Brexit: From Referendum to ‘Neverendum’ | Mackenzie Investments

Brexit: From Referendum to ‘Neverendum’

What started with a United Kingdom referendum on exiting the European Union in 2016 is turning, three years later, into what looks like more a ‘neverendum’1, i.e. a long, drawn-out process with an uncertain conclusion. Following this week’s events, Brexit is far from settled.

Recapping the situation

Let’s first recap the events of the last few days. Yesterday, the UK Parliament rejected the revised exit deal negotiated by Prime Minister Theresa May with the European Union. The revised deal included reassurances on the so-called ‘backstop’, a provision that was designed to ensure that if the UK and EU failed to agree to a relationship that delivers a frictionless border between Northern Ireland and the Republic of Ireland, the UK would automatically remain in a customs union with the EU. This was included to comply with the Good Friday Agreement, which delivered peace in Northern Ireland in 1998. Pro-Brexit MPs worried that this backstop risked keeping the UK in a customs union with the EU indefinitely, effectively nullifying Brexit.

Today, MPs voted to reject a no-deal Brexit. This type of Brexit is the more frightening prospect and the greatest immediate risk facing the UK, EU and global economies. A no-deal Brexit would entail a level of friction in the movement of people and goods and uncertainty that would be detrimental to the world economy. Markets always considered the risk of a no-deal Brexit to be relatively small, as evidenced by the strong performance of the U.K. pound so far in 2019.

Tomorrow, MPs will vote on the extension of Article 50, the process under which the UK was initially to leave the EU on March 29. A majority of MPs are expected to support such an extension under certain conditions. An agreement will also need to be ratified with the EU to temporarily extend the duration of the UK’s membership in the bloc.

The options going forward

At this point, there is still a small chance that EU leaders could reject an extension of the deadline, as the UK will need to explain why it is seeking an extension. This would entail a risk that the UK would crash out of the EU without a deal on March 29. However, the probability of this event is small — and if the EU does refuse to extend the deadline, the UK Parliament could still go back and approve the deal it rejected yesterday.

The more likely outcome is that the EU will agree to extend the deadline. Then, UK politicians will need to agree on a new way forward for Brexit. This is where the ‘neverendum’ begins, as a variety of options would then be available. The UK would need to choose between the “Norway-plus model” (also known disparagingly as “Brexit In Name Only” to hardcore Brexiters), holding a second referendum, going to a general election, or maybe even no Brexit altogether.

Effectively, the Brexit process would be back to square one! This means that the UK and EU would have spent roughly over three years discussing Brexit… still without a clear path to Brexit in the end.

What does this mean for investors?

It depends who you ask. For UK investors, the consequences are significant, as every move in the pound has a large impact on the value of international assets held. Brexit uncertainty also has a large impact on the valuation of UK equities and on domestic growth (mostly negative, as suggested by the current low UK bond yields).

But for Canadian investors, the consequences are limited. UK equity market capitalization accounts for approximately 5% of global market capitalization, so most Canadian investors are typically not very exposed to UK equities. From an economic standpoint, only about 5% of Canada’s exports are destined to the UK and about 10% to the EU (which, as of today, still includes the UK). By contrast, 75% of our exports go to the United States. This means that the direct economic hit to Canada would be small, should a disorderly Brexit take place.

Canadian Export Destinations
(Canada: export to certain destinations as a % of total)

Mackenzie Investments (IMF data via Bloomberg). Shaded areas = US Recession.

The scenario of a no-deal Brexit on March 29 certainly would represent an immediate shock to markets. Yet recall 2016, when US equities still somehow increased about 40% in the 18 months following the surprise Brexit referendum that shocked the world in June 2016. This means that despite the political turmoil and the hit to European/UK growth prospects, global growth still managed to improve, suggesting that Brexit uncertainty ultimately ended up having limited consequences on the global economy.

The most likely scenario — significant delays and a watered-down Brexit — would essentially constitute the most benign outcome for investors. Get ready for the ‘neverendum’.

1 The Montreal Gazette columnist Josh Freed first coined the term ‘neverendum’ in 1992, as Quebec was about to enter its second referendum in 1995.

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