Free trade as a bargaining chip is a 7-2

A 7-2 is the worst starting hand in Texas Hold'em Poker. No chance for a straigth or a flush and even if you get a pair it is a low one with a worthless kicker. Only absolute beginners keep this hand as they are hoping for a very unlikely 7-7-2 flop.

What does this has to do with free trade, now? Well, having been raised and matured in a world which put a lot of efforts in free trade, based on learnings from the darkest period in man kind beginning to mid of the 20s century and the experience that free trade is the foundation for wealth and well being of most parts of the world, I recently get the impression that in the political and diplomatic arena there are more and more "rookies" at the table playing "all in" with a 7-2. Or in other words: using free trade as a bargaining chip in political and diplomatic negotiations. For example, because of a perceived "disadvantage" in trade one site is restricting trade from outside ("the other side") with tariffs and trade barriers, triggering an immediate counter reaction of the other side. The starting gun for the race to the bottom of free trade and hence the wealth of nations.

The Swiss Exchange equivalence and free trade

At the end of this month the Swiss stock exchange is in danger of losing its EU market equivalence. That means that European market participants would no longer be allowed to trade shares in Switzerland which are also traded at an EU or EU equivalent exchange. On the Swiss stock exchange over 60% of the trades are made with participants from the EU, which are in danger of being lost. That would result in significantly less liquidity on the market with all the consequential disadvantages. The reason for the threatened loss of equivalence is not because of concerns about the Swiss market place and its regulations. It is used by the EU as a bargaining chip to make progress on the very important Framework Agreement which should replace the current patchwork of deals between the EU and Switzerland ("Bilaterale Verträge"). On 18 June the EU commission has indicated it does not consider the progress on the Framework Agreement sufficient enough to extend the currently temporary equivalence beyond the end of June.

Although not impossible to find a solution until the end of June, the withdrawal of the EU market equivalence has become much more likely. Something no one seriously would have expected end of last year.

Of course dealing with alleged superior empires in their neighbourhood is very much in the genes of the Swiss culture since centuries. Not surprisingly, the Swiss government has already established "countermeasures": at the end of November 2018, the Swiss Federal Council enacted an ordinance specifying that foreign exchanges will need recognition by the Swiss exchange market authority (FINMA) for listing and trading of shares of companies domiciled in Switzerland. Of course, it is likely that when the EU equivalent is withdrawn for the Swiss market, the EU markets will not be awarded with the required recognition. With that, the EU markets would not be allowed to trade shares of Swiss domiciled companies anymore.

So would that mean that European market participants could no longer trade shares of Swiss companies? No, but only at the Swiss stock exchange, which would then be allowed under EU regulation as there is no EU equivalent market where these shares are traded as the Swiss stock exchange is not considered an EU equivalent market place anymore. As a result, the EU ban could even have the effect to redirect more traffic i.e. liquidity into the Swiss exchange markets. Definitely something which is completely contradictory to the EU commission's intention.

All good then for the Swiss market place?

Yes, it is a very smart move setting a pinprick to the EU and suggesting the EU commission has shot itself in its feed from behind with its likely decision not to extend the Swiss market equivalence. On the other hand, do not forget the EU has an important trump card still on its hand: negotiation power. And negotiation power for capital markets means liquidity and volume.

Swiss companies could decide to change their trading venue to a EU or equivalent market, like London, Frankfurt or Amsterdam stock exchange. Although most of the 20 Swiss SMI companies have indicated not to disembark the domestic trading place, according to a quick survey a Swiss newspaper conducted, we do not have a crystal ball to see what really will happen in this scenario. However, it is true, that is not very likely, because there is not enough pressure on SMI companies to do so. For sure, EU market participants still want to trade in Nestlé, Novartis and ABB shares.

But what about all the very successful Swiss niche market leaders which do not have the pull demand from investors just because of their big names? Especially those companies with a large investor base outside Switzerland, but in EU countries might reconsider their situation.

And even if not a single Swiss company decides to change the trading place: it injects siginficant amount of uncertainty into the market place, which is the most effective poison for efficient capital markets. It is a draw back and a threat to free trade, one of the biggest achievements after World War II, which made us the wealthiest, healthiest and at the end of the day the most peaceful population mother earth has ever seen!

Because market places get more fragmented, it could lead to increased transaction costs, less liquidity and hence less enterprise values whith all the negative effects on efficient access to funds to finance the upcoming challenges and transformations comapines are currently facing: digital transformation, business model and technological innovation and, yes, managing the climate change.

I really hope, that this is just a rookie bluff, and no one of the players at the table is going "all in" with a 7-2.

What should CFOs do?

Although there is still some hope left, that the bargain chip will not be used, companies should start preparing themselves for the unexpected. Although the direct consequences of the potential withdrawal of the EU equivalence for each company might not be significant, they should include the scenario in their risk assessment, particularly in decisions of issuing capital or getting listed. And of course, the appropriate trading places for the company, if and when, should be reconsidered.

But the most important thing: because of all the uncertainties creeping into the market place, it is definitely something companies should be prepared to communicate with their investors. It might also have an effect on road show planning, whether deal or non-deal related. It might have an effect on places, representatives and content, of course. Something the finance function and investor relations should work on very closely together.

And probably also a good opportunity to join forces and fight back the tendency of chopping free trade!