Outside the Box: Gear up for a no-deal Brexit: 5 areas investors should watch
Brexit negotiations resumed on Tuesday as Brexit Secretary Dominique Raab met in Brussels with EU counterpart Michel Barnier. The prospect of a “no-deal Brexit” looms higher following little progress since when both sides agreed to a financial settlement in December of 2017. Time remaining to strike a deal is shrinking fast, and a self-imposed October deadline now seems likely to be missed, further complicating the ratification of any agreement before the final March 2019 deadline.
Thus, planning for a no-deal scenario is appropriately gearing up. On Thursday the British government will release the first of 84 papers detailing contingency plans for a no-deal Brexit. They mirror the 68 “preparedness notices” published by the EU Commission this past July. Importantly, blueprints for regulation of financial services after Brexit will be released in the coming days.
So, what are 5 key things to watch in a no-deal Brexit?
1. The U.K.’s fallback position on key areas
• Irish border backstop.This is still the key hurdle preventing a deal. The EU and the U.K. agreed to a backstop plan for Northern Ireland’s border last December, where Northern Ireland would stay within the EU’s customs union and the single market for goods. However, Prime Minister Theresa May has since denounced the arrangement as a recipe for a constitutional crisis, since it would create a border in the Irish Sea between Northern Ireland and the rest of the U.K. In her “Chequers” plan, her government advocated for collecting EU tariffs on the EU’s behalf and improved border technology to solve the thorny issue, but the EU has since rejected the idea. Until a satisfactory answer to this issue is found, the fallback plan as it currently stands is a source of friction.
• Freedom of movement.The U.K. has recently announced that it will continue to grant EU citizens the right to stay in the U.K. in the advent of a no-deal Brexit. While freedom of movement and immigration were pivotal issues in the initial decision to leave the EU, they were relatively easy items at the ensuing negotiations, and were solved as part of the December deal. Even in a no-deal scenario freedom of movement for EU citizens in the U.K. and vice versa would likely see little changes.
Read: Record number of EU nationals quit the U.K.
• On a range of other, complex but politically less high-profile topics, a no-deal Brexit would have immediate and very disruptive consequences. As one example, the U.K. British Medical Association has warned that the National Health Service is ill-prepared on topics ranging from maintaining supplies of key medications to preparedness for pandemics.
2. Domestic political uncertainty
Since the Brexit referendum two years ago, political instability has been high. The possibility of a no-deal scenario would only heighten the current turbulences. If no agreement is reached in time or at all, the subsequent instability will likely spell early elections and/or a leadership contest within Tory party, at a minimum. With an electorate essentially still greatly divided by the Brexit question, we expect unstable leadership, with limited mandates and fragile majorities to follow.
Read: UK government dashes London financial center’s hopes for all-access Brexit deal
3. Impact on trade
As a result of this political instability, there would be no immediate “wins” in terms of the presumed benefits of Brexit either. For example, it is unlikely there would be a quick free-trade agreement between the U.S. and U.K. in a broader environment of regulatory uncertainty and lack of visibility on the final outcome. Similarly, a weaker U.K. government would find it difficult to negotiate agreements on trade or other important topics with other countries in the world.
That is regarding the long term. In the immediate aftermath of a no-deal, we expect both sides to introduce stopgap measures to smooth a sudden falling back to WTO rules, but the disruption in trade would be significant nonetheless.
Read: Trump says a U.S.-U.K. trade deal will be possible after Brexit, after interview in which he said it wasn’t
4. Economic impact
Regardless of the shape it ultimately takes, Brexit remains a downside risk to the global economy, an important downside risk for European economic growth, and has no upside for the British economy itself. The case of a no-deal Brexit, with the prolonged uncertainties it would entail, would result in a reduced investment, trade disruptions, lower growth, and job losses, first and foremost in the U.K. and then also in its key EU trading partners such as Ireland and the Netherlands. The International Monetary Fund anticipates GDP losses in the case that trade relations between the U.K. and EU were to revert to WTO rules, for example, to be in the order of magnitude of 4% of GDP for the U.K. by 2030. The EU as a whole would see 1.5% less growth, with Ireland suffering the biggest hit, followed by the Netherlands, Denmark, and Belgium.
5. Financial volatility
In the event of no deal, financial markets will be tested, and the pound GBPUSD, -0.2478% will be put under significant stress. The City plays a key role in the European financial system and links are strong, with bilateral capital flows, foreign direct investment, portfolio investments, and bank claims, amounting to some 55% of the Euro area GDP in 2016, according to the IMF. Continental banks are worried about more than €100 billion of European bank debt issued under English law that could no longer comply with the EU’s “minimum requirement for own funds and eligible liabilities” regulation. This might prove a source for market jitters down the line. We expect the FTSE UKX, +0.11% to face heightened volatility and downward pressure.
While we wait for the UK’s contingency plans to be published on Monday, asset managers are stepping up their preparedness. A recent survey found that 83% of asset managers (collectively holding $ 1.4 trillion of assets under management) have contingency plans for Brexit, and half of them have already started to put the plans in action.
In conclusion: contingency planning for a no-deal scenario is appropriately gearing up. This scenario would bring prolonged uncertainty with regards to the investment climate in the U.K. and the future of its economic governance and trade relations with the rest of the world, and likely a period of domestic political instability as well.
Bart Oosterveld is the director of the Global Business & Economics Program at the Atlantic Council.
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