The pros and cons of Brexit

Commercial estate agents in Luxembourg may well be rubbing their hands in anticipation. Some time in the next 18 months or so, if British voters opt to eject the UK from the European Union, the Duchy's estate agents can expect a stampede of City companies looking to relocate.

Luxembourg is clear frontrunner among the cities hoping to provide a new home for UK fund managers wanting to keep a toehold in Europe post-Brexit.

For UK investors, the implications of a vote to leave the EU are somewhat less predictable - and deeply contentious.

Depending on which side of the argument you listen to, Brexit could mean increased volatility, lower returns and a narrower choice of investment products; or it could mean investments free of the EU regulatory burden, tracking a liberated, upbeat economy.

BREXIT: YES OR NO?

What is clear is that the rhetoric is set to heat up, and for anyone with financial assets, the prospects for savings and investments can be expected to play a key part in deciding their position in the referendum.

The referendum - which could take place as early as next June - has already seen some battle lines drawn up.

Peter Hargreaves, founder of broker Hargreaves Lansdown, who retired earlier this year, has announced that he expects to be 'at the forefront' of the campaign to leave the EU.

Helena Morrissey, chief executive of Newton Investment Management and chair of the Investment Association, is another who has nailed her colours to the mast for leaving.

On the other side of the fence, it is widely assumed that most in the City will be against Brexit.

A survey by the Centre for the Study of Financial Innovation published in April found that 73 per cent of City workers polled said they would 'definitely' or 'probably' vote to stay in the EU.

Their motivation was explained in terms of fear of London losing its position as Europe's premier financial centre, and with it unfettered access to EU markets.

Another poll, by NN Investment Partners, found that three quarters of international institutional investors believe the impact on the stock market of a British exit from the European Union would be negative.

MARKET WORRIES

The most obvious consequence of a vote to leave the EU is the anticipated heightened volatility of financial markets. Gregor Irwin, chief economist of consultancy Global Counsel and author of an in-depth report on the impact of Brexit, says: 'First, the prime minister would likely have to resign.

'Second, the odds of a second Scottish referendum and the break-up of the UK would significantly increase.

'Third, the future relationship between the UK and the EU would be uncertain, with implications for firms that trade with the single market. All of this adds up to a substantial amount of political risk and would take time to resolve.'

Investors can expect a white-knuckle ride even in the run-up to the referendum. Bill McQuaker, co-head of the multi-asset team at Henderson Global Investors, says: 'We can expect it to follow a similar pattern to the Scottish referendum.

'If you have a poll that shows a strong likelihood of a vote to leave, that will have an exaggerated impact on certain stocks. If the vote itself is to stay, then everything will be forgotten within 24 hours, but if it is to leave, then that will fire a starting gun for re-negotiation, and I expect it will be a significant event for financial markets.'

McQuaker warns that in this event, the asset that would be most vulnerable is sterling. 'We run a big trade deficit and a current account deficit, but we have not had to worry too much about that until now because money has flowed into the UK, into assets such as residential and commercial property. You'd have to wonder if that would continue.'

Ratings agency Moody's has already suggested that a vote for Brexit could put the UK's sovereign rating at risk.

WHICH SECTORS WOULD BREXIT HIT HARDEST?

In terms of the stock market sectors that would be hit by Brexit, property is one and financial services another.

But the Global Counsel report highlights the likely impact across a broader range of UK businesses, particularly on companies highly connected to international supply chains, or are dependent on foreign direct investment - car manufacturers, for example.

If British companies found themselves trading on less favourable terms, or unable to recruit freely from across the EU, these could also be factors leading to lower profits and dividends down the line.

For investors, a second major question is whether they would have access to the same choice and quality of financial products post Brexit.

Rehearsing the arguments for and against, John Greenwood, chief economist of fund management group Invesco Perpetual, recently wrote: 'London is home to more than 250 foreign banks.

'Many of these use the City as a base for their main European subsidiaries to take advantage of the automatic "passporting" rights to sell their products and operate across the other 27 countries in the single market.

'The proponents of Brexit argue that if Britain joined the European Economic Area (EEA) and the European Free Trade Area (EFTA) the country would still be able to enjoy the same access to the European markets, but this is not a certainty.'

According to Richard Metcalfe, director of regulatory affairs at the Investment Association, a key benefit of EU membership for investment companies has been 'the ability to run asset management on a scale to compete globally'.

Under the 'passporting' system, a fund can be domiciled elsewhere in the EU (such as Dublin or Luxembourg), managed in London where there is the most expertise, and sold throughout the single market and even further afield.

'It wouldn't necessarily be impossible for this to continue, but it's more difficult to judge whether over time it would become tougher to offer services from a third country,' says Metcalfe.

Untrammelled, albeit tightly regulated, access to the EU has also seen London become the preferred choice for asset managers from outside Europe - North America, Australia and South Africa, for example - to set up shop. And some of that investment may be at risk.

Does this matter to investors? 'In the UK, you've almost too much choice of products at the moment,' says Metcalfe. 'However, as an end user you are benefiting from a tried and tested regime that sets certain standards, and from the collective wisdom of regulators and providers across the EU.'

REGULATION IMPACT

So while it's hard to see that UK investors would be significantly stymied for choice, it seems equally unlikely that Brexit would have a very significant impact - either positive or negative - on the protections offered to investors.

The broad direction of regulation is increasingly driven at a global level, with legislation then appearing in EU-specific form, and the UK would still want to comply with EU rules on products popular with consumers, such as Ucits. Nevertheless in other areas, such as hedge funds, there may be a case for looser regulation post-Brexit.

One piece of EU legislation that some have in their sights is the Alternative Investment Fund Managers Directive, passed in July 2013, which imposed standards on client reporting and deposits, in the interests of protecting investors.

And what about transaction costs? The main issue here is the mooted financial transaction tax, which would add a levy of 0.1 per cent every time shares or bonds were traded, and has been opposed by the UK.

In fact, implementation has already been delayed and it seems doubtful it will ever be implemented as a statutory measure throughout Europe. Metcalfe says: 'It would arguably bring the rest of Europe more in line with us, given that the UK has stamp duty which many other states do not.'

The longer-term effect on the economy, and on investment prospects, remains highly contentious. The main consensus for now seems to be that the most significant impact Brexit will have for retail investors is the period of volatility that will surround the referendum.

As Jason Hollands, managing director of communications at Tilney BestInvest, puts it: 'It is quite likely that we will see volatility during the referendum campaign if the mood for Brexit appears gather momentum and some firms delay investment decisions.

'The most likely place for this anxiety to be manifested, however, is the currency markets - as we saw during the Scottish independence referendum. Let's not forget that the UK equity market is dominated by large, global businesses.

'But eurosceptics will argue this is a price worth paying for the longer-term opportunities if we are making policies closer to home.'