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Election 2015: UK banks facing ‘a nightmare’

  • Banking sector faces tough choices whoever wins
  • Labour victory likely to see increase in regulation
  • Conservative win would make referendum on EU a near certainty

Could a Labour victory suddenly see HSBC taking its bat and ball 
and uprooting headquarters to vibrant Hong Kong? 

The UK election on May 7 is approaching fast and for the country’s banks, it is going to be a nightmare no matter who wins the election.

Labour regulation

A more pure play on financials should the Conservatives win increasing future uncertainty with the referendum on EU membership would ideally be played through a basket (ETF on banks) to limit single stock exposure.

However, no liquid ETF on UK banks with acceptable amount of available shares for shorting exists. As a result, we would instead be playing Barclays short from current levels around 258p with a stop at 270p and target at 240p.

Saxo Bank Britain
Photo: istock

If Nigel Farage gets his way, then a referendum on Europe will happen and
that will create yet more uncertainty for the UK banking sector.

If Labour wins, the banking industry will be hit from multiple angles. It is very likely that Labour would impose more regulation on banks, including a new financial bonus tax, an increased tax levy and potentially a cap size limiting growth for the bigger players.

The first casualty will of course be HSBC. HSBC is already considering leaving London for Hong Kong due to the bank levy. The following domino pieces would likely be reduced employment due to a new bonus tax and it would likely long-term reduce competitiveness against the continent.

Conservative vacuum

UK banks are benefiting a lot from EU membership which gives the capital’s financial firms access to a vast continent to finance with almost friction-less rules for moving capital.

If the Conservatives win the election, it will trigger a referendum on EU membership in 2017 and thus create years of uncertainty for UK banks. Most of this uncertainty would immediately be priced into UK banking stocks after a Conservative re-election.

More generally, an EU referendum and potential exit from EU would have severe consequences for the UK because of a lack of easy access to European’s markets. For Europe, it will likely also have long-term growth implications.

How to play the UK election in equities

The most sensitive part of the market is financials due to its pro-cyclical characteristics and its benefits from EU membership. Additional to that is the sector’s vulnerability from increased regulation should Labour win the election.

We have identified two ways to play the UK election given the uncertainty around the banks.

Financials constitute 22.7% of the FTSE 100 Index and Energy has a 14.3% share.

This makes a play on the index a good choice should Labour win because the party has an aggressive regulation agenda on those two sectors. Our preferred way is to play it through put options to cap our potential losses should our trading hypothesis be wrong for reasons we cannot foresee at this point.

Buying the May 15 P7000 put option will cost around 101.5p corresponding to a premium of around 1.5%. This provides a good risk/reward ratio should the index react negatively to a Labour win and volatility spike.

 

Peter Garnry is head of equities strategy at Saxo Bank and part of the SaxoStrats team