Much to the chagrin of Bremainers, Brexit negotiations forge ahead as the United Kingdom and European Union enter the highly anticipated second phase of negotiations related to trade and the transition period. Even though some of the most prominent Brexiteers, like former UKIP leader Nigel Farage, have railed against the current status quo, the gaps between the two negotiating parties have narrowed enough for progress to be made on the key points that will really impact UK firms and European businesses operating in the UK.
EU and UK Progress or Process?
While progress on key issues including EU citizens’ rights, alongside the subject of borders and an exit payment, have largely been resolved, the closure of the first phase of negotiations sets the stage for significantly larger hurdles to clear before the October deadline. The UK’s negotiating teams faces an uphill battle with what is likely to prove a relatively intransigent counter-party. The European Union is deeply concerned that any successful exit by a member state could inspire similar actions from other members, potentially turning the political union’s grand experiment on its head.
Therefore, to prevent a smooth transition, they are likely to impose significant obstructions to hinder negotiations. Anytime new EU conditions are unveiled, it invariably hurts the . However, as evidenced by Sterling’s near double-digit performance against the dollar in 2017 (9.49% return) after the steep post-referendum plunge, investors remain optimistic that a deal is within reach. This was also reflected by the robust performance of the , which closed 2017 at a fresh high after returning 7.63% during the calendar year. Though traditionally the two assets exhibit more of an inverse correlation considering a strong Pound makes UK equities more expensive relative to foreign peers, the outcome of negotiations is likely to have significant implications for UK corporations.
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Trade Faces Major Obstacles
As the next stage of negotiations approaches, the UK Pound and corporations are finding themselves in the crosshairs. One of the big implications of Brexit is the UK’s access to European markets. As their single biggest trading partner, the UK’s loss of access to free trade with the EU is very likely to unleash problems for the financial services sector. However, to counteract this risk, the Bank of England has already taken steps to ensure that the UK’s position is accommodating for foreign banks operating branches and subsidiaries in the UK.
Right now, EU membership means the continent's leading banks can passport their services across member nations with branches instead of subsidiaries, a position the UK intends to maintain in order to avoid burdensome costs for these institutions. Even so, the UK’s moves are unlikely to yield a quid pro quo agreement from the EU. Yet, the dire forecasts that Brexit would lead to an exodus of tens of thousands of financial services jobs have failed to materialise. Estimates from the Financial Times now put that number closer to 4,600 positions being moved after Brexit is finalised to locations like Dublin, Paris and Frankfurt.
Already, is preparing to move portions of its asset management wing to Dublin, although only 20 jobs are expected to move. Others have announced plans to build new headquarters in mainland Europe to avoid heightened regulatory costs, with the destination most favoured by heavyweights such as , , and UBS being Frankfurt. If the EU intends to pave the way for a new trade agreement that allows for the easy passage of goods and services, the entire financial sector – especially foreign banks – may benefit as regulatory costs are kept in check.
Should trade restrictions prove onerous, it will be costly for UK-based banks like and , which will be forced to open subsidiaries on mainland Europe. This will likely hurt the Pound and London’s status as a major financial hub. Furthermore, FTSE 100 may feel the heat of reduced competitiveness with European peers, leading to a fall from grace as UK corporations must re-adjust for the new realities of Brexit. This impact has already been notable, with businesses tightening the purse strings and postponing investment in operations, hurting the outlook for the overall economy.
May’s Political Headwinds
Apart from the anxiety over what future trade relations may look like, there are real concerns about Prime Minister Theresa May’s ability to close the deal. After a disappointing defeat following snap elections held last summer, which saw the Conservatives lose their majority government, May has faced repeating calls to resign from within her own party. If confidence in her leadership continues to sag, winning Parliament's approval for any Brexit deal in 2018 will be an even tougher task. The decision to leave has also caused divisions within her government following the exit of infrastructure advisor Lord Adonis.
Britain’s Exit: Looking Ahead
While much hangs in the balance ahead of next October, there are promising signs that a Brexit deal is still possible. It might not resemble what the Brexit proponents had in mind when they passed the referendum but nevertheless it could turn out to be positive for the Pound and FTSE 100 index, especially if the UK is able to forge a strong compromise with Europe. However, with the European Union keen to keep its member states in line, the possibility of strong-arm negotiation tactics should not be ignored. With the Pound and FTSE 100 focused predominantly on the future of trade, this point of negotiations will be critical for the outlook of each asset, with any whiff of pessimism likely to sink valuations. Yet, when considering the wind in the sails following December’s phase one victory, the possibility of an agreement being reached should not be overlooked.