Confused about Brexit? With the clock ticking, we break it down

A perspective from E*TRADE Securities 04/11/19

On March 29, British Prime Minister Theresa May’s latest proposal for an orderly exit from the European Union was defeated by lawmakers for a third time. May has been granted an extension until October to come up with a plan that all sides can agree on, but after two years of bickering to no avail, it’s entirely possible the United Kingdom could still crash out of the EU with no agreement. You think your house is a shambles, mate? Take a look at British Parliament. Talk about a case of the collywobbles.

It has been a fiasco to be sure, but if you’re an international investor, there’s no reason to flee for the exits. The UK’s long-simmering debate over how chummy to get with mainland Europe didn’t begin with the Brexit vote, and it’s not going to end anytime soon.

Stay or leave? The great debate

The ramp-up to the current conundrum has been a long time coming.

Britain has been part of a European common market for nearly 50 years. Joining what would eventually become the European Union was intended to foster economic cooperation and reduce barriers to trade. And, by most measures, it did just that.

But in time, some Britons grew resentful of this new arrangement and wanted to wrest control of their economic affairs from what they viewed as an oppressive superstate. Eventually, they were allowed to vote on the issue in a widely anticipated national referendum.

The year was 1975.

More than four decades later, much has changed. But many of the arguments behind Britain’s great debate have not.

The fateful Brexit vote

The first time around, Britons voted decisively to remain in what was known as the European Economic Community. It was expected they would do the same in 2016, when then-Prime Minister David Cameron put UK membership in the European Union to a national referendum.

The results shocked the world: By a 52% to 48% margin, Britons elected to leave the EU—a decision that became colloquialized as “Brexit.”

We’ll leave the terms of the debate for another time, but suffice it to say that globalization and a rising tide of populism loomed large in the Brexit decision. Ultimately, the issue of immigration helped tip the scales.

British Parliament has been in varying degrees of chaos ever since.

Brexit timeline

Why is Brexit such a big deal?

At issue is the free movement of goods and services in and out of the United Kingdom—the world’s fifth-largest economy. Food, medicine, exports, jobs—all could be affected by a UK exit from the European Union, which exempts member countries from tariffs and applies uniform import standards.

Moreover, the EU has the power to negotiate deals with trading partners around the world. After Brexit, the UK must do that on its own. Some have predicted that without the advantages of a single market, commerce and industry will flee the UK and many thousands of jobs will be lost. Already, a number of multinational banks have shifted their European operations from London to Frankfurt.1

Obstacles to Brexit

So, why can’t a country that wanted out of the EU figure out how to get it done? Here are three primary stumbling blocks:

•  Soft Brexit vs. hard Brexit: How do you leave the EU and minimize trade disruptions? One option is to remain part of a European customs union without adopting the rules required of full EU membership. Known as “soft Brexit,” this would be similar to the pre-EU Britain of the 1970s and 1980s—an arrangement that many “remainers” could live with. “Leavers,” on the other hand, want a clean break from the EU. Hard stop. But that would require negotiating an entirely new set of complex international trade deals. Starting to see Theresa May’s dilemma?

•  The Irish border: This one is thorny. As it stands now, there are no customs duties or checks of any kind between Northern Ireland (part of the UK) and the Republic of Ireland (an EU member outside the UK). May has proposed that this arrangement, known as the “backstop,” should remain post-Brexit, preventing a hard border between Ireland and Northern Ireland that could inflame old tensions. For remainers, it’s a reasonable compromise, but hard-line Brexiteers view the backstop as a back-door common market that would handcuff a powerless UK to the EU.

•  Citizenship and immigration: This is what really moved the needle in 2016. Current rules allow for the free movement of EU citizens within the bloc, similar to how Americans migrate between states. How will this change post-Brexit? Will EU citizens still be allowed unfettered migration in and out of Britain? How about British citizens living on the mainland of Europe?

The bottom line

Given the complexities of Brexit and the head-butting in British Parliament, all that’s likely to come out of London in the coming months is more uncertainty—even with a deal. If an agreement can't be hammered out by October and the UK crashes out of the European Union, European stocks could come under pressure. Even another delay in the divorce proceedings might not be enough to assuage investor concerns.

But keep in mind that the effects of Brexit may take a long time to manifest. So far, at least, European markets have shown few ill effects from Brexit-related uncertainty. Whether that continues remains to be seen.

For investors, it may boil down to personal views on the issue. Interested in adding UK exposure to your portfolio? The FTSE 100 ETF tracks the 100 largest stocks on the London Stock Exchange by market capitalization, and there are more than a few funds that track this index. Concerned about volatility? High-quality fixed-income holdings like US Treasuries and money market securities may be a good defense. No opinion one way or the other? Take stock of your portfolio anyway. It’s always good to know what you’re holding.

And regardless of what happens in the markets, count your blessings. How’d you like to be in Theresa May’s shoes?

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1. “For Wall Street Banks in London, It’s Moving Time,” New York Times, March 14, 2019, https://www.nytimes.com/2019/02/17/business/brexit-banks-wall-street-london.html

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