It is still uncertain when the United Kingdom will leave the EU. “Brexit Day” was meant to be March 29, but UK Prime Minister Theresa May has requested an extension of three months in which she will try to get the UK parliament to approve the exit terms she has negotiated with Brussels, but MPs have twice rejected. An extension would require the unanimous approval of the remaining 27 members of the EU, far from guaranteed. Meanwhile, a “no-deal” Brexit, which would mean there are no agreements in place for the UK’s relationship with the EU, remains a possibility.
While the latter would bring immediate clarity of a sort, the prolonged uncertainty has been agonizing for businesses affected by the political process.
Japanese companies that have invested in Britain offer an interesting example of how international business is coping with the political tumult roiling the UK economy over Brexit. Japanese firms operating in the UK and the Japanese ambassador to London have been uncharacteristically outspoken about their dissatisfaction with Brexit and its inept handling by British politicians. However, they are not rushing to exit the UK. Instead, they are making limited, defensive moves while they wait for clarity to emerge from the chaos.
These include relocating headquarters to EU countries and moving where they legally base financial transactions. When they know more about critical aspects of the post-Brexit trade and investment relationship between the UK and the EU — from tariffs to customs procedures, supply-chain disruptions to corporate tax rates — they will determine the pace at which they will shift operations to the EU or back to Japan, or leave them in the UK.
Longer-term, there will likely be a UK-Japan free trade agreement. However, talks on this broke down in February with the Japanese side pushing for more favorable terms than Japan has under its current trade agreement with the EU. This was framed in part to compensate for the smaller size of the UK market and the fact that Japanese firms’ UK operations will no longer have unfettered access to the EU’s single market.
Japanese investment is still coming into the UK. But it’s going into the EU faster. From 2015 to June 2016, when the UK held the referendum in which it voted to leave the EU, Japanese investments into the UK and the rest of the EU were growing at the same rate. From mid-2016 it continued to grow at the same rate in the rest of the EU but slowed to half that pace in the UK.
Japan’s cumulative company investments into the UK totaled $158 billion, across 634 Japanese firms reporting annual sales of $68 billion and employing 150,000 workers as of the end of March 2017, according to Bank of Japan and Ministry of Economy, Trade and Industry figures. Although it accounts for 60% of the employment, manufacturing accounts for one-quarter of the total Japanese investment in the UK. Services account for more than 60% of the investment but less than 40% of the employees.
The most visible part of that is accounted for by Japan’s “big three” carmakers — Honda, Nissan, and Toyota — which employ around 60,000 UK workers in auto production and sales. Between them, they produce 40% of the cars made in the UK and it was their arrival that revitalized UK car-making after the industry collapsed in the 1970s. Perversely, they have plants (and thus jobs) in towns like Sunderland and Swindon that voted heavily in favor of Brexit.
Japanese auto companies’ calculations about where to put new investment are colored by more than just Brexit. Other factors include vehicle sales slowing across Europe and the Japan-EU trade agreement, which makes centralizing the output of some models in Japan more economically feasible.
Late last month, Nissan said it would cease production of its Infiniti Q30 and QX30 models at its Sunderland plant in the northeast of England by the middle of this year, but as part of a withdrawal of its luxury marque from Western Europe in the face of competition from Germany’s carmakers. This followed its announcement that it was cancelling a plan to produce the new model of its X-Trail sports utility vehicle at the same Sunderland plant, where it employs around 7,000 people, citing Brexit uncertainties.
In 2015, before the Brexit referendum, Honda promised a $263-million investment in its Swindon plant in southern England, its only European production facility and the sole global producer of its Civic hatchback. In mid-February, the company said it planned to shut the plant in 2021 with the loss of 3,500 jobs. Honda said that the decision is based on global trends — Honda’s sales in Europe have halved from their peak in 2007 — but acknowledged concerns over post-Brexit tariffs. Two-fifths of the components that Honda uses in Swindon come from the EU, and 35% of the plants’ exports go to the bloc. The company is expected to repatriate production to Japan.
Toyota said earlier this month that it could end its UK production in the event of no-deal Brexit. Of the 144,000 vehicles Toyota built in the United Kingdom in 2017, about seven-eighths went to the EU. The company did say it would make its next-generation Auris hatchback at its Derbyshire plant despite Brexit, following a $300-million investment (and a $28-million UK government grant) to retool the plant.
In the electronics sector, Sony and Panasonic are moving their European headquarters to the Netherlands to ensure that their European operations will continue to be subject to the EU’s common customs procedures. Panasonic will transfer only 10 staff from the UK, but Sony is not moving any at this point. Nor will Sony move any of its operations from the UK.
Many Japanese companies are also transferring their euro-denominated invoicing to an EU country. Post-Brexit, financial firms in the UK will lose their “passporting” rights — which let financial services companies based and regulated in one EU or European Economic Area country do business in any other member state.
To re-establish these, at least across the post-Brexit EU, Japanese financial institutions with UK-based businesses are establishing subsidiaries in the EU. This will increase regulatory complexity for them and require additional capital and liquidity but is the least bad of the available choices.
Japanese financial holding company Nomura, with about 2,300 people in London, will set up a broker-dealer in Frankfurt to use as its trading hub, shifting 50 to 100 staff to Frankfurt and elsewhere in Europe. Nomura plans to repatriate a small number of bankers to the EU countries that they cover, so bankers covering Spanish companies could move to Madrid, for example. Nomura already has a French banking license, but must get agreement from the country’s regulators to expand its balance sheet. It is in talks with French regulators about using Paris as its post-Brexit European lending entity.
And the list goes on: Mitsubishi UFJ Financial Group is expanding its operations in Amsterdam and plans a Paris branch, even while increasing its London staff modestly. Daiwa has opted for Frankfurt as its EU hub, but will still employ 450 people in London. Mizuho Financial Group and Sumitomo Mitsui Financial have also said they will set up German subsidiaries. Norinchukin bank has gone Dutch.
The UK could stem some of the bleeding by lowering its corporate tax rate significantly post-Brexit to retain or attract investment. However, Japan could then treat it as a tax haven. That would leave Japanese businesses at risk of potentially large liabilities at home arising from Tokyo’s anti-tax-haven rules. This is believed to have weighed heavily in Panasonic’s decision to move its European headquarters to Amsterdam.
One takeaway from these moves is that Japanese companies are keeping a clear head in the political fog, making sensible defensive decisions to position themselves from what they know is certain about Brexit in the short-term and holding off long-term investment decisions until there is true clarity. Given that the UK and the EU will still have to negotiate their future trade arrangements, which will likely take years as trade agreements often do, this approach may well be the one international companies have to consider when it comes to the UK — and not just for the immediate future, but several years to come.
Originally published on www.hbr.org