INVESTMENT STRATEGY APRIL 2019 by LYXOR CROSS ASSET RESEARCH

INVESTMENT STRATEGY APRIL 2019 By LYXOR CROSS ASSET RESEARCH

WHAT DO EUROPEAN ELECTIONS MEAN FOR MARKETS?

Philippe Ferreira Senior Cross-Asset Strategist

CrossAssetResearch @lyxor.com

Do European Parliamentary elections matter for investors? • Yes, they do! European elections are a matter of concern for investors considering the rise of non- mainstream parties and the potential adverse market implications associated with the rise of right-wing populism. • While polls currently suggest a contained rise in anti-establishment parties, it is worth recalling that they have caught investors off-guard in recent years, i.e. Brexit referendum or U.S. presidential election. Moreover, for the first time since 1979, polls indicate that the two largest political groups (EPP and S&D, see appendix) will not gain a majority of seats (i.e. 353 seats in the next term). Pro-EU parties would nonetheless still hold a majority, due mainly to the likely gains of the liberal ALDE group.

What is the likely market outcome? • The elections should be a non-event for markets if the polls get it right and Europhiles can secure a majority. • Expect some turbulence in currency and EMU bond markets if right-wing Eurosceptic parties (ECR, ENF, EFDD) outpace expectations and/ or form a coalition. While this scenario is unlikely given the parties’ diverse views, they could become the second largest group in the European Parliament – though still far from forming a majority even if they receive support from leftist groups (GUE/NGL and Greens/EFA). The EU would, however, face a crisis of confidence. This would probably translate into a weaker EURUSD and widening sovereign spreads in the eurozone periphery. • Another source of uncertainty is the participation, or not, of the UK in the election. If the country exits the EU after May 22nd, it would be compelled to participate in the election, making the outcome more uncertain.

Where is the EU heading to? • According to current polls, right-wing Eurosceptic parties could obtain 25% of all seats (a near 40% including left-wing Eurosceptic/Nationalist groups). This could lead to a stalling of the EU project. The EU budget could be more constrained and national interests could return to the forefront. Supranational authorities would also be potentially less powerful. Ultimately, fiscal rules could be challenged, and this would probably translate into higher refinancing costs for countries such as Italy, Greece and Portugal, which bear a heavy public debt burden. Al

The views and opinions expressed in this document are those of the authors and are not given or endorsed by the company. This document is for the exclusive use of investors acting on their own account and categorized either as «eligible counterparties» or «professional clients» within the meaning of markets in financial instruments directive 2004/39/CE. See important disclaimer at the end of this document.

INVESTMENT STRATEGY By LYXOR CROSS ASSET RESEARCH 5 APRIL 2019

EUROSCEPTIC PARTIES’ RISE LIKELY TO REMAIN CONTAINED Current polls suggest the EPP (European People’s Party) and the S&D (Progressive Alliance of Socialists and Democrats) would remain the main forces in the European Parliament, with 177 and 135 seats, respectively. However, this represents a meaningful loss of seats compared to the 2014 election (-44 and -56 seats, respectively) and even more when compared to the 2009 vote. Both parties would fall short of a majority in Parliament for the first time since the first European election was held in 1979. But a majority of moderate and pro-European parties is still achievable if the EPP and S&D receive a likely external support from ALDE (Alliance of Liberals and Democrats for Europe). ALDE is expected to gain 38 seats, up from 67 to 105 in the next parliamentary term, with the support of Emmanuel Macron’s La République en Marche. Source: Europe Elects (retrieved on March 28th), Lyxor AM Right-wing Eurosceptic parties are, however, on the rise. The anti-EU ENF (Europe of Nations and Freedom) is expected to gain 25 seats, up from 37 to 62. Combined with the ECR (European Conservatives and Reformists) and the EFDD (Europe of Freedom and Direct Democracy), right-wing Eurosceptic parties are expected to obtain 166 seats (+11 compared to the 2014 election). If these three political groups join forces, then anti-EU parties would nearly be the largest group in the European Parliament.

Traditional parties are losing clout… … to the benefit of right-wing Eurosceptic parties

Source: Europe Elects, Lyxor AM Source: Europe Elects, Lyxor AM

Right-wing Eurosceptic parties are classified as populist parties. Europe’s right-wing populism has spread since the late 1990’s in response to a perceived loss of sovereignty following EU membership and loss of identity related to rising immigration. 1 Right-wing populists share ideological features such as authoritarianism and nativism. They reject supranational authorities, such as the EU, and adopt aggressive stances on immigration.

The key question is whether Eurosceptic parties consolidate power in 2019. However, the influence of populist parties is likely to remain limited. If Brexit goes ahead, the ECR and the EFDD will lose major members (UK Conservatives and UKIP). Nevertheless, new initiatives to form new political groups are emerging, such as an alliance between the Northern League (Italy) and Poland’s Law and Justice – though in the past, such initiatives have usually failed. In the run up to the 2014 election, the alliance between the National Rally from France and the PVV from the Netherlands actually took one year to materialize. In the end, they managed to create a small group throughout the whole legislative period. So, it looks like the Populists’ electoral breakthrough could be postponed to a future date.

1 Mudde C. and C. Rovira Kaltwasser (2017), “Populism: A Very Short Introduction”. Oxford: Oxford University Press.

INVESTMENT STRATEGY By LYXOR CROSS ASSET RESEARCH 5 APRIL 2019

EUROPEANS SHOW LITTLE INTEREST IN EUROPEAN ELECTIONS European Parliament elections are held every five years and by universal suffrage. In this election, the votes will go to 705 MEPs, down from 751 in 2014, between May 23-26 in 27 EU Member States (see Appendix 2 for seat distribution in the chamber). The UK is not expected to vote, though this may change if Brexit is significantly delayed. European Political Parties (see list in Appendix 1) have the right to campaign EU-wide for the European elections, but, in fact, campaigns are generally run by national delegates from national parties focused on national issues.

Although the European Parliament is the only EU institution to be elected directly, voter turnout has decreased steadily and substantially between 1979 to 2014, from 62% in 1979 (EU 9) to 43% in 2014 (EU 28). However, there are noticeable differences depending on the country. In countries such as Italy, Netherlands, France and Germany, voter turnout fell dramatically between 1979 and 2014 by 20 to 30 percentage points. Voter turnout has always been low in the UK (36% in 2014) and in Eastern European countries (close to, or below, 25% in Poland, the Czech Republic, Slovakia, Slovenia and Croatia). Meanwhile, voter turnout has structurally been higher in countries such as Belgium and Luxembourg (85-90%) and has increased over time in Denmark and Sweden.

Voter turnout has decreased steadily over time Picture differs according to the country

Source: European Parliament, Lyxor AM Source: European Parliament, Lyxor AM

A POLITICAL EVENT; NOT A MARKET EVENT. IS THIS TIME DIFFERENT? The European elections will be an important political event, as its outcome has deep implications for the top EU positions such as: i) the President of the European Commission, ii) commissioners in critical areas such as energy, trade policy, fiscal surveillance, competition and, iii) the President of the ECB.

In fact, European Parliamentary elections do have market implications. But these are usually marginal, indirect and long-term, except for the competition commissioner whose approval (or not) of mergers has immediate market consequences.

This time however, the rise of right-wing Eurosceptic parties is a concern for investors. The cumulated share of the ENF, ECR and EFDD is expected to climb from 20% in the 2014 European election to 25% for this term. Adding the left-wing Eurosceptic group (GUE-NGL) implies that one third of the European Parliament comprises members distrust the EU and will fight for less integration.

Risk assets could be hurt by adverse market effects if these political groups achieve a higher score than currently suggested by the polls. As long as Eurosceptic parties are nowhere near to forming a majority, which is highly likely, we believe the impact will be short lived.

INVESTMENT STRATEGY By LYXOR CROSS ASSET RESEARCH 5 APRIL 2019

APPENDIX 1: A BRIEF DESCRIPTION OF EUROPEAN POLITICAL PARTIES

What they stand for

The Group of the European People's Party (EPP) is the largest political group in the European Parliament. - The party supports a European single market that ensures the implementation of a business-friendly environment in favor of small and medium-sized European People’s Party (EPP) Enterprises (SMEs) and provides the best financial and legal conditions for start- Centre-right, supports greater EU up businesses. integration - They claim that, supporting a Single Market is essential for improving Europe’s competitiveness in industrial sectors. - The party’s convictions include creating a stronger Europe and a European true defense union.

The Socialist Group is the second largest group in Parliament. It advocates increases in wages in a move for a more equal sharing of profits. - For the low income categories, the party advocates minimum wages above the Progressive Alliance of poverty level for all EU countries, and therefore also national minimum income Socialists and Democrats (S&D) schemes. Centre-left, supports a proper - Since the efficient tax system in the Union allows for better redistribution, the economic, monetary and social Socialist Group advocates progressive income taxation, stronger wealth taxation, progressive real estate taxation, and the taxation of bonuses, union in the eurozone dividends and stock options. - Given rising inequality throughout the Union, they defend social protection for all to protect workers from exploitation and low labour standards.

The Group of the Alliance of Liberals and Democrats for Europe (ALDE) is the third largest group in Parliament. It is a transnational alliance between two European political parties, the Alliance of Liberals and Democrats for Europe and the European Democratic Party. - ALDE Party supports a constitutional settlement for Europe and stands for Alliance of Liberals and individual freedom. Democrats for Europe (ALDE) - There conviction is that the European Union must contain globalization and Liberal-centrist, supports free-trade promote free trade to generate growth and jobs. in an increasingly globalized world - Regarding immigration issues, Liberals and Democrats urge the EU to reach migration agreements with the safer Middle Eastern and African countries and to commit to hosting refugees. - Finally, they believe the EU should implement a solid legal framework for new technologies used in public life such as blockchain or artificial intelligence.

In June 2015, the Europe of Nations and Freedom became the anti-EU ENF Europe of Nations and Freedom group, after nine counties united to oppose the European project. (ENF) The bulk of the group's MEPs is from the French National Rally, headed by Far-right, represents anti- Marine le Pen. The Northern League (Italy), the Party for Freedom (PVV, immigration views and hard Netherlands) and the Freedom Party of Austria (FPÖ) are also key members Euroscepticism of this political group. Some UKIP (UK Independence Party) members, including its head, have joined this parliamentary group.

INVESTMENT STRATEGY By LYXOR CROSS ASSET RESEARCH 5 APRIL 2019

European Conservatives and The European Conservatives and Reformists group focuses on reforming the Reformists (ECR) EU but not on totally rejecting it. It comprises groups that are socially Centre-right, claims to be a conservative. The UK Conservative Party and Law and Justice (PiS) of Poland Eurosceptic anti-federalist party are the two largest parties within the group.

Europe of Freedom and Direct Democracy (EFDD) The populist group includes both right- and left-wing parties and is mainly supported by the 19 MPS from the U.K. Independence Party (UKIP) and Italy's Right-wing, populist Eurosceptic 5-Star Movement. They are firmly opposed to a bureaucratic Europe and a political group opposed to centralized European federation. European integration

European United Left–Nordic Green Left (GUE-NGL) The European United Left–Nordic Green Left party is on the far left of the political spectrum and comprises several Communist and traditional Socialist Left-wing, remains Eurosceptic and parties. The group questions the European Union’s political structure but aims at making all EU institutions remains committed to the EU project. fully democratic

Greens–European Free Alliance The Greens–European Free Alliance primarily represents parties focused on (Greens–EFA) national interests. This includes the SNP (Nationalist party in Scotland), Plaid Left-wing, stands for environmental Cymru (Nationalist party in Wales), and Catalan Nationalist parties. The group protection, equal opportunities, is committed to building a society respectful of fundamental human rights and social justice and an open, environmental justice by advocating unilateral nuclear disarmament, investment in renewable energy and same-sex marriage. democratic Europe

Non-Inscrits correspond to Members of the European Parliament (MEP) who do not belong to any official political group. Their political ideologies are Non-Inscrits (NI) diverse and cover a wide range of convictions encompassing conservatism, nationalism and national conservatism to social liberalism, populism, communism and neo-Nazism.

New unaffiliated parties represent independent parties established after the New unaffiliated parties 2014 European elections.

Sources: Political group websites, Lyxor AM

INVESTMENT STRATEGY By LYXOR CROSS ASSET RESEARCH 5 APRIL 2019

APPENDIX 2: SEAT DISTRIBUTION IN THE CHAMBER Within the European Parliament, seat distribution is not proportional to each state's population but follows a "degressively proportional" pattern based on each member state’s population.

On 7 February 2018, the European Parliament voted a new distribution of seats following the departure of the UK and agreed to reduce the overall number of seats from 751 (including the President) to 705 to form the next house (2019-2024), adopting article 14 § 2 of the Treaty on European Union (TEU):

“The European Parliament shall be composed of representatives of the Union's citizens. They shall not exceed seven hundred and fifty in number, plus the President. Representation of citizens shall be degressively proportional, with a minimum threshold of six members per Member State. No Member State shall be allocated more than ninety-six seats.”

The redistribution of seats proposed by Parliament envisaged to keep in reserve 46 of the 73 British seats left vacant after the UK’s exit. The other 27 former British seats would be reallocated to 14 countries currently slightly under-represented in the Chamber.

Hence, France (79 against 74 at present) and Spain (59 against 54) will be the main beneficiaries, but also Italy (+3 to 76 seats), the Netherlands (+3 to 29 seats), Ireland (+2 to 13 seats). Meanwhile, Poland, Romania, Sweden, Austria, Denmark, Slovakia, Finland, Croatia and Estonia will send an additional MP to the Parliament.

However, there are some uncertainties regarding the participation of the UK in this election. In a letter to European Council President Donald Tusk, Juncker declared that the UK's exit from the bloc should be completed by May 23-26 EU elections. "If the United Kingdom has not left the European Union by then, it will be legally required to hold these elections, in line with the rights and obligations of all Member States as set out in the Treaties."

Seat distribution among European countries

Hungary; 21 Czech Republic; 21 Greece; 21 Portugal; 21 Luxembourg; 6 Sweden; 21 Belgium; 21 Cyprus; 6 Austria; 19 Netherlands; 29 Estonia; 7 Bulgaria; 17 Slovenia; 8 Denmark; 14 Romania; 33 Finland; 14 Slovakia; 14 Latvia; 8 Poland; 52 Other; 77 Lithuania; 11 Malta; 6 Spain; 59 Ireland; 13 Germany; 96 Croatia; 12 Italy; 76

France; 79

Source: European Parliament, Lyxor AM

INVESTMENT STRATEGY By LYXOR CROSS ASSET RESEARCH 5 APRIL 2019

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