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Commercial Awareness: The Fortnightly Round-Up (w/b 27th March)

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About The Author

Jack Turner (Commercial Awareness Guru)

Jack is a law graduate from the University of Manchester and is currently working for as an analyst for a 'Big 4' accountancy firm. He has an interest in current affairs, business and commercial law, while also being a talented and passionate musician.

This article is part of the 'Commercial Awareness Fortnightly Round-Up' series, edited by Jack Turner.

Every two weeks, Keep Calm Talk Law will bring you an overview of main commercial stories that have occurred. Detailing the main players involved, the interesting and salient facts, and the main points of discussion that arise from each story, this round-up is intended to be vital tool for developing that commercial knowledge and awareness demanded by the country’s top law firms.

Other articles from this series are listed at the end of this article.

The Pound is Choppy Amongst Political Events

A country's currency relative to the value of other currencies can sometimes be indicative of that country's economic health or, at least, the market's prediction of it in the future. For example, the value of sterling fell to a 31-year low on currency markets immediately after the Brexit referendum result as traders contemplated the strength of Britain's economy outside the EU.

The value of a currency can have varying effects on companies. For example, a weak pound will damage UK companies that rely heavily on imports, as they can buy fewer goods and materials with their money than they would have been able with a stronger pound. Similarly, companies that export goods to the UK from the Eurozone or the US are likely to suffer as their goods become less attractive financially. Following the Brexit referendum, the Irish Business and Employers Confederation claimed that Irish exports to the UK, including meat and dairy, were 15% less competitive in light of the falling value of the pound. 

On the other side of the coin, UK assets have become cheaper for foreign investors. This can have a positive effect for some commercial law firms. Take law firms with strength in commercial property/real estate, like Berwin Leighton Paisner, Nabarro or Ashurst. As the pound decreases in value relative to foreign currencies, UK real estate becomes more affordable for many foreign investors. This may result in an uptick in real estate deals. Indeed, earlier this month the iconic Leadenhall ("Cheesegrater") Building in London was sold to a Chinese property tycoon for £1.15bn – a deal on which Herbert Smith Freehills, Mayer Brown, and Berwin Leighton Paisner all landed key roles.

This fortnight there have been a number of political developments that provide a great example of how politics can affect the value of currencies. The graph below allows for the tracking of fluctuations in the value of the pound against the dollar over the past few weeks and explain some of the factors behind these movements. 

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Note that the graph is for the period between 12/03/2017 and 30/03/2017 and events are not necessarily mapped to their exact date but to the peaks and troughs of their effect on currency values.

Article 50 Effect

The pound took a tumble on 14 March to $1.2153 as politicians cleared the way for Theresa May to trigger Article 50. The night before, Parliament passed the Article 50 bill after 70 hours of debate giving the Prime Minister the power to trigger Article 50 and begin the formal process of Britain's exit from the EU. The bill passed unamended despite the House of Lords proposing two amendments that would give EU citizens living in the UK a guarantee of their rights, and give parliament a "meaningful" vote on the final terms of the Brexit deal. MPs struck down these amendments before the bill was returned to the Lords who voted heavily to reject their amendments. This reaction by the market was viewed by some at the time as indicative of what would happen to the value of the pound when Article 50 was actually triggered.

Unsurprisingly when Article 50 was triggered on 29 March, the pound fell to an average of $1.2343 for the day – down just under 2% from highs reached two days earlier. However, on the surface, the drop appears to be relatively modest considering the significance of this event. Some analysts attribute this to the fact that the political shock of Brexit is already represented in the price of sterling and that in reality, the triggering of Article 50 was not a surprising event; it was expected for some time and a date was even given in advance for when it would happen.  

Markets have been optimistic that Trump's policies of tax cuts, deregulation and increased infrastructure spending will help boost corporate profits. This led to an increase in the value of the dollar and US stocks. However, after a planned vote on a healthcare reform bill was abandoned, this optimism was stifled somewhat as traders started to question Trump's ability to force through reform and infrastructure spending. Passage of the healthcare reform bill was important for the Trump administration to reduce expenditure and access funds, this would have made it easier to persuade fiscal conservatives to back tax reform.

The markets reacted quite strongly to this news. The US dollar index, which measures the value of the United States dollar relative to a basket of six foreign currencies, sunk to a four-month low. However, as the graph illustrates, the fall in the US dollar did help to strengthen the value of the pound. The pound rose to an average of 1.2559 on Monday 27 March – up over 3.5% from its value just under two weeks earlier.

Talking Points

Now that Article 50 has been triggered and Britain has begun the formal process of leaving the EU, the shock factor of Brexit that was dragging on the value of the pound is likely to be over. Instead, the value of the pound will be heavily influenced by the negotiations taking place over the next two years between Britain and the EU and the developments that come out of this. Furthermore, President Trump's success or failure in bringing about economic stimulus in the US will impact the value of the pound relative to the dollar. The value of the pound relative to the euro will also be tested in coming months if the European Central Bank reigns in its quantitative easing programme and far-right candidate Marine Le Pen is defeated in the French presidential election.

Commercial awareness requires the ability to be able to spot opportunity and risk within a commercial or political development and anticipate how this might affect commercial law firms and their clients. As this story highlights, political developments have the tendency to result in fluctuations in the value of currency. In turn, these fluctuations present opportunity and risk for certain businesses. As such, it is important to keep up to date with political developments from around the world in order to develop your commercial awareness – especially as Britain starts to negotiate its future with the EU and Trump begins to implement his policies.   

Tesco

Tesco has been in the financial press a lot over the last fortnight as penalties have been levied against them over an accounting scandal and a planned takeover has come under scrutiny by shareholders.

Fines for Accounting Scandal

Tesco's UK arm has entered into a "deferred prosecution agreement" with the Serious Fraud Office (SFO) to pay a penalty of £129m for its false accounting practices in 2014. This agreement allows the prosecution to be suspended against Tesco UK providing that the £129m penalty is paid. However, the agreement doesn't absolve liability for Tesco as the parent or any of its employees or agents. The Financial Conduct Authority (FCA) also ordered Tesco to set up a £85m scheme to compensate investors who bought assets for more than they were worth as a result of the false accounting practices.

In September 2014, Tesco was found to have overstated its profits by £263m by claiming that their half-year profits for 2014 would be £1.1bn – the overstated profits eventually grew to £326m. Tesco attributed this discrepancy to "accelerated recognition of commercial income and delayed accrual of costs". This essentially means that they had delayed payment to their suppliers while taking money from them earlier than they should have done. The FCA found that by claiming its half-year profits would be £1.1bn, Tesco had created a false market in its shares and bonds which amounted to market abuse. On the back of this scandal, Tesco reported a £6.3bn loss in 2015, one of the biggest in British corporate history.

These sanctions mark the first time the FCA has forced a company to pay compensation over market abuse. Previously this power had most frequently been used for mis-selling and sanctions against individuals involved in market abuse cases. Similarly, this is the first time an FCA compensation scheme has been levied alongside a fine by the SFO. This novel use of the FCA's powers could pave the way for a much more aggressive approach towards companies involved in market abuse in the future. This is a prospect that companies which find themselves in similar positions, and the law firms defending them, should prepare themselves for.

From Tesco's perspective, the compensation agreement may help prevent a host of private litigation from investors who were misled by the misstatement of profits. Similarly, the deferred prosecution agreement will help Tesco avoid potentially costly litigation fees and bring certain matters to a close. However, the retailer still faces a £100m civil lawsuit brought by more than 125 institutional funds as well as two US class actions. Manning & Napier, a US investment management company, also filed a lawsuit in January claiming damages up to £150m. Furthermore, three senior Tesco UK employees are due to stand trial in September for false accounting and fraud. While the payments are an important step in bringing this scandal to a close, the saga is not yet over for Tesco.

Tesco instructed Freshfields during the investigation into its accounting practices and the upcoming litigation arising from it.

Shareholder Dissent over Booker Deal

Earlier this year, Tesco agreed to buy Booker for £3.7bn in a cash and share deal. Booker is the UK's largest food wholesale operator. The acquisition would make Tesco a major supplier to small retailers, restaurants and pubs. Tesco claims that they will gain an extra £200m in annual profit from the deal within three years. Most of this will come from cost savings as it leverages its increased exposure to more and different kinds of customers to squeeze discounts from suppliers and create synergy in logistic operations.  

However, not everyone is convinced of the benefits of this deal. Senior independent director, Richard Cousins resigned in January in opposition to the acquisition and last week two of Tesco's biggest shareholders have come out against the deal. Schroders and Artisan Partners, who together hold 9 per cent of Tesco, believe that the £3.7bn price tag is too high – it represents 23 times the peak profit of Booker. They also note that Tesco has benefitted from simplifying its business structure in the past few years by pulling its operations out of South Korea and Turkey and selling the restaurant chain, Giraffe. This acquisition, they claim, marks a reversal of this strategy and creates too great a risk for what they perceive to be a small prize.

Tesco has responded to this opposition by confirming that it remains committed to the deal. They defend the high price as being representative of Booker's strength as a business. Indeed, on many metrics it is superior to Tesco; its operating margins (the proportion of a company's revenue left over after accounting for variable costs of production such as wages, raw materials, etc.) are almost twice those of Tesco, it also has less debt than Tesco, and its sales are growing. Tesco needs a majority of shareholders to approve the deal, so although this opposition marks a setback for the company, it is not in itself enough to bring the deal down. The biggest worry for Tesco is that Schroders and Artisan Partners' arguments may persuade others to vote against the deal and opposition to the deal may generate momentum.

What is particularly interesting about this deal was that takeover talks were so secretive and the parties did such a good job of keeping the deal under wraps that the City was generally surprised when a formal offer was announced. In a previous round-up, we discussed the importance of keeping a deal confidential from the markets and the press. However, among those Tesco chose not to disclose this deal were two of their largest shareholders who have now been far from secretive about their opposition to this deal. Tesco prioritised keeping schtum over keeping key shareholders on side – a strategy which may come back to punish them if shareholder opposition to this deal mounts.  

Freshfields are acting for Tesco in this deal, while Clifford Chance are representing Brooker. Macfarlanes are advising Tesco’s financial

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Tagged: Banking & Finance, Brexit, Commercial Awareness, European Union, Legal Business, Legal Careers, Regulators, Trade

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