Breaking down the brexit deal
Four and a half years after the 2016 referendum, the brexit saga has finally come to an end. With only 7 days until the transition period was set to expire, the UK and European Union (EU) agreed on a trade deal. Now, the agreement will go to UK Parliament for voting and approval, while the EU Council will look to grant provisional implementation until a vote can take place in the EU Parliament in the new year. Today, we break down the core elements of the deal, as well as explore its economic impact and what it means for investors.
1. What does the deal include?
AT its heart, the deal will maintain zero-tariff, zero-quota goods trading between the two powers. Yet, the deal also covers a host of other elements of the UK-EU trade relationship. Here, we break down the core elements of the deal:
Fishing rights: This topic was contentious, and almost prevented a deal before the deadline. The final deal pares back EU fishing quotas, but preserves some of the EU’s fishing rights in UK waters—25% of the EU’s current catch will be transferred to the UK over a “transition period” of five-and-a-half years. After the transition period, there will be annual negotiations between both sides. Notably, if the British seek to reduce the EU’s access in those negotiations, the EU will be able to retaliate.
Level playing field: There are two aspects here: standards and state aid.
On standards in environmental and labour matters, the UK will be free to set its own rules. However, the EU can retaliate if the UK strays too far from EU law. An arbitration process will govern a “rebalancing mechanism” available to both sides if they believe their businesses are AT an unfair disadvantage. This arbitration sits outside of EU law and does not include the European Court of Justice, a crucial point of concern throughout the negotiations for the UK.
On state aid: The UK will not be bound by EU state aid rules, and will set up an independent state-aid authority to facilitate transparency on the grants the country intends to provide. Companies on both sides will be able to challenge state aid awards if they believe those awards violate the principle in the trade deal.
The Northern Irish border: Both sides had already agreed that there will be a regulatory border between Northern Ireland and the rest of the UK, which will prevent the need for checks on the land border between Ireland and Northern Ireland.
Transportation: For goods, UK haulers will have their licenses recognised and be able to cross multiple borders—but, they will only be able to make one drop-off within the EU. For air passengers, there are similar restrictions; UK airplanes can fly into the EU but not between EU countries (although many airlines have already set up subsidiaries within the EU to address this).
In the food, retail, chemical and pharmaceutical industries: Tariffs have been avoided, but the cost of red tape and product checks look likely to increase industry and some consumer costs.
Manufacturing and the car industry: Broadly, manufacturers have avoided tariffs, but will now have to comply with two sets of certification and testing regimes. Within the auto industry, UK-manufactured cars may now incur tariffs if they are manufactured with a certain amount of non-UK-manufactured components (but there are concessions for batteries and electric vehicles).
Defence and security: While the UK will maintain access to some EU databases, for example air passenger data, the country will lose real-time access to the European Criminal Records Information System (ECRIS).
2. What’s missing from the deal?
The deal does not include an agreement on two crucial areas: data flows and UK authorisations for financial and professional services.
While there are data-related agreements in the specific areas of law enforcement and police co-operation, the rest of the flow of personal data between the UK and the EU is not covered in this agreement. There will be a separate “adequacy” decision, made unilaterally by Brussels in early 2021, on the wider data-sharing issue that is crucial for the digital economy. While it is likely that adequacy will be granted in the new year, this set-up will likely provide significant leverage for the EU in the future.
UK professional service providers (like doctors, nurses and architects) will no longer benefit from pan-EU recognition and must get their qualifications recognised in each member state they wish to work in. This represents a significant barrier for the UK’s access to the EU market. In financial services, the deal does not cover access to EU markets; rather, the topic will be decided by a separate process after 2021 whereby the EU will either grant “equivalence” to UK regulated firms, or those firms will have to work with individual EU states. Such firms will be confronted with significant uncertainty as the year begins.
3. What does the deal mean for the UK economy?
From a macro perspective, this deal comes AT a crucial time for the UK, which has instituted new lockdowns amid rapidly rising COVID-19 cases and deaths. The good news is that the deal avoids the immediate disruption that would have ensued under a no deal outcome. However, the deal is far from holistic and represents a significant loss of access to the EU market, as well as increased costs for UK businesses dealing with the EU.
Estimating the exact impact of this deal is fraught with difficulty, but most estimates suggest that the direct impact of the changed relationship could cost the UK between 2% and 4% of GDP over the coming years. That cost emanates from existing businesses relocating, as well as stunted future growth due to the inability to offer access to the EU market. Further, it’s worth noting that such estimates do not include second order effects from lower migration flows, and slower productivity growth from diminished trade intensity and competition. While significant, these hits are dwarfed by the impact of COVID-19 and the associated lockdowns.
Some will hope that growth will be boosted from regulatory autonomy, a new regime on state-aid and trade-deals that the UK can strike as an independent country. Yet, it will be a tall order for the UK government to execute on such an agenda and effectively outweigh the detrimental impact of the factors outlined above.
4. How are markets reacting to the deal?
The run-up to the agreement sparked a wave of optimism in European markets. Throughout the ordeal, investors have primarily expressed their outlook on brexit through the UK currency. AT the time of writing, Sterling is trading AT $1.35 vs. the U.S. dollar, which is right around what we believe is fair value. This falls in line with our long-held view that GBPUSD would rally on a deal; however, we’d start to grow cautious should it reach $1.37-$1.38. From here, we wouldn’t be surprised to see this rally stall—despite avoiding a worst-case, no deal scenario, the agreement is far from perfect and, as we mentioned, will likely weigh on the UK economy. Our year-end outlook for Sterling sits AT around $1.35.
UK and mainland European equities alike have also rallied. Just since Monday, December 21st, when an imminent brexit deal was first rumoured, the Stoxx Europe 600 is up +2.4%, the UK’s indice anglais 100 and indice anglais 250 are up +1.3% and +4.3% respectively, and Italy’s indice anglais MIB +3.4%, Germany’s DAX +2.6%, France’s cac 40 +2.4%, and the Swiss Market Index +1.0% are also all higher. Within the UK market, homebuilders and banks are leading the rally. UK 10-year government bond yields jumped a full 10bps between Tuesday and Wednesday, and are currently sitting around 0.26%.
5. How should you invest?
Investors tired of the brexit saga can breathe a sigh of relief—while this deal is not the final chapter in hashing out the UK-EU relationship, it is probably the last time that a deadline related to the brexit process has the power to materially move markets. We expect that brexit will recede from the front pages, even as deals with other countries are struck and even should the UK and the EU return to the negotiating table to build on this agreement.
As we survey the investment landscape, we think UK equities still look oversold (yes, even after the recent rally). Consider that the indice anglais 100 has been underperforming global and European equities since the brexit referendum in 2016—while the indice anglais 100, on a price return basis, has only managed a gain of +2.6%, the Stoxx Europe 600 has rallied +14% and the MSCI World Index is up +57%. We think UK equities stand to rally further, given their underperformance, attractive valuations, and exposure to emerging markets (it has the highest exposure among major European indices). Additionally, the UK economy appears to be well placed to benefit from the vaccine rollout (it was the first western country to authorise the widespread use of a COVID-19 vaccine). The region was particularly hard hit by the pandemic, and activity levels remain depressed; successful vaccine distribution could lead to a sharp bounce back in 2021. Within UK domestic equities, we believe homebuilders are best placed to enjoy both a recovery in investor sentiment and longer-term secular growth support.
Within mainland Europe, we believe both German and Swiss equities are well-poised to outperform their global peers and continue to advocate for a barbell approach between the two markets. With an export-oriented economy, Germany stands to benefit from cyclical tailwinds as the global healing process continues. For instance, the country’s DAX Index has an over 20% allocation to emerging markets, as well as high exposure to industrials and materials sectors. AT the same time, the Swiss stock market offers a degree of defensiveness through its stable dividend yield and exposure to healthcare.
And last, but certainly not least, the one key point we want to underscore in any given year is to have a plan. Before you act on optimism, make sure you have a solid, long-range investment strategy that aligns with the goals you have for yourself and your family. Planning holistically is the only way you can truly build—and keep full confidence in—your investment portfolio. As you look for opportunities and meet the challenges that 2021 will bring, we will be there to help you and your family achieve your financial goals.
We wish you all a Happy New Year.
Four and a half years after the 2016 referendum, the brexit saga has finally come to an end. With only 7 days until the transition period was set to expire, the UK and European Union (EU) agreed on a trade deal. Now, the agreement will go to UK Parliament for voting and approval, while the EU Council will look to grant provisional implementation until a vote can take place in the EU Parliament in the new year. Today, we break down the core elements of the deal, as well as explore its economic impact and what it means for investors.
1. What does the deal include?
AT its heart, the deal will maintain zero-tariff, zero-quota goods trading between the two powers. Yet, the deal also covers a host of other elements of the UK-EU trade relationship. Here, we break down the core elements of the deal:
Fishing rights: This topic was contentious, and almost prevented a deal before the deadline. The final deal pares back EU fishing quotas, but preserves some of the EU’s fishing rights in UK waters—25% of the EU’s current catch will be transferred to the UK over a “transition period” of five-and-a-half years. After the transition period, there will be annual negotiations between both sides. Notably, if the British seek to reduce the EU’s access in those negotiations, the EU will be able to retaliate.
Level playing field: There are two aspects here: standards and state aid.
On standards in environmental and labour matters, the UK will be free to set its own rules. However, the EU can retaliate if the UK strays too far from EU law. An arbitration process will govern a “rebalancing mechanism” available to both sides if they believe their businesses are AT an unfair disadvantage. This arbitration sits outside of EU law and does not include the European Court of Justice, a crucial point of concern throughout the negotiations for the UK.
On state aid: The UK will not be bound by EU state aid rules, and will set up an independent state-aid authority to facilitate transparency on the grants the country intends to provide. Companies on both sides will be able to challenge state aid awards if they believe those awards violate the principle in the trade deal.
The Northern Irish border: Both sides had already agreed that there will be a regulatory border between Northern Ireland and the rest of the UK, which will prevent the need for checks on the land border between Ireland and Northern Ireland.
Transportation: For goods, UK haulers will have their licenses recognised and be able to cross multiple borders—but, they will only be able to make one drop-off within the EU. For air passengers, there are similar restrictions; UK airplanes can fly into the EU but not between EU countries (although many airlines have already set up subsidiaries within the EU to address this).
In the food, retail, chemical and pharmaceutical industries: Tariffs have been avoided, but the cost of red tape and product checks look likely to increase industry and some consumer costs.
Manufacturing and the car industry: Broadly, manufacturers have avoided tariffs, but will now have to comply with two sets of certification and testing regimes. Within the auto industry, UK-manufactured cars may now incur tariffs if they are manufactured with a certain amount of non-UK-manufactured components (but there are concessions for batteries and electric vehicles).
Defence and security: While the UK will maintain access to some EU databases, for example air passenger data, the country will lose real-time access to the European Criminal Records Information System (ECRIS).
2. What’s missing from the deal?
The deal does not include an agreement on two crucial areas: data flows and UK authorisations for financial and professional services.
While there are data-related agreements in the specific areas of law enforcement and police co-operation, the rest of the flow of personal data between the UK and the EU is not covered in this agreement. There will be a separate “adequacy” decision, made unilaterally by Brussels in early 2021, on the wider data-sharing issue that is crucial for the digital economy. While it is likely that adequacy will be granted in the new year, this set-up will likely provide significant leverage for the EU in the future.
UK professional service providers (like doctors, nurses and architects) will no longer benefit from pan-EU recognition and must get their qualifications recognised in each member state they wish to work in. This represents a significant barrier for the UK’s access to the EU market. In financial services, the deal does not cover access to EU markets; rather, the topic will be decided by a separate process after 2021 whereby the EU will either grant “equivalence” to UK regulated firms, or those firms will have to work with individual EU states. Such firms will be confronted with significant uncertainty as the year begins.
3. What does the deal mean for the UK economy?
From a macro perspective, this deal comes AT a crucial time for the UK, which has instituted new lockdowns amid rapidly rising COVID-19 cases and deaths. The good news is that the deal avoids the immediate disruption that would have ensued under a no deal outcome. However, the deal is far from holistic and represents a significant loss of access to the EU market, as well as increased costs for UK businesses dealing with the EU.
Estimating the exact impact of this deal is fraught with difficulty, but most estimates suggest that the direct impact of the changed relationship could cost the UK between 2% and 4% of GDP over the coming years. That cost emanates from existing businesses relocating, as well as stunted future growth due to the inability to offer access to the EU market. Further, it’s worth noting that such estimates do not include second order effects from lower migration flows, and slower productivity growth from diminished trade intensity and competition. While significant, these hits are dwarfed by the impact of COVID-19 and the associated lockdowns.
Some will hope that growth will be boosted from regulatory autonomy, a new regime on state-aid and trade-deals that the UK can strike as an independent country. Yet, it will be a tall order for the UK government to execute on such an agenda and effectively outweigh the detrimental impact of the factors outlined above.
4. How are markets reacting to the deal?
The run-up to the agreement sparked a wave of optimism in European markets. Throughout the ordeal, investors have primarily expressed their outlook on brexit through the UK currency. AT the time of writing, Sterling is trading AT $1.35 vs. the U.S. dollar, which is right around what we believe is fair value. This falls in line with our long-held view that GBPUSD would rally on a deal; however, we’d start to grow cautious should it reach $1.37-$1.38. From here, we wouldn’t be surprised to see this rally stall—despite avoiding a worst-case, no deal scenario, the agreement is far from perfect and, as we mentioned, will likely weigh on the UK economy. Our year-end outlook for Sterling sits AT around $1.35.
UK and mainland European equities alike have also rallied. Just since Monday, December 21st, when an imminent brexit deal was first rumoured, the Stoxx Europe 600 is up +2.4%, the UK’s indice anglais 100 and indice anglais 250 are up +1.3% and +4.3% respectively, and Italy’s indice anglais MIB +3.4%, Germany’s DAX +2.6%, France’s cac 40 +2.4%, and the Swiss Market Index +1.0% are also all higher. Within the UK market, homebuilders and banks are leading the rally. UK 10-year government bond yields jumped a full 10bps between Tuesday and Wednesday, and are currently sitting around 0.26%.
5. How should you invest?
Investors tired of the brexit saga can breathe a sigh of relief—while this deal is not the final chapter in hashing out the UK-EU relationship, it is probably the last time that a deadline related to the brexit process has the power to materially move markets. We expect that brexit will recede from the front pages, even as deals with other countries are struck and even should the UK and the EU return to the negotiating table to build on this agreement.
As we survey the investment landscape, we think UK equities still look oversold (yes, even after the recent rally). Consider that the indice anglais 100 has been underperforming global and European equities since the brexit referendum in 2016—while the indice anglais 100, on a price return basis, has only managed a gain of +2.6%, the Stoxx Europe 600 has rallied +14% and the MSCI World Index is up +57%. We think UK equities stand to rally further, given their underperformance, attractive valuations, and exposure to emerging markets (it has the highest exposure among major European indices). Additionally, the UK economy appears to be well placed to benefit from the vaccine rollout (it was the first western country to authorise the widespread use of a COVID-19 vaccine). The region was particularly hard hit by the pandemic, and activity levels remain depressed; successful vaccine distribution could lead to a sharp bounce back in 2021. Within UK domestic equities, we believe homebuilders are best placed to enjoy both a recovery in investor sentiment and longer-term secular growth support.
Within mainland Europe, we believe both German and Swiss equities are well-poised to outperform their global peers and continue to advocate for a barbell approach between the two markets. With an export-oriented economy, Germany stands to benefit from cyclical tailwinds as the global healing process continues. For instance, the country’s DAX Index has an over 20% allocation to emerging markets, as well as high exposure to industrials and materials sectors. AT the same time, the Swiss stock market offers a degree of defensiveness through its stable dividend yield and exposure to healthcare.
And last, but certainly not least, the one key point we want to underscore in any given year is to have a plan. Before you act on optimism, make sure you have a solid, long-range investment strategy that aligns with the goals you have for yourself and your family. Planning holistically is the only way you can truly build—and keep full confidence in—your investment portfolio. As you look for opportunities and meet the challenges that 2021 will bring, we will be there to help you and your family achieve your financial goals.
We wish you all a Happy New Year.
