesday 4 December, BoE Agents released the latest findings from their Decision Maker Panel (DMP) survey.

According to the report, through “using simple calculations, the survey suggests that companies expect output to fall by between 2.5% and 6.9% over the next 12 months in a ‘no-deal and no transition’ scenario, but to rise by between 0/8% and 2.7% if a deal and transition period are agreed.”

The DMP survey, developed by the BoE with academics from Stanford University and the University of Nottingham consisted of 6,600 firms in November 2018. 45% responded that month, so it is important to consider the fact that around one-third of these responses were received before May announced the draft Brexit deal on 12 November.

One concerning revelation cited in the survey was that most of these companies have not yet made changes to their business plans, or they are still in the process of drawing up their contingency plans. With mere months to go before the UK leaves the EU, businesses will be working up until the deadline to ascertain they are prepared for the changes coming their way. Just under a third said that they had made some changes to their original plans in the face of Brexit—yet, a third has admitted that they plan to make no changes at all.

This could reflect the caution with which UK businesses have been relying on in the face of uncertainty. With the question of a second referendum still being debated, investing in preparations for changes that have not been solidified could just be a waste of money.

According to the Agents, these applied changes are largely the “setting up [of] new legal entities, changing sourcing and/or supply chains, and, in some cases relocating offices.”

The report continued: “Brexit has created uncertainty for many businesses, and the DMP data suggests that Brexit’s importance as a source of uncertainty has risen further in recent months. Half of DMP members reported that Brexit was in their top three current sources of uncertainty in the November survey. That was similar to the September and October surveys, but 12 percentage points higher than the average of earlier waves.”

By the end of March 2019, just under 50% of businesses that took part in the DMP survey expected to have changed their business plans. For example, they will have assessed potential stockpiling requirements.

In the scenario where a ‘deal and transition’ agreement is reached, companies expect modest growth in their output over the next year. Conversely, if a ‘no deal and no transition’ deal goes through, they – rather unsurprisingly – predict a significant fall in their output. Exports, in particular, have anticipated significantly lower export activity in this situation.

Other key points included:

  • Professional services have anticipated fewer M&A deals and expansion/developments plans in the near term if it is ‘no deal’.
  • Companies expect a sharp drop in employment over the next 12 months if there is ‘no deal’.
  • UK businesses largely expect investment growth to be slower—although they are largely positive, even if it is a ‘no deal and no transition’ scenario.

When asked in the DMP survey about the “probability that they attach to a disorderly Brexit whereby no deal is agreed by the end of March 2019”, 42% (46% unweighted) believed this to be the case, compared to 40% (41% unweighted) in February to April 2018.

How can firms and businesses best prepare?

Moving forward with the high risk of a working capital crunch, KPMG has cited ways in which businesses could and should prepare, despite ongoing uncertainty.

“Given the extra capital being set aside by some of the banks, financing for incremental inventory purchases may be available, which will be comforting news for many,” said Nimmo. “However, we’d caution that we expect such funding to be limited to those with a strong credit proposition, backed by robust analysis. In simple terms, that means illustrating clearly why and when any significant new funding will be required, but perhaps more importantly, how and when inventories will be unwound, and that short-term funding repaid.

“With the threat of a new working capital crunch looming large, it’s heartening to see so many firms taking actions. However, our message to companies who are in ‘wait and see’ mode is this: if you can lock-in liquidity now, you should. That means any borrowers with debt maturing in 2019 or 2020 should be actively considering refinancing processes right now.”

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