Financial Implications of the Brexit

[QuantMan2318]

On the 23rd of June 2016, a historic decision was taken, The English and Welsh voters decided to leave the European Union (Collectively they constituted the majority in Great Britain, the Scots wished to remain while Northern Ireland was a mixed bag)
While I cannot comment whether the decision was right/wrong (it's their opinion), this is certainly a day wrought with massive ramifications. The consequences of this decision is unclear.

What do you think this means from a Financial and Economic perspective? I have attached a map from the NYT, the breakup is startling

http://nyti.ms/28RwypK

Meanwhile, you may have a look at the series of articles on the British breakup from the EU here

http://nyti.ms/28TBE8a

Please note, this discussion is purely on Financial consequences of this decision, no other discussion please.

For starters, it seems that Pound is on a free fall, and those who had earlier shorted the Pound would have made a windfall ( remember Soros in 1992? )

 

[QuantMan2318]

Like you had earlier entered into a contract to purchase some goods from British suppliers, you must have entered into some hedges, now will that hedges backfire? you renegotiate the hedge? create new hedges?

You are an Asset Management company holding a wide variety of securities with a significant exposure to Great Britain , what would you do?

You see, by seeing how the markets respond to this and what we would do as Risk Managers, we can learn from current events

 

[Arka Bose]

Hi, nice thread. The repercussions are different for different players, here I take position as a US resident
For a US manufacturer, a currency hedge will backfire. The pound is down to its lowest levels in 30 years and the firm is going to rue lost margins. Moreover, engaging in a future contract may induce liquidity risk??? He could have however entered into a new opposite position in currency future just before the brexit saga took place, in that way maybe he would have limit his losses?
If i am an asset manager having large exposure in britain, i will have a tough time in the near future. in that case, i would definitely try to exit positions. however, given the fact that britain is the leading consumer in europe, economic recovery will be likely and the central bank will reduce the interest rates going forward, thus i would invest in british short term securities.
Others, as well as Mani, plz let me know your thoughts. What would you do if you had invested in an emerging market economy whose businesses have large exposure to european economy (including britain)

 

[QuantMan2318]

Hi there Arka

Good points, those, I want to encourage others to write here, so let my points come at the end.

 

[Dr. Jayanthi Sankaran]

Hi @QuantMan2318,

One good trading strategy, prior to the Brexit, that an investor or a trader could have entered into, was to purchase both a European call and a European put on the FTSE 100. Both of them should have had the same strike price K and expiration date T.

Given, that either way there would be a large move in the FTSE 100, there would be a significant profit. The payoff from the straddle would be as follows:

ST < K: Payoff from Call = 0, Payoff from Put = K - ST, Total payoff = K - ST
ST > K: Payoff from Call = ST - K, Payoff from Put = 0, Total payoff = ST - K

A straddle is an approriate strategy to use when investors or traders know that there will be significant moves in the

FTSE 100, but do not know the actual direction of the move. For option traders willing to take a chance to make many

times their investment with limited risk, buying straddles is one way to profit.

The most important thing to do is to buy the straddle for the nearest expiration date and to sell it within hours of the

Brexit announcement.

Thanks!

 

[Deepak Chitnis]

Hi @QuantMan2318, thank you for starting great conversation. I am not expert nor a real world experienced, but if I think this position as asset manager I will think this as differently. UK is one of the powerful economy in the world. They record high employment rate so the GDP. After brexit I think now UK has a great chances to solve there internal matters and also to focus there investments in more emerging markets like china and India. I think there will be high volatility for short term there is reason, this Britain exit is not going to happen in one or two days it will take some time, so I think short term volatility will high but long term returns are going to be great. There are the powerful one in European union, employment rate will rise in UK. So final thing I will remain long term but exit short term. All suggestions and comments are welcome also share your view.
Thank you

 

[Dr. Jayanthi Sankaran]

Hi @arkabose,

As far as implications for the Indian markets (an emerging market) go, foreign institutional investors were purchasing downside protection prior to the Brexit. They were hedging their positions with out-of-the-money puts. Out-of-the-money puts have stock price higher than the strike price. However, the Indian markets were not that affected because the regulators had put in place sufficient safeguards, including liquidity in both the US dollar and Indian rupee...

Thanks!

 

[Mkaim]

From a US investor's perspective (living in Mexico), Hedge Funds in particular, if this leads to the London property value devaluation as some are predicting, I'm going in. Not sure of the exact entry point, but total devaluation of over 15% (total = currency devaluation + Property devaluation) would be inviting.

 

[brian.field]

not sure I can add much to this discussion other than mentioning that this event is the quintessential rare event that risk management attempts to anticipate. Therefore, assuming some corporations had implemented strong risk control cultures, policies, governance, etc., I am not sure I would have anything else to suggest at this point. I'd be more inclined to wait for more information while leaving the ERM to its intended and designed purpose.

Now if the corporation is lacking in risk management, your guess is as good as mine. Luck favors the well prepared....

 

[Mkaim]

I thought a little more about this. Another area of concern is investments regulation. Did UK benefit from being in the EU from an investment regulation standpoint? If so, will it experience a net negative impact from a regulatory perspective? 80% of the EU hedge funds were in UK, what's the impact on non UK investors? Regulatory capital for UK/EU investments?? As you can see, I don't have any answers, only questions. Have to wait for the dust to settle, but I can see this one taking time to sort out.

 

[Dr. Jayanthi Sankaran]

Inverse ETFs can be great products for people who are looking to profit from a decline in the value of an index or a commodity without the complications of short selling. Inverse ETFs can be effectively added to hedge an existing portfolio, or used to speculate on a market decline.

The demand for inverse ETF's on the FTSE 100 skyrocketed immediately after the Brexit....

Also, majority of the investors who had stashed away cash prior to the referendum, moved into ETFs in order to gain exposure to safer asset classes.

 

[Dr. Jayanthi Sankaran]

As far as hedge funds go: those who had shorted UK equities; bought US Treasuries, UK Gilts and German Bunds, and took a long position in stocks of gold mining companies profited from the Brexit....

Also, investors who took long positions in the stocks of companies that sold products outside the UK - in countries whose currencies strengthened against the sterling and Euro - made gains. A lot of these stocks were in the pharmaceuticals sector...

 

[QuantMan2318]

The last post of @Dr. Jayanthi Sankaran sums up what was done in the wake of the referendum.

In addition, I wish to add a couple of more points here
A. Short Term Trade Actions
1. Traders could have used the CBOE VIX on the S&P 500 and its equivalents on other indices, as the chance for a rare event (The Brexit being a Black Swan) was present, we could have gone long on the VIX futures contract that are traded, they would have seen rapid increases in value and we could have shorted them off as the dust settled
2. We may also use the VIX options, (I am assuming here), as the VIX would increase as these shocks increase the volatility, we may enter into calls on the VIX and enter into myriad option strategies (ITM Calls?)
3. Then there is the equivalent Index for Bonds, as we anticipate huge demands for the same, we may enter into appropriate contracts for the same.

I will come with other thoughts later

 

[QuantMan2318]

Right, in continuation of the above,
B. Medium term Trades
1. The Govt. Bonds of the usual suspects, Italy, Greece et.al, would probably have their spreads widened due to increased perception of risks from these, so, we may short them now to earn these spreads.
2. Gold will increase in the coming turbulent times, so Gold ETFS all the way as well as Long Yellow Metal futures?
3. Oil drops even further? We may enter into Shorting of the Oil futures, if we anticipate the Black gold will drop further.
4. How about some IRS? will the LIBOR increase as a result of this fall out? therefore, can we enter into some IRS to receive the increasingly rising LIBOR?
5. The Swiss Franc and the Japanese Yen are bound to strengthen, atleast in the short term, therefore, both Long Futures of these currencies as well as any options based on their indices will suffice, what if we enter into options on the TOPIX, we short the TOPIX as well as some of the exchanges/indices of the Stronger currencies, say, Puts on these.

For both these short and mid term strategies,
1. We as risk managers should ensure that the safe haven transactions above are ensured and we put in place sufficient limits to all these trades. In addition, any exposure to GB and EU should be subject to stress tests.

From an economic perspective, risks remain that they would no longer have access to the EU common market and any benefits associated with common membership. In addition, negotiations with the EU member countries will be difficult and protracted and perhaps will be at a disadvantage compared to other nations outside the EU and definitely at total disadvantage compared to member states.

The above might be, to some extent, compensated by better control over monetary and fiscal policies as well as chance for multilateral agreements with the world at large, perhaps better trade agreements with the Commonwealth.

 

[QuantMan2318]

Some Final Thoughts on the same:

The greatest threat is the existential, this one will cause the global markets to tank further than what the referendum did. As you may have noticed from the NYT chart. The vote left the UK deeply divided as a nation. The country which was the progenitor of modern industrial civilization and technology and to some extent the first wave of Globalization is ironically a victim of the same. The seeds of modern economy was under the Tudors and the seeds of modern industry were laid when the thrones of Scotland and England were united after several years of war and when King James of the Scottish Stuarts, ascended the throne of England. Who can forget the union of Scotland and England which was officially consummated in 1707 having led to prosperity and by extension Adam Smith and his Wealth of Nations in 1776 in Glasgow?

Now, we see that the Scots have agreed overwhelmingly to be part of the EU, while their case for separation from the crown was and is mandated on the Economics of Oil and other industries, we must watch out for Oil price and other indicators. We may only hope that there is some tripartite compromise with the English, Scots and the EU to preserve their Union.

In the longer term, England, Wales and perhaps Northern Ireland will certainly prosper, so will Scotland, these three may pursue different economic policies to further their agenda, the only thing that remains to be seen is whether they set aside their differences and strive to work as a Union.

Thanks all for your valuable inputs

 

[Dotun]

Some of the key findings highlight:

• A comparison of the impacts between UK GDP and FS GVA showing that the FS sector is disproportionately impacted by the UK leaving the EU compared to the UK
• The UK FS sector will continue to grow under both exit scenarios
• An estimated reduction of 70,000-100,000 in UK FS employment (number of people employed) in 2020 relative to the counterfactual
• There are significant uncertainties on the economic impacts of a potential UK exit from the EU, in particular for the FS sector.

Full report by pwc http://www.pwc.co.uk/industries/fin...ons-for-the-UK-financial-services-sector.html

 

[brian.field]

For those that may be interested in a discussion.

 

[QuantMan2318]

Dear @brian.field

Thanks for this, I would love to attend

By the way, this seems to be a topic still pregnant with ramifications as discussions abound on multiple sites.

Here is a site that you might be interested, it has some famous minds like George Soros who have commented on this
https://www.project-syndicate.org/c...ntegration-inevitable-by-george-soros-2016-06

And REITs seem to be winners out of this calamity of the markets, the reduction in US Treasury yields have played well for them

 

[brian.field]

We are treading very dangerous ground with this thread! It is difficult to speak about the causes/consequences without moving into a political discussion.

 

[QuantMan2318]

Dear Brian , I have tried my best to avoid political discussions (that was my first rule in this thread) and have kept it purely for Finance. By the way, did you check out the earlier posts on my short and medium term strategies? What do you feel?