Will Neil Woodford Succeed?

How long do you give a fund manager before giving up on poor performance? This is the key question faced by investors in the funds run by Neil Woodford and his Woodford Investment Management company.

Neil Woodford had a very successful record at Invesco – their High Income fund turned £10,000 into £230,000 over 25 years. In 2014 he departed to set up his own investment company and he attracted many followers to the new platform but the record since then has been very poor. For example the main LF Woodford Equity Income C Acc fund has delivered a return of -7.0 % over 3 years according to TrustNet while the stock market has in general been booming. The Woodford Patient Capital Trust which invests in smaller, early-stage companies is even worse with a share price total return of -10.7% over 3 years according to the AIC.

Woodford also run funds for Hargreaves Lansdown and St. James Place although they might have slightly different mandates. Recent articles in the FT suggest those companies still have faith in Woodford with comments about the “contrarian” approach of Mr Woodford and that it is likely to come good in the end. But will it? Has the market changed while the style of the fund manager has not? Has he simply lost his touch as a stock-picker? Over-confidence in one’s ability can be a great danger for stock-pickers. But perhaps he has just been unlucky with his stock selections?

Three years is about as long as I give fund managers before exiting completely, and I would reduce my holding in a fund before then. My decision tends to be based on my view of the investments the fund is holding. For example, the top 5 holdings in the Equity Income Fund are Barratt Developments, Imperial Brands, Burford Capital, Provident Financial and Theravance Biopharma. The last one is a one-product biopharmaceutical company with no profits, Barratt is a housebuilder when investors are fleeing the sector due to house price declines and the threat of higher interest rates, Imperial Brands is a tobacco company subject to ever tougher Government regulation, Burford Capital is a backer of law suits (a litigation funder) and Provident Financial is a consumer loans business. These are all companies that other investors might avoid so they are truly contrarian investments. The holdings of Woodford Patient Capital are even more idiosyncratic. One of the largest holdings is in Purplebricks which I have commented on negatively in the past. Investors therefore need to judge whether these kinds of investments will come good in the next year or two. I have my doubts.

Another question to be asked is whether Woodford has simply spread himself too thinly with multiple funds now under management. Does he have the same level of support from a team that he had at Invesco? Large fund managers are not one-person businesses.

One issue to look at in addition is does the fund manager have a clear investment process, i.e. do they stick to clearly stated rules or are just idiosyncratic? Is it the process that is failing or the manager’s decisions that are at fault? All fund managers make some mistakes but a look back over past investments can be a good indication of what is going wrong.

My past experience tells me that “contrarian” fund management approaches often fail. Swimming against the tide of investment trends is positively dangerous and rarely works. Incidentally I watched the Burt Lancaster film “The Swimmer” last night – a very stylish film indeed. The ending might represent the failure of dreams over reality. Perhaps Neil Woodford’s dream is fast disappearing?

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Safestore and Fundsmith AGMs

Today I attended the Annual General Meeting of Safestore Holdings Plc (SAFE) in Borehamwood. Their head office is next to one of their self-storage units. They now have 146 stores with a concentration in London/South-East England, and in major UK cities, plus some in Paris.

The Chairman, Alan Lewis, commenced the meeting with a very brief statement. He said 2018 was a good year with good strategic progress. He is confident value creation will continue. Note that Mr Lewis is stepping down as Chairman and they are looking for a replacement as he has now served for 9 years.

Safestore is a growing company in a growing sector. As people accumulate more junk, house sizes shrink and more people live in flats, they run out of space for their belongings. The demand is also driven by divorce and death. In addition to personal users, small businesses find such facilities useful to store goods, tools & equipment, or display material.

Revenue was up 11% last year, and earnings up 125% (or as this can be seen as a property company, EPRA earnings were up 15.5%). The dividend was increased by 13.8%. Self-storage companies can be perceived as property companies but they are best viewed as operating businesses in my view (the CEO seemed to agree with that). The market cap is way higher than the book value of the assets unlike in most property companies of late. Self-storage is one of the few growth areas in the property sector at present.

Page 8 of the Annual Report gives some information on the market for such facilities. Compared with say the USA, the UK storage space per head of population is only a small fraction of the USA. In other words, the UK market is relatively immature and to reach the same level as the USA would require another 12,000 stores!

I asked the Chairman why the company did not expand more rapidly if the potential is there? The response from the CEO was that there were problems with finding suitable new sites and with planning restrictions. They are also conservative on finance. A question on potential acquisitions arose as it is a fairly fragmented market in the UK but it seems few such opportunities are reasonably priced and meet the quality criteria they have. They did take over Alligator last year. Competitors don’t seem to be growing any more rapidly, and the CEO suggested they were gaining market share.

The main other question I raised was about their Remuneration scheme. At the 2017 AGM they only just managed to win the Remuneration Policy vote and at the 2018 AGM the Remuneration resolution was again just narrowly voted through. Remuneration Committee Chairperson Claire Balmforth explained that institutional investors were unhappy with the LTIP and the “quantum” of pay – that’s a polite way of saying it was too high. Indeed remuneration at this company is high in relation to the size of the business – the CEO received a total pay of £1.6 million last year (single figure remuneration). Even the Chairman received £135,000.

However it’s apparently all change after extensive conversations with institutional investors. The executive directors have agreed changes to the LTIP and a “more conventional” LTIP will be introduced in 2020. As a result they did better on the remuneration vote, and the votes on the re-election of Balmforth and Lewis, with the Remuneration resolution passing with 70% support.

It was not until later when I chatted to the directors that I discovered where I had come across Claire Balmforth before. She used to be HR Director, then Operations Director, at Carpetright when I held shares in that company.

Anyway I gave them my views on remuneration. Namely I don’t like LTIPs at all, particularly those that pay out more than 100% of base salary. I prefer directors are paid a higher basic salary with an annual bonus paid partly in cash, partly in shares.

Other than the pay issue, I was positively impressed as a result of attending the meeting.

One issue that arose was the poor turnout of shareholders at the meeting. There were more “suits” (i.e. advisors) than the 3 ordinary shareholders (two of those were me and son Alex). Now it happens that earlier in the day I was watching a recording of the annual meeting of Fundsmith Equity Fund which I had not been able to attend in person this year. Terry Smith was in his usual good form, and he said there were 1,300 investors at the meeting. That’s more than any other UK listed company or fund (most funds do not even have such meetings). An amusing and informative presentation helps enormously to attract investors of course. I wish all companies would bear that in mind.

You can watch the Fundsmith meeting recording here: https://www.fundsmith.co.uk/tv .

Anyone who wishes to learn how to make money in stock markets should watch it. Terry Smith has a remarkable record at Fundsmith. He said last year was not a vintage year as the fund was only up 2.2%. But that beat their benchmark and only 7.8% of UK funds generated positive returns last year. In the top 15 largest UK funds over 3 and 5 years, they are the clear winner.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Patisserie and Interserve Administrations, plus Brexit latest

Yesterday the administrators (KPMG) of Patisserie (CAKE) issued their initial report. It makes for grim reading. The hole in the accounts was much worse than previously thought with an overstatement of net assets of at least £94 million. That includes:

  • Intangible assets overstated by £18m;
  • Tangible assets overstated by £5m;
  • Cash position overstated by £54m;
  • Prepayments and debtors overstated by £7m;
  • Creditors understated by £10m.

The accounts were clearly a total fiction. It is uncertain whether there will even be sufficient assets to make a distribution to preferential and unsecured creditors. As expected ordinary shareholders (who are not creditors) will get nothing. You can obtain the KPMG report from here: http://www.insolvency-kpmg.co.uk/case+KPMG+PJ12394136.html

KPMG suggest there may be grounds for legal action against various parties including Patisserie auditors Grant Thornton by the administrator, but as Grant Thornton are the auditors of KPMG they are suggesting the appointment of another joint administrator to consider that matter.

Otherwise it looks a fairly straightforward administration with assets sold off to the highest bidders and reasonable costs incurred.

Another recent administration was that of Interserve (IRV). This was forced into a pre-pack administration after shareholders voted against a financial restructuring (effectively a debt for equity swap) which would have massively diluted their interest. But now they are likely to get nothing. Mark Bentley of ShareSoc has written an extensive report on events at the company, and the shareholder meeting here: https://tinyurl.com/yy7heunl . He’s not impressed. I suspect there is more to this story than meets the eye, as there usually is with pre-pack administrations. They are usually exceedingly dubious in my experience. As I have said many times before, pre-pack administrations should be banned and other ways of preserving businesses as going concerns employed.

Brexit. You may have noticed that the stock market perked up on Friday. Was this because of some prospect of Mrs May getting her Withdrawal Agreement through Parliament after all? Perhaps it was. The reasons are given below.

There were two major road blocks to getting enough MPs to support the deal. Firstly the Irish DUP who had voted against it. But they are apparently still considering whether they can. On Thursday Arlene Foster said “When you come to the end of the negotiation, that’s when you really start to see the whites of people’s eyes and you get down to the point where you can make a deal”. Perhaps more concessions or more money for Northern Ireland will lubricate their decision.

Secondly the European Research Group (ERG – Jacob Rees-Mogg et al) need to be swung over. Their major issue is whether the Agreement potentially locks in the UK to the Irish “Backstop” protocol for ever. Attorney-General Geoffrey Cox’s advice was that it might, if the EU acts in bad faith. I have said before this legal advice was most peculiar because nobody would enter into any agreement with anyone else if they thought the other would show bad faith. Other top lawyers disagree with Cox’s opinion. See this page of the Guido Fawkes web site for the full details: https://tinyurl.com/y4ak6q3c

Mr Cox just needs to have a slight change of heart when his first opinion must have been rushed. He has already said that the Vienna Convention on international treaties might provide an escape route so he is creeping in the right direction.

Mrs May will have another attempt at getting her Withdrawal Agreement through Parliament, assuming speaker Bercow does not block it as repeat votes on the same resolutions are not supposed to be allowed in Parliament.

It was very amusing watching a debate at the European Parliament over Brexit issues including whether an extension of Article 50 should be permitted – the EU can block it even if the UK asks for it.  The EU MEPs seemed to have as many opinions as UK MPs on the issues. The hardliners such as Nigel Farage wish that it not be extended so that the UK exits on March 29th. Others are concerned that keeping the UK in will mean they have to participate in the EU elections in May with possibly even more EU sceptics elected.

It’s all good fun but it’s surely time to draw this matter to a close because the uncertainty over what might happen is damaging UK businesses. A short extension of Article 50 might be acceptable to allow final legislation to be put in place but a longer one makes no sense unless it’s back to the drawing board. But at least the proposal for another referendum (or “losers vote” as some call it) was voted down in Parliament. Extending the public debate is not what most of the public want and would surely just have wasted more time instead of forcing MPs to reach a consensus.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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FCA Makes Platform Switching Easier

The Financial Conduct Authority (FCA) have today announced some measures to improve competition in the platforms market. Experienced investors who use electronic trading platforms will be well aware of the problems of switching to another provider if they are dissatisfied with the service, wish to move to a cheaper provider or for other reasons such as consolidating on one provider or spreading their risk over several. It simply takes too long to move “in-specie” holdings from one platform to another ̶ it can take many months to transfer with endless chasing required.

Such transfers are also discouraged, resulting in an uncompetitive market, by the charging of exit fees by platforms. Together with the delays that investors face, this tends to lock in investors to their existing platform providers.

You can read my response to the FCA’s previous public consultation on this subject here: https://www.roliscon.com/Investment-Platforms-Market-Study.pdf . I mentioned my and others past experiences of delays of over 3 months on transfers.

The FCA is proposing to ban or limit exit fees. The FCA is also encouraging firms to take part in the STAR initiative (see https://www.joinstar.co.uk/) to improve the efficiency of the transfer process.

One particular problem with fund transfers is that sometimes a conversion of unit class is required, or it is preferable to move to a discounted class. They have set out proposals to mitigate that issue.

More information on the FCA’s proposals and a public consultation on the subject, to which I will certainly be responding, is here: https://tinyurl.com/yyjw2jpf .

At least one platform provider, AJ Bell Youinvest, has welcomed the FCA’s findings. They say a restriction on exit fees will not have a material impact on their business, and as a net receiver of assets they would expect to benefit from more transfers if they are made easier. Other platform providers may not be so happy, and may complain they won’t be able to cover their real costs of handling transfers. But there is little incentive to reduce those costs and reduce the complexity and delays in transfers at present. Therefore surely these are positive proposals that all investors should support. Everyone can respond to the consultation so if you have been affected by these problems in the past, please do so.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Superdry – Does It Need a Revolution?

I mentioned the requisition of an EGM to appoint two new directors at Superdry (SDRY) in a previous article. Here’s some more analysis:

The requisition has been submitted by two founders – former CEO Julian Dunkerton and James Holder who together hold about 29% of the ordinary shares. They wish to appoint Julian and Peter Williams as non-executive directors – Mr Williams is a very experienced director of consumer products companies and is currently Chairman of Boohoo.com Plc although he is stepping down from that role this month.

One does not doubt that Mr Williams would act independently as required by company law, and it is surely not unreasonable to have a nominee on the board representing shareholders who hold 29% of the company.

There was another announcement from the board of Superdry yesterday even more vociferously opposing the resolutions but they had already rejected the need for the requisition as not being in the company’s interest. They said that the current strategy is supported by shareholders and that this requisition will impose needless distraction and costs, i.e. the usual reasons given to rebuff any change.

Let’s look at the reasons for the requisition – apart from the general impression given that the founders think their baby is being screwed up by the new management – a common feeling of departed founders as I know personally. But the company does appear to have real problems if you just look at the share price – down from its peak of 2025p in January 2018 to 520p now, i.e. down 75%. In the results published in July 2018 the company proclaimed “double digit growth in sales and profits” and declared a special dividend, but subsequent announcements have been negative in tone. In October the company reported unusually warm weather had affected sales of heavier weight products which were a big proportion of its sales normally. They announced a diversification into lighter weight clothes and new product categories as a result. But weaker consumer confidence was also mentioned as affecting all retailers.

The latest Q3 trading statement, in February 2019, recorded group revenue down by 1.5%. Wholesale was up but e-commerce and particularly store revenue was down – the latter by 8.5% despite retail space being up. Cost savings were being progressed and the “comprehensive transformation programme” has been intensified. Consensus earnings forecasts have been falling so that the company is now on a prospective p/e of less than 10 and a dividend yield of 5%. When once it was seen as a growth business, it is clearly now perceived as having problems.

Superdry has now fallen out of the FTSE-250 index which will have caused some funds to dump the stock, and institutions who picked up 5.5 million shares from Mr Dunkerton in July 2018 will be none too pleased. Is this an example of how quickly a “fashion” retailer can go out of fashion, or simply down to some operational cock-ups? Such as not having the right stock for the prevailing weather conditions?

Mr Dunkerton claims the change in company strategy in 2017 is the cause of the problem and his return to the board would revive the company. He refers to other examples of founders returning such as Steve Jobs (Apple), Howard Schultz (Starbucks), Charles Schwab (at his brokerage), Jerry Yang (Yahoo), Malcolm Walker (Iceland), Steve Morgan (Redrow) and Michael Dell (Dell) who revived their companies’ fortunes.

Mr Dunkerton also alleges failings in product design and a number of operational changes that have impacted sales – he aims to fix the former by bringing back James Holder as a consultant to “reinvigorate the DNA of the brand” whatever that might mean. Although the board says Dunkerton was responsible for the Autumn/Winter 2018 range which contributed to the company’s underperformance, he denies it and says he was cut out of the design process.

Doing my own market research, a quick look at the Superdry web site tells me that the products look expensive, particularly for the target market and against likely competitors. Indeed when I asked one of my sons whether he purchased Superdry products he said only from E-Bay where they are cheaper.

We know High Street retail sales are difficult but on-line sales should be booming, but not at Superdry it seems. Though the on-line market is getting a lot tougher with “fast fashion” retailer QUIZ recently reporting a shortfall in sales due to forced discounting. Comparison pricing by shoppers on the internet is clearly becoming more common and if a brand like “Superdry” loses its reputation and exclusivity they will not be able to charge supra-normal prices. Perhaps that is the issue when there are so many channels now selling Superdry products and discounting so prevalent?

One brand extension being pursued is a move into children’s wear. As the founders’ say: “a kidswear range would destroy the ‘cool factor’ for the 16-24 age group, a key demographic”. I would agree with that statement. You can read more about the reasons for the requisition on this web site, set up by the requisitioners: https://www.savesuperdry.com/

My conclusions: I always discount claims about the weather hitting sales and profits in companies – they tend to complain about the weather being either too hot or too cold when the weather is fundamentally variable. Their stocking and supply chain need to cope with that. Otherwise there seem to be major failings in both strategy and operations at the company. But will just appointing a couple of non-executive directors (one of whom clearly has an urge to interfere in operations) really help? It might just lead to a divided board who cannot agree on anything.

However, there is obviously a need for changes, in leadership and in other regards, which the board has rebuffed in essence. Shareholders are in a difficult position due to the limited nature of the proposed revolution. Shareholders might wish to support the requisition, but urge the board to make more substantive changes at the same time. Or at least have a more constructive dialog with the founders. There certainly seems no good reason to oppose Mr Williams’ appointment.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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FRC Revolution to Fix Audit and Accounting Problems

A major announcement that will impact investors was made yesterday by the Government. You may not have noticed it in the midst of political turmoil, but it’s worth studying.

The Kingman review of the Financial Reporting Council (FRC) was published last December. It was a quite damning criticism of many aspects of the current regulatory regime that had resulted in so many audit failures and poor-quality financial reporting. See my previous blog post on this subject here: https://roliscon.blog/2018/12/18/all-change-in-the-audit-world/

There are few experienced investors who have not suffered from audit failures in the last few years. Accounts need to be accurate, reliable and trustworthy but they have been far from that in the last few years. It is now proposed that the FRC, which regulates the audit world and sets accounting and corporate governance standards, be scrapped and replaced by a new body to be called the Audit, Reporting and Governance Authority – ARGA as it will no doubt be abbreviated to. ARGA will have stronger powers, a new mandate and new leadership.

There is a public consultation on the proposed new body and supporting legislation which can be obtained from here: https://tinyurl.com/y55a376d . Anyone with an interest in improving auditing, and preventing company failures such as those at Patisserie or Carillion and major banks in 2008 should respond. But there are so many changes proposed that the document may take time to digest. I pick out some of the more important ones below:

A new Chairman and Deputy Chairman are being recruited to head ARGA so there will be change at the top. Let us hope they manage to change the culture of the FRC even if many of the FRC’s staff move into the new body. It needs to be more than a change of name.

The ARGA will have clear statutory powers with a clear purpose and objectives, supported by a “remit letter” from the Government. One objective will be “to protect the interests of users of financial information and the wider public interest…” which is a positive statement and replaces the unclear historic accumulation of limited powers by the FRC.

The new board responsible for the ARGA will be smaller, more diverse and less representative of “stakeholder” interests. Let us hope that this means less dominated by major audit firms and the audit profession.

The Audit Firm Monitoring Approach will be put on a statutory basis and with enhanced skills and seniority in the team. There are also proposals to improve the Audit Quality Review system which sound promising although such reviews only affect large companies. There will also be expansion of Corporate Reporting Review activity focused on higher risk companies and the new regulator will have the power to change accounts without going to Court.

The “audit expectation gap” where, for example, investors expect auditors to detect false accounting or even fraud whereas auditors don’t perceive that as part of their job will be reviewed. There is indeed a problem with the failure of auditors to challenge the information they receive from management and the latter’s forecasts and interpretation. Let us hope that is a meaningful independent review that results in some changes.

A new “pre-clearance” system will be introduced to enable companies and their auditors to obtain approval for “novel and contentious matters in accounts in advance of their publication”. This may assist auditors to “pass the buck” to someone else if they have doubts about how to present the financial figures.

More transparency in the new body is encouraged on such matters as disclosure of undertakings from concluded cases and it will become subject to the Freedom of Information Act. There will also be more publication of information on complaints and improved handling of them. Such changes are to be encouraged to stop the current secrecy under which the FRC operates which frustrates investors.

The oversight of the accountancy profession is proposed to be improved although the details are unclear and it may require primary legislation. The wording suggests that audit firms may escape substantial change.

The prevention of corporate failure is to be tackled by developing a market intelligence system to identify emerging risks in companies. This will enable a change from a purely historic analysis of corporate failures which is rather like shutting the stable door after the horse has bolted to a more proactive, future-looking approach. Auditors may also be required to warn of concerns about viability.

The AARG will be able to commission a “skilled person review” where concerns are raised about a company. Details of how this will operate are to be determined, but this appears to be a useful step forward. The cost would be charged to the companies where it is invoked.

The Government accepts that there is merit in improving internal company controls by something along the lines of the US Sarbanes-Oxley regime. They will explore options in this area and do a consultation on it in due course. This is a welcome move and I covered the benefit of such a change in a previous blog post: https://tinyurl.com/yxmx9gzg

It is proposed to improve “viability” (i.e. “going concern”) statements and the FRC has been tasked with taking that on immediately. Such statements are certainly ineffective at present and could be improved in several ways, e.g. to avoid the “all or nothing” approach at present. Such questions are not simple black and white issues in most cases.

It is proposed to replace the existing, and most peculiar, voluntary funding arrangement of the FRC with a new statutory levy for the ARGA. This is surely welcomed as money is the key to improving many of the regulatory functions. It is clear that the FRC is under-resourced in terms of the numbers and skills of staff.

In summary, most of the recommendations in the Kingman review are being taken forward.

Comment: These long-overdue reforms are certainly welcomed and the Government does seem to be applying some urgency to them, although with a log-jam in Parliament at present it may take time to get some of the needed statutory law changes in place. But cultural changes in organisations are never easy. Old bad habits in the FRC may persist, while it remains to be seen whether adequate funding will be put in place for the ARGA. There is also a lot of detail yet to be worked out. Let us hope it is a case of welcome to ARGA and not AARGH when we learn the details.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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Brexit – Now a Supportable Deal

Mrs May’s latest agreement with the EU is surely a satisfactory outcome – at least for everyone except those who wish the UK to depart with “no deal” or oppose Brexit altogether. She has agreed very much what I suggested at the end of January when I said “She is getting near a clear mandate from Parliament which will help in the battle with EU bureaucrats and politicians who are adamant they won’t renegotiate the Withdrawal Agreement. But they will have to if they don’t want the UK to exit without one, which would threaten a lot of EU country exports. Come March 28th, it will be time for a face-saving compromise – no change to the Withdrawal Agreement – just the addition of a codicil providing alternatives to the Backstop.”

And it’s not even March 28th yet, but whether she will get this agreement through Parliament remains to be seen. Later today the vote will decide, but it may not be a final resolution.

Why does the latest “update” to the Withdrawal Agreement provide a satisfactory outcome in my view? Because many people wished to retain uninhibited trade with the EU – at least for a transition period. That did require adherence to some common standards. That is what the Withdrawal Agreement provides and which primarily covers a 2-year transition period. After that the relationship is subject to negotiation and mutual agreement. But there was an issue with the Irish “backstop” that might have prevented the UK from ever exiting the EU fully. That is what many people objected to and what caused MPs to previously vote it down.

The Withdrawal Agreement may not be perfect in all other regards but it is a reasonable compromise and should now be supported. At least that’s my view but I can see some folks disagreeing on this.

You can read the latest legal “codicil” to the Withdrawal Agreement here: https://ec.europa.eu/commission/sites/beta-political/files/instrument.pdf

Postscript: It has been disclosed that Attorney-General Geoffrey Cox does not believe the aforementioned “codicil” as I called it ensures that Britain will not be trapped in the Irish Backstop. He has said so in a 3-page letter to Mrs May – see https://tinyurl.com/y58jzzev . In summary he suggests that the “clarifications and amplified obligations provide a substantive and binding reinforcement of the legal rights available to the United Kingdom in the event that the EU were to fail in its duties of good faith and best endeavours” but he ends by saying that legal risks remain, particularly if the EU shows bad faith.

This seems excessively negative if you read it carefully. If bad faith is shown by either party to an agreement, then it fails. One or other party simply walks away. But Mr Cox’s comments will certainly not help the Prime Minister.

Roger Lawson (Twitter: https://twitter.com/RogerWLawson )

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