Summary of Brexit
On June 23, 2016, the people of the United Kingdom voted by a margin of 51.9% to 48.1% to leave the European Union (EU), a customs, trade, political, and partial currency bloc comprising 28 countries in Europe. This outcome to the referendum was a surprise, effectively ousting UK Prime Minister David Cameron and briefly disrupting global markets. On March 29, 2017, the new Prime Minister Theresa May triggered Article 50 of the Lisbon Treaty, starting a two-year clock for the UK’s exit from the EU.
In the months since, May and her government have been working to negotiate an exit (or “Brexit”, as a conglomeration of British and Exit) that both the UK and EU could abide that would ensure an orderly separation. An issue of particular importance in the Brexit negotiations is how to establish a custom’s border between the UK and EU. While for the most part the English Channel makes such a custom’s border between the two rather natural, the border between Northern Ireland (part of the UK) and the Republic of Ireland (part of the EU) is particularly challenging. The UK government is concerned that a hard border between Northern Ireland and Ireland could violate the Good Friday Accords and possibly restart the Troubles of Northern Ireland, an outcome they would rather avoid.
Director of Wealth Planning
The Brexit negotiations have not gone very well and the deal May negotiated with the EU was overwhelmingly-rejected by the UK government on January 15, 2019. While May survived a no-confidence vote on January 16, 2019, her government is still no closer to a negotiated exit. Despite the lack of a deal, however, the Brexit clock continues to tick, and unless something changes, the United Kingdom will leave the European Union at 11:00 pm (UK time) on March 29, 2019.
Possible Brexit Deals
No Deal Brexit / Hard Brexit
Some have advocated a "hard" Brexit, meaning that Britain would leave the EU's single market and custom’s union with no pre-negotiated withdrawal agreement, then negotiate future arrangements to govern their relationship. This outcome would likely result in substantial uncertainty and disruption for the UK, the EU, and global markets. Upon such a jolting exit, the UK and EU trade relationship would be governed by the World Trade Organization rules while the two would be separated by custom’s enforced borders, including between Northern Ireland and Ireland. Immediately, customs would be imposed on all people and goods moving between the two parties, likely causing massive confusion and delay at trading ports and crossings, which generally lack custom’s infrastructure. Once the initial dust settles, the UK and EU may be able to forge a new relationship, potentially modeled on Norway (participation in single market, but stay out of the custom’s union), Switzerland (trade governed by series of bilateral pacts, but out of the custom’s union), or Canada (a separate, comprehensive free-trade agreement, but no custom’s union). How exactly the UK and EU will proceed following a hard Brexit is anyone’s guess?
The much-preferred option for the UK to leave the EU is through a dually-negotiated withdrawal arrangement. However, the 585-page agreement May negotiated with the EU reads like a long-term stall arrangement whereby the UK would be required to adhere to EU rules indefinitely, and only really leave the EU as further incremental agreements were reached in years (and potentially decades) to come. As mentioned above, this proposed exit deal was decisively rejected by the UK Parliament last month. At present, the UK government is ostensibly trying to re-negotiate this withdrawal agreement, but the EU has indicated there will be no further negotiations, and time is running very short.
The UK Parliament did agree to a backstop deal, whereby the border between Northern Ireland and the Republic of Ireland would remain open, Northern Ireland would abide by EU rules, and the Irish Sea would become a custom’s border between the islands of Ireland and Great Britain (the UK, less Northern Ireland). This backstop would be only a temporary measure, but might defuse the Irish problem.
It is possible that the UK will not actually leave the EU. This would be accomplished either by the UK Parliament halting the exit on its own volition or by introducing another referendum to the UK population with the majority voting to remain. While both options would likely prevent the trade and customs’ disruptions between the UK and EU, either option would likely create a constitutional crisis within the UK. The domestic political disruption of such an expected crisis means that this option is disfavored by the politicians and remains relatively unlikely.
Likely Economic Outcomes from Brexit
- Major companies are already leaving the UK and relocating to Frankfurt, Luxembourg, and the Netherlands. The largest threat seems to be that major financial institutions will leave the City of London with Brexit. Several major banks, including Morgan Stanley and JP Morgan Chase, have started relocating their European headquarters to the continent, while others, including Barclays and Citigroup, are expanding existing offices outside the UK.
- Economists debate the effects of Brexit on UK GDP, but most agree that it will have a negative impact with estimates ranging from -2% to -9% Gross Domestic Product (GDP) growth over the next 10 years. Some research suggests that the U.K. economy is already 2.5% smaller than it would have been had the UK not voted for Brexit.
- Predicting the effects on foreign direct investment is harder. Some arguments suggest that the UK will still receive strong foreign direct investment (FDI) due to sophisticated financial and business infrastructure, but others suggest that the real draw to the UK is as an entrance to the EU market, which will be lost with Brexit. The jury is still out.
- So far, Brexit’s effect on the UK stock market has been muted, with an initial sell-off after the June 23, 2016, vote but followed by a moderate bull market since then. Yet, in the past several months, UK volatility has increased as the deadline looms and no deal has been reached.
- The pound sterling declined in value in the weeks following the Brexit vote, falling from about $1.50 to about $1.20. However the pound has leveled off since 2017, and now holds a rather stable value between $1.30 and $1.40.
David Frederick is the Director of Wealth Planning with First Bank Wealth Management and an Adjunct Professor of Economics with Washington University in St. Louis. David.Frederick@fbol.com.