Knock-On Effects Bigger Than Brexit for Capital-Markets Firms

Our impression on Brexit for capital market-related companies is that their earnings may be more affected by the knock-on macro effects of Brexit than the future operational disruption.

Based on our current understanding, a relatively simple response to Brexit is for institutions to open a subsidiary in the EU to continue enjoying trade privileges similar to the ones in the United Kingdom. Some additional capital may be locked-up for regulatory requirements, and duplicative expenses will be incurred, but overall we don't expect it to be material.

More material to near- to intermediate-term earnings will be Brexit effects on macro factors. Global uncertainty shifts central bank policy to a more accommodative stance. Firms leveraged to rate hikes, such as retail brokerages, may have to wait longer to receive earnings boosts. Companies with material earnings denominated in European currencies will have EPS depressing translation effects--25% of

Wealth and asset management firms that bill based on client asset levels will also have their fortunes affected by any decrease in asset prices and assets denominated in foreign currencies.

Volatility will increase trading volumes, definitely helping trading platforms like the financial exchanges, while having a somewhat mixed effect on brokerages that will have higher trading volumes potentially offset by valuation marks on their trading inventories. Continued capital market volatility will also dampen underwriting and advisory revenues.

In the long run, if more countries split off the European Union, we believe that brokerages, exchanges, and financial information providers stand to benefit. More countries with their own currencies and monetary authorities with disparate interest rate policies would lead to higher currency and rates trading volumes. Information providers collecting and disseminating these new data points will also be more valuable.

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