Utility Week

UTILITY Week 28th October 2016

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UTILITY WEEK | 28TH OCTOBER - 3RD NOVEMBER 2016 | 13 Finance & Investment Market view W hat will be the impact on utilities investors of the UK's vote to leave the European Union? It is clearly too early to call definitively, but what do we know now and how can that be applied to the utilities space? Before turning to the crystal ball, it is worth pausing to reflect on what investors have seen (and continue to see) in utili- ties, particularly over the past 15 years, that resulted in the sector being such a focus for investors. What are the fundamentals that make infrastructure and utilities attractive investment opportunities? In no particular order these are: their long-term nature; stable regulatory environ- ment; high barriers to competition; and close correlation to inflation indices. In summary, certainty. For investors looking for yield in a low- yield environment (particularly those such as pension funds who may be looking to manage and match long-term inflation- linked liabilities), the logic of utilities has been inescapable. The big question is, what has the vote done to alter the picture? You can look at Brexit in a number of ways. One way is to divide impacts chrono- logically. So: Short/immediate: significant market volatil- ity as the market adjusted to a version of life many had not expected. Medium term: a change of government in a highly unusual situation – the largest popu- lar mandate the UK has seen rejecting both the government and opposition's advisory positions. A new government to some extent without a manifesto. Long term: the UK disengaging from the EU. In summary, for the investor there are three new sources of uncertainty and volatility. The first 24 hours aer the vote dem- onstrated that the market may not have anticipated the outcome, because they expe- rienced substantial price volatility. Given that experience, and volatility since, there may be some investors who remain cautious about such significant short-term market shis occurring again as the future relationship becomes clearer and the market reacts. Even if hedged, investors with foreign exchange risk may be more wary about the additional cost and the impact in their model of breaks and margin calls. Medium to long term The medium and long-term observations are linked. We now have a little more detail from prime minister Theresa May on how she sees Brexit will be initiated. We have been told that current EU rules will remain the same but they will be domesticated. What does that mean for the investor? It's important to remember what it is that much of the EU rule-making does in the util- ity sector and the regulatory approach. Some EU laws simply mandate a particu- lar approach, for example environmental law has driven capital expenditure for utili- ties that has supported investment cases. That should not change simply through domestication. Other EU rule-making that investors look at, such as unbundling, is based on facili- tating a competitive regulatory model, oen with a regulator overseeing it. From the investor perspective, the impact of the competitive models from the EU has to some extent insulated the utilities sector from domestic politics and entrenched some of the positive attributes of the sector. To paraphrase the policymaker's stock response – I hear your immediate concern, I'm looking at it very hard but, while I really want to do something my hands are tied until we have engagement at the EU level and so its going to be hard for me to intervene here or alter the shape of that industry there. Regardless of the frustrations on all sides of the debate as to the veracity of that approach, in a post-Brexit world, where politically the government has a less clear mandate and the regulator has been "domes- ticated", there may be less opportunity for policymakers to deploy those arguments when pressed politically for an immedi- ate change to the rules. If that is the case, short-term political expediency could mean greater policy and regulatory volatility. Change can be good While the vote has clearly created the poten- tial for greater uncertainty, policymakers are acutely aware of the benefits that have been driven by investor focus on utilities, as well as infrastructure's wider role, and that it is imperative that utilities are funded as effi- ciently as possible. Given the greater space policymakers in the UK may be given, it is entirely possible that they will look to seize the opportunity to make utilities an even more compelling investment case. Charles Ford, counsel, Hogan Lovells Investors weigh up Brexit Utilities in the UK will soon be freed from the shackles of European rules and regulation, but this could also leave them vulnerable to political expediency at home, says Charles Ford. HISTORICAL RATES FOR CONVERSION OF GBP TO EUR 1.30 1.25 1.20 1.15 1.10 1.05 EUR per GBP 20 May 2016 20 Jun 2016 20 Jul 2016 20 Aug 2016 20 Sep 2016

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