Brexit – Where To From Here?

A new (September 2016) KPMG survey of 100 chief executives in the UK with company revenues between $130 million and $1.30 billion found that 69 percent were confident about the British economy’s growth prospects over the next three years.  Still, over half do believe that the UK’s ability to do business will be disrupted once Brexit happens.  Seventy-six percent of those surveyed are considering relocating all or parts of their businesses outside of the UK.  It should be noted, however, that ‘considering’ is not the same as ‘doing’.  

In a survey of 115 firms in the UK financial services sector, conducted by PwC and the Confederation of British Industry, 53 percent feel the vote to leave the EU is bad for their organisations, while only 12 percent think it is good. Currently, the financial sector has a £20 billion surplus with the rest of Europe which many in the sector want to protect and grow.

All that anyone knows for sure is that uncertainty reigns.  Theresa May, the new British Prime Minister (who was a Remain supporter) says often that “Brexit Means Brexit”, i.e. the vote to leave must be honored.  Unfortunately, does anyone know what that actually means?  

In an excellent article in the Harvard Business Review (August 2016), Prof. Deepak Malhotra of Harvard Business School, lays out the complexities and possible outcomes of the Brexit negotiations which won’t really begin until Britain invokes Article 50 of the Treaty on European Union.  If this Article is invoked in 2017, as the British Foreign Secretary – Boris Johnson – believes it will be, then Britain and the EU have 2 years in which to reach an agreement.

What are some of the complexities?

• The two-way flow of free-trade between the UK and Europe was worth $650 billion last year, just over half the UK’s total.  With Brexit, a new EU-UK deal will have to be struck.  Any deal with the EU is going to have to take into account what the EU calls the four freedoms of capital, goods, services, and people.  Nothing is insurmountable, but the UK being allowed continued access to a single market while limiting the movement of people is going to be a particularly difficult challenge to overcome.

• The EU manages preferential trade deals with nearly 60 other nations on behalf of its members.  The UK will have to strike its own deals with those countries.
• The UK’s trading relationships with the rest of the world (including the US and China) is based on global standards overseen by the World Trade Organization (WTO).  The EU manages Britain’s WTO membership, and so post-Brexit the UK will have to renegotiate another set of deals. 

Beyond the deals, Brexit poses process complexities.

• Any deal with the EU requires the agreement of a “qualified majority” meaning 72 percent of the member states – representing at least 65 percent of the EU population must vote in favor of the agreement.

• If the agreement is broad in scope – something called a “mixed agreement” covering issues like security and foreign policy issues – it would have to ratified by the parliament of every member state.  In other words, every state has a veto which makes the likelihood of an agreement much more remote.

And so, what outcomes are the most likely?

• If at the end of 2 years following Article 50 being invoked no agreement was reached, the existing treaties would expire; in this case the WTO trade rules would come into effect which most likely means tariffs would come into effect where none existed before.  According to Prof. Malhotra, this would hurt all sides, but particularly the UK.

• A model exists – the Norway model – for countries that want access to the single market without membership of the EU.  In their model, Norway agrees to many EU conditions including the free movement of people, most EU regulations, and financial contributions to the EU.  If this was the outcome, Britain would operate under roughly the same conditions as pre-Brexit, but without a vote.

• Switzerland has negotiated over 100 bilateral agreements with EU member states – a clunky set of arrangements that took decades to negotiate.  Switzerland is subject to some EU policies, and also contributes financially.  Canada has negotiated a deal with the European Commission, but whether it will be ratified in Europe is still an open and controversial question between the Commission and the member states.

• A special, one-of-a-kind deal is what the UK wants, but once Article 50 is invoked, the clock starts ticking.  It this scenario, it would be difficult for the UK to get a deal acceptable to the British public.  Time pressures would empower Europe to demand concessions.  Any extension to the two years would need the agreement of all the EU member states.

• One possibility is that Brexit never actually materialises.  I doubt any British politician would want to say “Forget Brexit” out loud, but there does seem to be a playing for time right now by many politicians who never wanted Brexit in the first place.

As the Financial Times said on September 22, 2016, “Brexit has not yet happened.  We do not know what kind of trading arrangement the UK will end up with.  Until we do, the only certainty is that uncertainty will last.”  If I can make use of an old British saying, the post-Brexit future is as clear as mud.  It’s time for UK businesses – and those who do business with them – to sharpen their scenario planning and risk management tools.

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