When the U.K. and EU announced their trade agreement on December 24, 2020, government officials, business leaders, and private citizens in both areas were relieved that the worst outcome, the U.K. departing the EU without a trade deal, a “no-deal Brexit,” had been avoided. Though it is generally expected that Brexit presents more challenges for the U.K. economy than for the EU’s, both jurisdictions are facing new administrative burdens, red-tape expense, and uncertainty due to unresolved issues.
Immediately after the announcement of the trade deal, sterling rose on the UK market by approximately 0.47% on the US dollar and 0.46% on the Japanese Yen. However, markets already had taken into account the expected cost of Brexit to the British economy, including to some extent the possibility of a no-deal outcome. It is expected that it will take years for the British markets to overcome Brexit’s adverse economic effects.
The current severe restrictions on economic and trade activity in response to the COVID-19 pandemic in Britain and on the Continent probably outweigh Brexit’s immediate impact. However, certain Brexit effects are already clear: some sectors and regions that are unaffected or even benefited by Brexit appear to be “winners,” while more are likely “losers.”
Let’s take a look at how Brexit has affected various industries in the U.K.
Businesses whose activities rarely or never cross the English Channel will feel little direct impact from Brexit. Similarly, the impact should be minor for businesses whose activities and product sources are confined to trade within and between Northern Ireland and the Irish Republic. Thus, businesses that rely on domestic goods and services to run their operations and trade largely within their respective domestic markets generally will not be affected meaningfully by the new terms and conditions for trade. Some local U.K. and E.U. businesses may even gain some advantage over businesses in other parts of the world because of the trade deal’s requirements that manufactured goods contain a specific percentage of content from U.K. and/or EU sources to qualify for the tariff-free treatment and other mutual benefits of the agreement. However, to the extent a domestic EU business relies on goods and services from the EU to operate, and vice versa, Brexit will increase administrative and regulatory costs.
Manufacturers of Specialized Machine and Equipment Parts
New product origin, or content source, requirements for qualifying as U.K. or EU products, will require adjustment by some manufacturers, such as automakers, who currently rely heavily on other regions of the world for parts in their finished products. These businesses are likely to seek alternative European or British sources for such parts so that their products contain the mandatory content-source percentages for treaty benefits. With some companies, such as Nissan and Toyota likely to seek qualified sources for parts currently obtained from Asian countries, local U.K. and EU manufacturers might enjoy new sales opportunities.
The many international mining companies based in the U.K. have little economic activity with the EU. Extraction industry giants, such as Glencore, PB and Rio Tinto, have little exposure to Brexit because they conduct their operations far beyond the EU and U.K. and are not subject to EU regulation.
Media and Telecoms
Because language differences confine most media businesses to their domestic markets, Brexit will likely have little impact on this sector. Most U.K. media companies earn revenue from English-language audiences within the U.K., the US, Australia, and Canada, with only minor income generated from EU members. Media in EU member states likewise depend principally on audiences fluent in the local languages. Telecom companies with mainly U.K. or EU holdings and operations also would experience minor impact.
U.K. gambling is a substantial business valued at approximately £14.4 billion annually and engages a large portion of the population. Many of the largest companies operate online. As an almost entirely domestic U.K. business, it should feel little effect from Brexit.
United States Bankers
Because most financial institutions based in the City of London are losing free access to the EU market and must establish new Continental offices to conduct many of their activities in the EU, US-based banks may benefit from Brexit. Many US retail and investment banks already have “passporting rights“ and/or operate registered companies in the EU and U.K. These US banks can immediately conduct business for clients in the EU and U.K. They also can serve clients outside those areas whose current U.K. or EU bankers no longer will be able to give them immediate and direct access to either market. In particular, US institutions with capital markets activity are likely to pick up business formerly done in the City of London.
Brexit will complicate UK-EU cross-border relationships in every sector with new administrative and regulatory burdens. New requirements including local licenses, visas, border checkpoints, business entity formation, and personnel relocation apply to all types of business organizations from agriculture to air transport, manufacturing, and finance, and to individuals – professionals, athletes, artists, and tourists. Many business sectors found themselves unprepared for the new regulations and concerned about the costs of compliance, including re-sourcing goods and relocation of personnel and business, as well as the costs of potential border delays affecting the transport of goods.
In addition, the trade agreement establishes a ‘level-playing field” to ensure fair and open competition and to prevent businesses in one area from undercutting businesses in the other. This provision requires that two jurisdictions have similar, but not identical rules, relating to workers’ rights, social and environmental protection, taxation, and government subsidies for business.
Ironically, although Brexit will affect almost all industries, it was a relatively small industry, fishing, that presented the major negotiating challenge to reaching a trade accord. The EU sought to preserve broad rights to fish in U.K. waters for its coastal fishermen. In some EU member states, especially France, the political significance of the fishing industry far exceeds its economic import. The U.K., for whom ‘sovereignty’ was a motive for the “leave” vote for Brexit, insisted on preserving its territorial rights. Ultimately, the negotiators settled on a five-year compromise which is subject to annual renegotiation and is considered unsatisfactory by the fishing industry in both areas. It requires the return to the U.K. of 25% of the value of fish caught by EU boats but allows the EU fishers to operate within six miles of the U.K. coast.
Food and Agriculture
Regulations and border controls affecting agricultural exports and imports create issues for everyone in both areas – from farmers to distributors, grocery store chains, restaurants and consumers. In advance of Brexit, U.K. retailers and consumers stockpiled food resulting in shortages and supply chain problems and prompting warnings about panic-buying. Because the UK relies in winter on fresh food–90% of lettuce, 80% of tomatoes, and 70% of sweet fruit—are delivered from, or via, the EU, delivery delays immediately created problems. Scottish exporters have complained about delays in the transport of fresh seafood at border controls in Scotland and France. Sainsbury’s supermarkets blamed the new and complex arrangements affecting Ireland for their need to obtain alternative sources of goods. And, unusual, empty shelves were observed in Tesco stores. Supply chain and logistics challenges extend beyond agriculture to all industries.
As noted, logistical challenges similar to those facing agriculture are affecting manufacturing. But, as in other sectors, the UK will face problems greater than those of the EU. Even before the deal was concluded and tariffs officially avoided, significant companies in automobiles, aerospace and industrial supplies, including Honda, Nissan, BMW, Toyota and Jaguar Land Rover had begun U.K. job-cutting and plant closings. Panasonic and Sony planned to move their European headquarters from London to Amsterdam. Almost two years earlier, the Dutch company, Phillips, closed its only UK factory.
As noted previously, the agreement imposes substantial controls on goods transported between the EU and UK. It establishes “rules of origin” mandating that goods contain a percentage of locally sourced content, generally more than 50%, in order to qualify for the free-trade and other benefits of the deal. Larger manufacturers with complex products containing parts acquired from other parts of the world likely will need to make sourcing adjustments. Specific products are subject to specially prescribed rules with some allowances for adjustments. For example, carmakers, who have relied heavily on Asian manufacturers for electric batteries, are allowed until 2024 to find sufficient EU- and U.K.-sourced batteries to meet the over 50% local content requirements.
Financial services companies recognized that Brexit likely would require the relocation of significant operations and personnel from London to Continental locations and would mandate local registration and licensing to conduct business in the EU. Major banks, including JP Morgan Chase, Morgan Stanley, Nat West, Goldman Sachs, BOA-Merrill Lynch, UBS, and Credit Suisse, moved hundreds of employees and capital from the London to European capitals in advance of the deal’s December 31, 2020, deadline. Similarly, insurers based in London set up EU locations, including Lloyds of London in Brussels and Aviva in the Republic of Ireland. Approximately S1.6 trillion (£1.2 trillion) in financial sector assets left London since the 2016 Brexit vote and the end of 2020. More than 7500 financial sector jobs have been relocated from London to European cities.
Brexit ended U.K. investment houses’ “passporting” rights, which permitted companies registered in one EU member to operate in the others. As a result of Brexit, in order to conduct EU business, U.K. investment banks will need to obtain EU “equivalence” rulings that recognize regulations in a company’s home country as sufficiently similar to those of the EU. Although European firms will be allowed to continue using London clearinghouses at least until June 2022, the EU has not provided any plan or schedule for issuing equivalence rulings on derivatives- and stock-trading, portfolio management, investment advice, underwriting, and trade-execution.
Moreover, most core-banking businesses, such as deposit-taking, investment services to retail clients, and syndicated and other lending services are not included in the equivalence system. Thus, U.K. banks must establish EU offices to continue these activities with EU clients. While the City of London will continue to be a major financial center, its status will be diminished, especially if equivalence rulings are not soon forthcoming and clients outside the U.K. turn to institutions in other countries, including the US, that already have the rights and ability to operate in the EU.
Pharmaceutical companies are concerned about potential differences in EU and U.K. standards for medicines. In anticipation of diverging rules, AstraZeneca and GlaxoSmithKline established parallel labs in the EU. For medicine, the imposition of border checks and dispersion of manufacturing are expected to cause delays in distribution. Both areas reported drug stockpiling in advance of Brexit because of concerns about prompt access to medications.
Transit, Transport and Haulage
Brexit creates legal and logistical challenges for travel and shipping. Both the EU and U.K. have allowed a six-month ‘grace’ period for flights between and within the two areas under present licensing and safety qualifications. But future flights within the EU, across and within member states borders, will be restricted. Generally, only airlines that are majority-controlled by the EU, European Economic Area (EEA), and Swiss nationals will be allowed to fly between EU airports. However, a special provision allows U.K. airlines that are controlled by a combination of EU and U.K. shareholders, for example, the Madrid-based International Airlines Group that owns British Airways, to continue to operate in the EU. The application of this special rule to majority U.K.-owned airlines EasyJet and Ryanair may require further study of their ownership.
Movement of labor and goods, whether by air, water, or Channel tunnel, will entail time-consuming procedures. Passport requirements will apply to travelers between the EU and U.K., and business personnel, students, and others who stay abroad for a period of time will need visas. Many U.K. freight haulers may not obtain permits to operate on EU roads because the EU has authorized only 2000 permits for 2021 while 10,000 are needed. Permits and border checks could require approximately 250 million pieces of paperwork each year and 50,000 customs agents, six times the present number.
Equity investors prospered in the months preceding the vote as U.K. markets rose to all-time highs, thanks in large part to the cheaper British pound attracting foreign money. However, sentiment has slowly changed as the reality of “going it alone” sinks in. Economic data has gradually turned south, and the rapid rise in inflation has put the Bank of England between a rock and a hard place. With that uncertainty, investors have turned their backs on the U.K.
In each of the eight weeks preceding the start of the June 19, 2017 negotiations, the U.K. experienced a record amount of investment outflows, and sentiment fell as the nation became the least popular market in Europe for investors, according to Bank of America. Despite the outflows, U.K. equity markets continued to rise. After closing 2016 at 7142 – an all-time high – the FTSE 100 continued its rally into the middle part of 2017, reaching 7558 on June 1. On June 23, 2017, one year after the Brexit vote, the FTSE 100 was higher by 1086 points, or 17.1% over the 12-month period.
It will take years to determine whether or not U.K. equity investors are winners or losers, but they can expect periods of volatility as the economy remains in the hands of political negotiations.
The U.K.’s exit from the EU has left millions of citizens who live both inside and outside the U.K. in a state of limbo. Directive 2004/38/EC of the EU constitution gives citizens and their families the right to “move and reside freely within the territory of the Member States.”
More than three million EU nationals live inside the U.K. and close to one million U.K. residents live within the EU. These people face considerable unknowns in their employment status and contractual agreements with a real possibility of deportation.
The Bottom Line
When Britons voted to leave the EU, Brexiters campaigned on hard-line immigration and border control. Much like Trump supporters, the Brexiters felt they had lost their identity. However, now as negotiations occur between the U.K. and its former partner, risks to the U.K. economy have never been higher. If policy makers can’t strike favorable deals, the U.K. will have a new economic identity, just not the one Brexiters promised.