Brexit update

What has happened?

The UK and EU negotiating teams have agreed on a draft text for the withdrawal agreement. This includes details of the financial settlement, citizens’ rights and arbitration of the customs backstop arrangement. As per the June 2018 Withdrawal Act, the UK will exit the EU on the 29th March 2019 and, if a withdrawal agreement is approved by the UK and EU, the transition period will begin. The transition period is expected to last until December 2020, by which date the UK and EU need to agree on a future trade relationship. In June 2020, the government can decide to extend the transition period or implement an all-UK temporary customs backstop if a future relationship cannot be put in place in December 2020.

What will happen next?

The draft withdrawal agreement still needs to be formally approved by the EU. This is likely to take place at a special EU summit on the 25th November. There are already indications that some countries would like to strengthen the language in the document around ensuring a level playing field.

If the agreement receives EU approval, it also needs to be presented to UK parliament for approval; which is expected to be in early December. Here, the deal may run into some difficulties. The Conservative party relies on an alliance with the DUP for a majority, and that majority is only 13-seats strong. As the agreement does not meet the six tests set out by the Labour party it is unlikely to have the party’s official support. This means that, if the DUP or a relatively small number of Conservative MPs vote against the government, the agreement may not be passed.

A number of prominent resignations and letters of no confidence indicate dissatisfaction with the draft agreement. Parliament needs to approve an agreement by the 21st January 2019 according to the June 2018 Withdrawal Act. If no agreement is in place by then the likelihood of the UK leaving the EU without a withdrawal agreement increases, as does the possibility of a second referendum or a leadership change.

What would it mean if the agreement is approved?

If the withdrawal agreement is approved, the process of the UK leaving the EU is likely to be relatively gradual and it may be some time before the precise arrangements for the future relationship are known.

During the transitional period, the UK would remain part of the economic framework of the EU: the single market for goods, services, capital and labour, and the customs union. The UK would continue to apply EU law in full during the transitional period.

With regards to the future relationship, a political declaration has been published, that sets out objectives for an economic partnership. This includes a free trade area for goods, liberalisation in trade in services “well beyond the Parties’ WTO commitments”, prioritising equivalence assessments for financial services, and a high degree of regulatory cooperation.

While the details of the political declaration are sparse, the tone suggests that the future relationship between the UK and the EU is likely to be relatively close if the withdrawal agreement is approved. This implies that changes to the UK’s relationship with the EU may be more limited than some had feared.

What does this mean for the UK economy?

Uncertainty has weighed on UK activity in recent quarters, particularly through the channel of business investment. Many companies have put off investment plans, awaiting greater clarity as to the UK’s future relationship with the EU. Approving the withdrawal agreement may remove some of that uncertainty, and the UK economy may receive a boost from deferred demand. Approval may also support Sterling, helping to keep a lid on inflation and offering some support to consumption spending. However, if economic activity rebounds, the Bank of England is more likely to raise interest rates in order to prevent the economy overheating.

What does this mean for markets?

At this juncture, a wide range of outcomes appear possible. Parliament may approve the withdrawal agreement, setting in train a gradual withdrawal from the EU. However, the agreement may be rejected, making both a second referendum and a disorderly departure from the EU possible, and increasing the likelihood of a change of government. We would expect markets to respond positively to the approval of the withdrawal agreement, as it would offer greater clarity. In contrast, should Parliament reject the agreement, we anticipate markets to respond negatively, as uncertainty will be highest.

How are we positioned?

On a tactical basis, our portfolios have been underweight UK assets versus our long-term asset allocation since before the referendum, with a bias towards overseas earners versus domestically exposed shares. This has benefited clients because Sterling has weakened and overseas earners have outperformed.

As the March 2019 deadline approaches, we remain underweight UK assets, as there remains a risk that no deal is agreed between the UK and the EU, or that a deal is agreed but is then voted down by Parliament. However, we think that UK assets could become more attractive if the balance of risks changes and valuations remain attractive.

In the meantime, we are focused on names with stock specific investment cases not connected to Brexit, as well as those benefiting from strong economic growth elsewhere in the world.

As global, multi-asset investors, we also have greater flexibility in positioning our portfolios so as to diversify our sources of risk, reducing the exposure we have to any one investment theme and holding shares in international markets. We also hold diversifying assets, such as alternatives, that can help limit volatility in times of market stress.

In summary, while Brexit is a significant source of uncertainty, we are closely monitoring the balance of risks. Each of the many permutations that the course of the negotiations may take will offer investment opportunities and we are poised to take advantage of them as they arise.

Important information
The value of investments will go up and down and clients may get back less money than they invested. Past performance is not a reliable indicator of future returns. The information contained in this document is believed to be correct but cannot be guaranteed. Opinions constitute our judgment as at the date shown and are subject to change without notice. This document is not intended as an offer or solicitation to buy or sell securities, nor does it constitute a personal recommendation.