The Good, the Bad and the Ugly: Top 3 News Stories of the Summer

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On Brexit, Italian Banks and Pokemon GO

Brexit

On June 22, Great Britain voted in the referendum to exit the European Union. “Leave” supporters scored a narrow victory, receiving 52% of the votes. The decision, which was largely driven by elderly and rural voters, was met with disappointment in the continental Europe. “We have to recognize the decision of the majority of the British people with deep regret today,” Chancellor of Germany Angela Merkel said after the referendum. The Latvian Ministry of Foreign Affairs made a similar statement, noticing that the countries would continue to cooperate the referendum result notwithstanding.

The formal clause that needs to be triggered before the official talks between the EU and the UK commence is Article 50 of the Lisbon Treaty, which stipulates that any state may decide to leave the EU, notifying the European Council and negotiating the new legal format for the relationships with the bloc in 2 years. As of now, no action in relation to the Article has yet been taken. David Cameron, the former UK Prime Minister, declined to start the process and resigned soon after the vote insisting that “we [the UK] need to determine what kind of relationship we want with the EU, and that is rightly something for the next prime minister and their cabinet to decide.” However, Mr. Cameron’s successor, former Home Secretary Theresa May, does not seem to rush with the start of negotiations either. She claimed that the process would start no earlier than in 2017.

The plebiscite and the decision to withdraw from the European Union are, though, quite ambiguous in terms of the future UK-EU relations. The new trade deal and the British involvement in many European political organizations is the most important and complicated point of the whole story. Right now, Britain has three major “models” on the table. The Norwegian one saves the membership in the EEA and access to the EU single market. In exchange for that, the UK will have to accept virtually all regulations as well as the free movement, in effect losing the representation in the European Parliament while still contributing to the common budget, thus leaving all the “brexiteers” wishes unfulfilled. The Swiss model would be a bigger step towards the separation. Switzerland negotiates specific bilateral agreements for each industry (there are around 100 in place) and has a wider degree of independence in law making, but the confederation still complies with the free movement laws, which happens to be one of the most contentious issues for the “Leave” campaigners. In the end, there is always a possibility to trade according to the World Trade Organization rules without a specific agreement. This result will enforce basic anti-protectionist measures for the trading countries, but export-import tariffs will rise and the regulatory environment will likely deteriorate.

The problems that Brexit brings are not limited to trade. The London branches of big banks are already starting to search for a place to move operations from the UK, while non-financial companies halt investment. The future political formation of the United Kingdom is not straightforward either. A strongly pro-EU Scotland is starting to push for another independence referendum, while Northern Ireland may decide to follow suit. The upcoming years are unlikely to be easy for Britons and European bureaucrats, but the complete Brexit is still far away. The preparations and initial discussions are going to be slow and deliberate. The former head of Civil service Lord Kerslake prepares us for a long procedure, “I think it’s at least five years away, maybe longer. All this talk of it being a two-year process is optimistic.” There were speculations after the referendum that a new one may take place soon, and the “Remain” backers even got a few million signatures for the respective petition, but the rhetoric of the British government shows that we should prepare for a total, lengthy, and likely painful divorce.

Italian Banks

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Italy has never been a particular economic success. It has been keeping investors on their toes since the European debt crisis. The government debt is accumulating, while the annual GDP growth figure has hiked above 1% only once since 2008. The piles of government and private debt were relatively trouble-free when the times were good. Now, when banks all around the world are starting to feel the pressure from the increased regulation, squeezed margins and, mainly, slow growth, Italian banks are among the most affected. They have accumulated €360bn of bad debts and now the solvency of some is being put into question.

The world’s oldest one, Banca Monte dei Paschi di Siena, has 24% of non-performing loans on its balance sheet and requires immediate capital injection. The lender’s stock price has fallen more than 80% since last September, so raising money through equity is an unlikely way to follow. Moreover, there is a big question mark over the long-term creditworthiness of the bank. Moody’s rate the bank at B- (highly speculative), and so the bank might find it challenging to borrow at a reasonable interest rate as well.

The Italian government could have bailed-out the bank, but with the new EU rules in place, it is no longer possible. Now, the bondholders of the bank should also incur losses in such a case. With a third of Italian banks’ bonds in the hands of retail investors, a failure to repay in full will likely trigger a huge wave of dismay among the ordinary Italians. It is the worst thing to have for the incumbent Prime Minister Matteo Renzi on the eve of the constitutional referendum in autumn. Mr. Renzi already promised to step down as Prime Minister if he fails to win the vote. In such a case, the populist “Five Star Movement” is very likely to win the next elections and set abandoning the euro as the cornerstone of their program.

To cope with the issue, the government created a €5bn Atlante bank to purchase bad debt and equity in the troubled banks. The institution is expected to take €70bn of non-performing loans off the banks’ balance sheets as well as recapitalize the worst banks in an attempt to return private investment. While larger banks such as Unicredit are able to raise equity on their own, the Atlante fund was one of the possible ways to prevent smaller Italian banks from failing without breaking the European rules. The fund’s ultimate success will depend on further measures taken by the Italian government. The constitutional reform referendum is one of them.

Although the bad debt issue seems to be temporarily handled in Italy, the sluggish growth in other European countries may cause similar problems soon. With the total amount of non-performing loans standing at €1tn, policymakers need to ensure that growth will revive to prevent the next debt crisis.

Pokemon GO

One more event literally shook the world in July. An augmented reality game Pokemon Go was released by Nintendo on July 6 and immediately went viral all around the globe. The game’s core idea of wandering around and catching Pokemons has led millions of people out on the streets with the number of daily users peaking at 45m in mid-July. According to a poll by Survey Monkey, it is now the most downloaded mobile game in the US.

Millennials were not the only ones responding to the great hype around the game. The markets also reacted abnormally, resulting in an overwhelming run for the Nintendo stock. As a result, the Japanese company saw its share price more than double in the two weeks following the launch. This is even in spite of the fact that the company holds only 33% in Pokemon Company, so most of the revenues will go to the other shareholders. The share price plunged after the announcement, but the company’s equity is still valued 1.58 times more than in the pre-Pokemon Go days.

Many stock traders are starting to notice the temporary nature of the game’s success. It is no longer in the headlines of the major news agencies; walking around in colder months becomes a less pleasurable activity than in July, while the game itself is extremely repetitive, so the first wave of players is already feeling bored. The latest statistics support these assertions – the number of daily users has dropped by 10m down to 30m. This figure is likely to get even lower going forward. Pokemon Go has managed to deal a much-needed shake-up to Nintendo. However, if no further action is taken, the game’s success is doomed to tarnish over time. The entire Pokemon franchise may yet revive. After the years of dismay, it seems that the company got a second wind and may become a major gaming market player again.