Hotel Brexit: You can check out but never leave

As the UK now moves inexorably towards the exit door from the European Union, reality will kick in says Erik Vynckier, Interim CEO, Foresters Friendly Society.  

He warns that we are now entering a period of extended uncertainty as the UK’s new relationship with the EU is hammered out. With the spectre of a hard Brexit at the end of 2020 still looming large, he urges CIOs to apply a mixture of caution and diligence as they monitor the impact it could have on their portfolios:

“We have nothing to judge it by. We don’t know whether it could be good for gilts or Sterling. A soft Brexit could see Sterling rally a bit but we simply don’t know what impact a bad Brexit could have. Should we get out of UK companies if it goes badly? You will be forced to look at individual companies and individual projects to see what the impact will be on them. We will need to understand on a case-by-case basis how exposed they are to Brexit and Sterling. We will need to know whether they are global businesses with strong foreign earnings.”

However the new government’s bullish rhetoric around Brexit shapes the final departure, for the financial services sector a deep and close long-term relationship with the EU is not just inevitable but essential, according to Vynckier:

 “Brexit is rather like the Eagles’ song [Hotel California] - You can check out any time you like. But you can never leave! If you are an economy that is subject to a bear hug from the EU – just like Switzerland – then you have to keep closely aligned with them rather than develop double standards. I understand the arguments about not being rule takers, and that works for purely domestic insurers, but the global players want regulatory alignment.”

Like many Europeans – he originally qualified from the University of Gent with an MSc in chemical engineering before moving into financial analysis and investment management – Vynckier believes both the EU and UK will lose out because of Brexit: “The UK has been massively influential in all financial regulations for all of the EU. We are giving up a lot by leaving as we will not have the same influence.”

As CIOs grapple with the fallout from Brexit, they face a myriad of other challenges as they try to navigate a course through the low yield world seeking a destination where good quality, higher returns can be secured. This is the world of alternative assets. Getting there is not easy.

“Scarcity of assets is one of the biggest challenges facing CIOs. We know it is not easy to make yields with the traditional portfolio mix and this has strengthened the move into alternative assets.

“Another driver towards alternative assets is that credit spreads have narrowed so attractive public credit is hard to come by.”

ErikVynckier

CIOs have been surveying this horizon for sometime but are now narrowing their focus on assets that offer secure longer term returns and measure up against the demands of investment committees and regulators. Some winners are emerging: “Infrastructure debt, private debt and the leveraged loan market, although leveraged loans don’t exist in sterling and look overvalued. Equity release is another asset that is generating a lot of interest but that needs to be looked at very carefully”.

Concerns about volatility and regulation are never far away when the conversation truns to alternatives: “With many of these assets illiquidity is an issue that needs to be taken into account.

“When it comes to many of these alternative assets you always have the solvency capital question. And, you will always require a store of eligible collateral and margin cash to support ALM driven hedging although insurers have successfully argued that they have longer liabilities with little need for liquidity.”

Vynckier is clearly sceptical about the claims of the army of asset managers now promoting their often new found expertise in alternative assets:

“Asset managers want to say they have the ability to do this [alternative assets] at scale but it is only a small sample of asset managers that are really able to offer the range that insurers need.”

When it comes to specific assets, equity release is one that has thrust itself to the fore but still looks unconvincing:  “I wonder why it is in the UK that we have focussed on equity release while it is regular first-time mortgages in the Netherlands. There seems to be no logic behind such divergences. It is obviously to do with origination and distribution. We have tactically ended up there rather than made the decision as part of a considered strategy”.

The other big issue for CIOs is the need to respond to the growing clamour for investment portfolios to embrace the ESG (environment, social and governance) agenda. This comes with a serious health warning: “The risk is there that we no longer make investment decisions for the right reasons but just to respond to the interests of the day.”

“We have seen trends like this before that have been met by offers that are not genuine. Some have done it and done it too soon, there were some early investment in wind farms that have come to grief. This is despite some ratings agencies giving them a strong rating.”

It is an issue that cannot be ducked, however: “The regulators are taking a keen interest in ESG, especially around climate change and you cannot argue with that, but there are a lot of questions that still need to be answered before insurers feel comfortable. Is there an accepted standard to judge ESG by? What is the taxonomy? There is still no agreement on taxonomy and methodologies. What does the reporting look like? Do you get comfort that it is not greenwashing?”

There is still one huge problem looming once you answer those questions: “There will be a scarcity of good assets to own. There will not be enough to go around”.

Fancy checking out? It isn’t an option with any of these challenges.