It's finally here.
In fewer than 75 days—if all goes as expected—the UK is set to leave the European Union after nearly two years of negotiations and very few results. With the country still under a cloud of uncertainty and no definitive plan, it is difficult to predict the ultimate effects of this event. However, looking back over the past few years since the initial vote, it is clear that Brexit has already had an impact—and private equity hasn't been spared.
Many UK-based investors have been adopting a more cautious attitude toward dealmaking while waiting for the situation to become clearer, with senior members of the private equity space telling PitchBook that their firm has effectively put on hold a number of major transactions for fear of the consequences if a suitable deal cannot be made between the EU and the UK.
It isn't just that some deals have been postponed—others have actually fallen through. This is evident in the case of a £2.8 billion bid for real estate company Intu from a consortium of investors, including The Peel Group, Saudi Arabia's Olayan Group and Canada's Brookfield Property Group. After three extensions to the deadline, the deal collapsed in November with Brexit cited as one of the factors, per the BBC.
According to PitchBook data, there has been significant fluctuation in the number of transactions and the amount of capital invested in UK-based businesses from European investors since 2016. There is a wide range of factors that shape the private equity space, but an event as major as the UK's move to exit the EU after nearly half a century is not something that can be ignored.
Starting in 2016, the year of the referendum, there was a massive drop in PE activity in the UK from EU-based investors, falling from 113 deals worth €22 billion in 2015 to 89 totaling €10 billion. With all the uncertainty in the run-up to the actual vote, it makes sense that caution prevailed and led to a drop in activity. While the decline was significant in 2016, the rise in 2017 was even more so—and at first glance perhaps surprising. The number of PE transactions that year shot up to 118, with European investors pouring a record of almost €28 billion into the industry, cementing 2017 as private equity's best year of the past decade. In 2018, activity fell somewhere in the middle with deals dipping slightly but not to the same extent as 2016, although the amount of capital invested dropped to close to €14 billion.
The spike in activity may well be explained by the pressures of the surrounding uncertainty. If you don't know what the country is going to look like in two years' time, there's an incentive to get your ducks in a row beforehand.
With no more clarity at the beginning of this year than at the end of the last, private equity firms are reportedly starting to put in place contingencies for the worst-case scenario, a no-deal Brexit. While it is difficult to imagine what a post-Brexit (deal or no-deal) world will look like, there will almost certainly be some consequences in the short term which would likely hit the industry. So, what could be the impact of Brexit on UK private equity?
No-deal, less appetite
Should the UK no longer have access to the single market, this could create a myriad of problems surrounding regulation. A no-deal Brexit could mean that UK private equity firms and foreign sponsors who have chosen the country as their European base would no longer fall under the Alternative Investment Fund Managers directive, which has created a single marketplace within the EU for hedge funds, private equity funds, real estate funds and other structures, according to the Alternative Investment Management Association. This could leave many investors scratching their heads as to which funds to invest in post-Brexit. It would also mean that UK-based investors would not be able to manage EU funds, a consequence of which could see a mass exodus from the country as investors set up shop on the continent.
The UK, and London in particular, could see a veritable ‘brain drain' as members of the industry relocate. According to a 2018 survey from recruitment consultants PER, more than 80% of non-UK EU citizens working in or around UK private equity wish to leave Britain following the Brexit referendum with most planning to leave within the next two years. France, Germany and Switzerland emerge as the most likely recipients of this talent as they vie to take the mantle of Europe's largest financial center. France in particular has stepped up its efforts to lure UK-based private equity executives to relocate by promising to cut the tax rate on the cut of profits managers share with their investors.
There is a silver lining however as the European Commission and European Securities and Markets Authority are currently considering allowing a number of non-EU jurisdictions to access certain provisions of the AIFM directive. If this were to happen—and the UK were to qualify—the negative consequences for the industry would be somewhat mitigated. The British government has also announced plans to put forward legislation creating a temporary permissions regime to allow European funds to access the UK market for a limited period after the exit date.
On the deal side, we have seen that Brexit has already had an impact, a phenomenon which is expected to continue. Aside from the cautious investor attitude, the volatility of the pound sterling is limiting private equity investors' ability to accurately price British assets in other currencies. This too could potentially lead to fewer deals.
Brexit is likely to have a bigger impact on certain sectors more than others, especially those which are heavily regulated, such as pharmaceuticals and financial services. Companies in these areas may find themselves in a less attractive position in the event of a no-deal, certainly with respect to foreign private equity firms.
Sunlit uplands?Without a crystal ball, no one knows how Brexit is going to play out and what the effects will be for the private equity industry. That being said, the last couple of years have seen very strong fundraising with firms sitting on an ever-increasing pile of dry powder. Regardless of what kind of deal—if any at all—the UK gets, PE investors still have money to spend, and British businesses still need money to grow.
Deals could get smaller and less frequent, or it could be business as usual. One thing is for certain though: The UK has many benefits, and a key one is the quality of its companies and their capacity to adapt.
For more on the future of private equity, have a look at our 2019 Private Equity Outlook