On 29 March, British Prime Minister Teresa May officially triggered Article 50 of the Lisbon Treaty. This started the process for the United Kingdom to leave the European Union (EU). The trigger is irrevocable and the process is limited to a maximum of two years from the trigger date. This means that by 29 March 2019, even in the absence of an exit agreement, the United Kingdom will automatically leave the Union.
Other than the current European Union agreements, the next level of economic relationship between the UK and the European Union is that both are members of the World Trade Organization (WTO). Brexit without an agreement will, thus, default the relationship between the two entities to that of fellow WTO member entities.
This level of relationship will affect many aspects of Britain, especially since WTO is primarily a trade agreement and is silent on many non-trade issues, such as the flow of talent, standards and regulations of various products and services, and the UK’s participation in various EU level research programs.
Politicians and business leaders from all sides are cautioning against this scenario, as it will be the permutation that is the most disruptive to the global trade and economic structure.
The immediate impact of the Brexit vote, which happened in June last year, was much more muted than the most conservative expectations. The full-year GDP growth in 2016 was estimated to be 1.8 percent, the second highest amongst the G7 industrial nations. Inflation, at 2.3 percent in February 2017, is at its highest in three and a half years, and unemployment rate has continued to fall to an 11-year low of 4.8 percent.
We believe that the continued strength in the UK economy can be partially explained by the Cameron government’s austerity measures, which have lowered the UK economy’s dependency on the public sector. Thus, at least some UK-bound investment has likely been made because of the UK’s own economic strength and not necessarily because of the UK’s access to the wider European markets.
However, the relatively calmness in the economy and the finance markets is also because of the common expectation that Brexit will not be disruptive. Immediately after the vote, for example, stakeholders, as diverse as then US President Barack Obama and various financial commentators, went on record describing that several possibilities, such as the Norway or Canadian models, exist between the WTO and the full EU membership models, and thus, the market could expect a generally smooth transition.
The British government is also showing initiative to maintain continuity. A day after Mrs. May triggered Brexit, the British government published its white paper for the Great Repeal Bill, which addresses various EU laws that the UK accepted as an EU member state.
The Bill would sever legal ties to the European Parliament, but it would convert all existing EU laws into British laws. The Bill will also accept all European case laws, up to the date of Brexit, as case laws for the British courts. In other words, instead of reviewing each EU law and EU court decision for its continued adoption, the bill would ensure that the legal and regulatory environments remain stable through the exit date.
However, the upcoming negotiation will have many moving parts. On March 31, Donald Tusk, the President of the European Council, published the negotiation guidelines from the European Union’s perspectives. One key issue he raised was to separate the negotiations on trade and other areas.
For example, as current arrangements allow all European Union citizens to freely live and work in other EU countries, the status of the hundreds of thousands of EU citizens who are working in the UK and those British citizens working in the EU will need to be resolved. Separating the trade and other discussion, however, may create additional complications that is beneficial to either side.
Given that negotiations can always fail, even if both sides understand the severity of not reaching an agreement, we believe that the current valuation levels in Europe are broadly justified.
However, this also means there are investment potentials for investors who are willing to track the negotiations closely and uncover industries or companies that may benefit from the new structure. For Asian investors, Europe may yet represent opportunities for those who can put in the efforts.