The implications of a no-deal Brexit

As 2020 comes to a close, so does the UK's withdrawal agreement with the EU. If a new agreement between the EU is not reached before the end of the year, there will be various implications.

The implications of a no-deal Brexit

The UK officially left the European Union (EU) on 31 January 2020 but continues to follow the EU bloc’s rules until the end of 2020 under the terms of the ‘withdrawal agreement’, the purpose of which was to set out a process which allows the UK to leave the EU in as orderly a fashion as possible

The agreement covered issues such as agreeing a transition period and how it would work; how to prevent the need for checks along the Irish border; and the UK’s financial settlement with the EU.

What the agreement did not cover were the terms of a future UK-EU relationship. Negotiations aimed at agreeing the terms of the new relationship including a trade deal, fishing access, regulations around the supply and trade of medicine, and security co-operation were always intended to be held after Brexit day and during the transition.

If no agreement has been reached by the end of the year, trade between the UK and EU will default to World Trade Organisation (WTO) rules. This will result in tariffs being introduced on many imports and exports, which could push costs up for both consumers and businesses.

It appears that the UK-EU delegations are battling to find common ground currently, despite assertions from UK Prime Minister Boris Johnson that the ‘deal is there to be made’. It remains to be seen whether this is part of the hardball pre-deal phase, or part of deeper issues which can’t be resolved.

Although the EU is pushing hard to reach an agreement, three preconditions need to be met. These include agreeing on the autonomy of the EU and the UK, and providing effective governance and ways to enforce what is agreed on; robust guarantees of free and fair trade and competition based on shared high standards – and allowing these to evolve coherently over time; and finally, agreement on stable and reciprocal access to markets and fishing opportunities.

It appears unlikely that a deal will be agreed unless the EU is prepared to accept the reality that the UK will reclaim control of its coastal waters and needs to be seen as an independent coastal state. A no-deal Brexit could potentially see the EU’s fishing fleet being blocked from British waters. The EU’s position, however, is that it should retain the same level of access for their fleet in UK waters.

The EU hopes to trade the promise of lucrative access to its markets for key UK manufacturing sectors, with Brussels threatening to block access for British hauliers and airlines if the European fishing industry is not granted ‘fair access’ to British waters.

If no trade deal is agreed, the UK will automatically drop out of the EU's main trading arrangements including its single market and customs union. The single market means the countries share the same rules around access to services and on product standards. The customs union, on the other hand, allows for tariff free status on goods from EU countries.

Tariffs and border checks will be applied to UK goods travelling to the UK under the rules of the WTO. By the same token, the UK will decide what tariffs and checks to apply to EU goods entering the UK. Tariffs will ensure goods are more expensive and less competitive to sell in the EU or UK.

The logistical implications of border checks, meanwhile, has the potential to adversely affect the movement and cost of goods. Services will also be affected with the UK losing its guaranteed access to the EU. This latter point is a significant risk to the banking industry in particular, among others.

One of the biggest issues that still needs to be addressed is the 500km border between Northern Ireland and Ireland - the only land border between the UK and the EU. Ireland’s political history makes all sides want to avoid a situation where border checks are required.

There will be an impact on South African investors invested in dual listed JSE and LSE stocks should the UK leave the EU under the WTO’s rules at the end of the year rather than a free trade agreement. The important consideration will be whether the dual listing on the LSE is a function of the liquidity and capital raising characteristics of the LSE, or whether the dual listing is because of a focus on the UK/European market from a trading perspective.

If the former, the effect on LSE stocks is then whether London retains its role of being one of the top three or four financial capitals of the world both for capital raising and ongoing liquidity. The tech and financial linkages are not replaced easily but if the people who run the systems can’t actually be employed to do so then there’s a dual-listing concern.

That said, London is firmly embedded in the global financial system and it is unlikely that the city would lose its status as a major financial centre in the near future, irrespective of the outcome of Brexit.

The next consideration is whether the dual listed company is UK focused, or in fact a global company. The more global the orientation of the LSE listed company – in other words, its focus is beyond just Europe and the UK - the less impact there would be on trade related issues between the EU and UK. However, dual listed businesses that have an operational focus and reliance on the UK and Europe certainly would be impacted by a disorderly Brexit.

Local companies with UK exposure will obviously be impacted to the extent that they have UK domestic income statement drivers that are unhedged, based on the assumption that a bad Brexit will be bad for the pound.

Investments in direct UK real estate face a different challenge. Exposure to physical assets can’t be diversified away easily, but the currency exposure can still be hedged if necessary. Just how attractive the UK remains for global companies will determine property prices. A degradation in the UK economy – on the back of trade issues – could impact both commercial and retail property. However, over time it will be easier to diversify UK income statement drivers relative to direct UK real estate property trends.


The implications of a no-deal Brexit  This article was written exclusively for Finweek's 13 November newsletter and Fin24. You can subscribe to the Finweek newsletter here.


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