What does Brexit mean?

Director General | Institute of Export

Staying in the EU does not mean ‘no change’ and leaving does not mean regulatory freedom – the vote itself creates volatility.

A quick summary:
• The EU remains UK’s biggest trading partner, accounting for 45 per cent of UK goods exported and 53 per cent of imports.  China equates to 4 per cent of exports and 8 per cent of imports.  USA equates to 14 per cent of exports and 8 per cent of imports.[1]
• The UK runs net internal and external deficits.  Its government debt at the end of January 2016 was £1,581.6 billion, equivalent to 82.8 per cent of GDP; an increase of £52.7 billion compared with January 2015.  Approximately a quarter of this is funded by foreign lenders.[2]

Staying in does not mean ‘no change’

The Prime Minister’s decision to call the referendum was made after agreeing on 19 February 2016 certain changes governing the UK’s relationship with the EU.  Although the press concentrated on changes to social welfare rights obtained by Mr Cameron, the changes which affect financial markets are critical and, in essence, recognise the ring-fencing of non-Euro states from Euro states going forward and the creation of a two tier EU.  For example: Banking Union and resolution of banking issues only applies to Eurozone states thereby recognising that the European Central Banks’s (ECB) remit is limited to Eurozone members.  Similarly further economic and monetary union can progress within the Eurozone but must respect the rights of non-Eurozone member states to opt out.

‘Leave’ campaigners frequently make reference to the wish to be free from Brussels-originated regulation.  However, it should be noted that with regard to financial regulation, the basic terms of CRD, BRRD, EMIR, and MiFID arise from the Pittsburgh commitments by the G20.  As a matter of legal process, they have been implemented through the EU.  As the UK is a member of G20 and is not voting on 23 June on whether to remain in the G20, these regulations will still apply in the UK.

‘Equivalence’: a crucial word

The UK financial community is able to operate across the world’s major financial centres, including those in the rest of the EU, because the UK’s financial regulation is similar in substance and enforcement to that of other global financial centres.  Changing substantially from the current form would lose the UK’s equivalence status and those markets would be closed to the UK.  Losing equivalence would lose a substantial export market (and potentially the very people who populate much of the City of London as they decamp to other financial centres).

The vote itself creates volatility

The immediate concern is the volatility arising in financial markets by the decision to call a referendum.  This volatility makes it more important for businesses to manage their financial exposures to protect profit margins.  However, the uncertainty of the result makes it even more problematic to hedge transactions which span the referendum.  The volatility may continue after June, as change to the EU/UK relationship will take place irrespective of the result of the referendum.

Options debated:

The Norway Model: European Free Trade Association (EFTA) with European Economic Area (EEA) membership: Norway is a member of the EEA, which allows access to the single market and follows EU legislation on free movement of goods, services, people and money but is not bound by EU laws governing agriculture or monetary union.  It does make a financial contribution to the EU budget which equates to 90 per cent per capita of the UKs equivalent payment with no decision making power, votes or veto – and is still liable to certain tariffs.

The Switzerland Model: EFTA membership: Access to the single market is governed by a series of bi-lateral agreements, which cover some but not all areas of trade.  For example, Switzerland has agreements in place for goods but not services.  It makes a financial contribution to the EU although it has no vote or veto over the creation of EU rules.

The World Trade Organisation (WTO) Model: Free Trade Agreement: The WTO sets out rules for international trade that apply to all members, so this is what the UK would adopt, after a period of transition, if no bi-lateral agreements were made following an EU exit.  It would mean that the UK would not have to accept free movement or contribute to the EU budget, but goods exported to EU countries would still have to meet EU standards.

WTO trade arrangements mean that the UK would have to apply to have a single, universal set of tariff rates, covering imports from the EU and the rest of the world alike.  Under WTO rules, the UK would not be allowed to treat any of the WTO’s 161 other members differently, unless there was a trade agreement in place.

For more information visit: https://www.gov.uk/government/publications/alternatives-to-membership-possible-models-for-the-united-kingdom-outside-the-european-union

The Commonwealth has also been put forward by some as a new trading partner.  However, it is a political union, not a trading bloc, and represents approximately seven different trading blocs.  This means seven different rules of origin calculations and most importantly, more paperwork.  At a time when we are looking at international growth it will place more onus on British businesses to learn how to export properly and one of the reasons given for leaving the EU is the call for deregulation.

Finally, the UK needs to grow its exports to the rest of the world whether it is a member of the EU or not.  The UK track record for this is not strong to date; if exports are to grow it may be time to stop looking at blame and start looking at how to export well.  No quick fixes, but a concerted programme of education and professionalisation for our businesses.  To quote Einstein; first learn the rules of the game, and then go out and play it better than everyone else!

1. Source: ONS UK Overseas Trade Statistics February 2016
2. Source: ACT Briefing note March 2016

For further information about the Institute of Export visit: http://www.export.org.uk