On June 23, 2016, the United Kingdom held a referendum on membership in the European Union (EU), which the country had joined in 1973. As a surprise to many, the referendum resulted in a majority favoring an exit. The Brexit vote prompted a change in political leadership in the following month, with Theresa May being appointed Prime Minister. On March 29, 2017, the United Kingdom triggered Article 50 of the Treaty of Lisbon, which offers the UK two years to negotiate the terms of the exit and the ground rules for future cooperation before the country leaves the EU
The pending departure of the UK from the European Union affects the run-off industry in multiple ways. For one, the new steady state of the UK regulatory environment and the path toward it are unknown, generating uncertainty around the business model of the UK financial services industry, in particular as it pertains to cross-border transactions. Further, more than four decades of EU membership have given rise to an industrial structure that will have to adjust to a material realignment in exchange rates, increased uncertainty regarding terms and conditions of access to world markets for goods and services, and reduced access to foreign labor. Finally, there are questions around the unity of the United Kingdom, considering that Scotland and Northern Ireland (unlike England and Wales) voted to remain in the EU.
Chart 1 depicts the movement of the effective exchange rate of the pound sterling around the Brexit vote (vertical line). The effective exchange rate is an index comprised of the currencies of major UK trading partners, weighted by trading volume. Starting with an initial drop of 6.7 percent, the UK currency has lost 12.4 percent (as of March 1st, 2017) of its value since the referendum. All else being equal, the depreciation of the pound sterling improves the UK price competitiveness in world markets, although the effect may not be as strong as in the past due to a generally increased foreign share in the production chain of exports. The currency depreciation also generates inflationary pressure, which contributes to the inflation risk premium.
The change in the UK industrial structure in response to an exit from the EU is likely to be both profound and protracted. Most importantly, the UK economy will have to adjust to new ground-rules for international commerce. Upon exiting, the UK may not qualify as a member of the European Economic Area (EEA), a status currently enjoyed by non-EU members Iceland, Liechtenstein, and Norway. EEA membership would not only provide the UK with continued access to the Internal Market, it would also allow the country to continue to benefit from trade deals that the EU has struck (and will strike) with the rest of the world. Fundamental to EEA membership are the principals of (1) the free movement of goods, (2) the free movement of services and freedom of establishment, (3) the free movement of persons (and citizenship), including free movement of workers, and (4) the free movement of capital. Restricting access to the UK labor market was a major Brexit campaign item and ranks high on Theresa May’s agenda (The United Kingdom’s exit from and new partnership with the European Union, Presented to Parliament by the Prime Minister by Command of Her Majesty, February 2017) — controlling immigration ranks fifth out of twelve goals. It is thus unlikely that the UK will be granted EEA status. Without EEA membership, the UK is destined to resort to WTO (World Trade Organization) rules, which establish the most-favored nation (MFN) principle for the exchange of goods and services and for trade-related protection of intellectual property rights. The UK will have to supplement the WTO framework by an array of bilateral trade deals that may take decades to negotiate. As pointed out by the Lords Select Committee (European Union Committee Brexit: the options for trade, December 17, 2016) in regards to Switzerland, which is not an EEA member country, “[o]ver the last two decades, Switzerland and the EU have negotiated a bespoke bilateral arrangement which encompasses over 100 individual agreements.” (italics added).
For the full article, refer to page 6 in the Spring 2017 issue. https://www.airroc.org/assets/docs/matters/AIRROC%20Matters%20Spring%202017%20No%2013%20Vol%201.pdf
