Buyer's Remorse? Will Britain really leave the EU?

The world saw one of the most cataclysmic political events in decades on Thursday, June 23, 2016, with a majority of British voters choosing to leave the European Union (EU). The decision was a huge surprise, with oddsmakers and financial market traders expecting the opposite. Betting markets gave ‘Remain’ an 88 percent chance to win. Instead, ‘Leave’ won 52 percent to 48 percent.

Final polling leading up to the referendum showed ‘Remain’ with a slight edge, but there was always the possibility of ‘Leave’ pulling out ahead given the margin of error – 17 of 35 surveys in June showed ‘Leave’ ahead, while only 15 had ‘Remain’ in the Lead. Of course, most forecasters expected undecided voters to break heavily toward the ‘Remain’ camp but this was always conjecture.

Immediate Repercussions

Financial markets started falling sharply as referendum results started trickling in and the odds of Britain leaving the EU rose. They continued to fall after official results were announced. The British pound really took it on the chin, falling more than 8% on Friday to its lowest level since 1985, and resumed its slide on Monday. Equity markets across the globe are hardly faring much better, with financials taking the biggest hit.

The uncertainty over Brexit is especially hurting European banks, just as they were beginning to recover from the 2008 financial crisis and subsequent Eurozone related emergencies. Banks have to decide whether to remain in Britain or shift operations to continental Europe. Up until this point, most global banks have set up shop in the UK and done business in the EU by “ passporting ” into the rest of the 28-member bloc. London is also a major center for clearing and settling trades for EU securities. On Saturday, France’s central bank governor, Francois Villeroy De Galhau, was clear that London will lose its prized stature, saying:

“If tomorrow Britain is not part of the single market, the City cannot keep this European passport, and clearing houses cannot be located in London either.”

London has been a global financial center for more than a hundred years, but even more so over the last few decades with deregulation and globalization. That status is now under question.

As we noted in our paper “ To Leave or not to Leave: Brexit and Implications “, one possible path for Britain is to follow the Norway model: access the single market by becoming a member of the European Economic Area (EEA). This obviously comes at a price – unfettered movement of European citizens across borders, accepting EU regulations and contributions to the bloc’s operating budget – all of which ‘Leave’ supporters explicitly campaigned against. The open door immigration policy was a prime motivator for most voters choosing to leave. At the same time, Britain will no longer have a say in creating EU laws.

Another alarming aspect is that Britain apparently lacks the skills to go it alone on trade deals with the EU and the rest of the world. The European Commission has taken the lead in trade negotiations for the past four decades, leaving the country bereft of people equipped with the right technical knowledge. Negotiating trade deals takes such intense effort that even concluding them in five years is considered an achievement .


Leadership crisis

It is an open question as to what happens next. While there are several potential paths the UK can take (laid out in our paper ), we have no idea who is going to take them down one of these. Ultimately, this is a political question.

Prime Minister David Cameron, an advocate for remaining in the EU, announced his resignation on Friday. He also left it up to his successor to invoke ‘Article 50’ of the EU treaty, which would start a two-year clock for Britain and EU to negotiate the terms of divorce. Note that no country has ever invoked this before and the treaty does not lay out a roadmap for negotiating an exit – these complex negotiations could potentially take years. However, Britain will immediately cease to be a member of the EU at the end of those two years, whether or not an agreement has been hashed out – which could significantly disrupt business, trade and travel. Triggering Article 50 essentially switches the balance of power from Britain to the EU, since the new British Prime Minister will be under enormous pressure to have a deal before time runs out.

Some European leaders are already asking Britain to invoke Article 50 and begin negotiations immediately. They are reluctant to be charitable to the UK, or even be seen as charitable, so as to prevent a further splintering of the union. In an interview with German television, the President of the European Commision, Jean Claude-Junker, said:

“ Britons decided yesterday that they want to leave the European Union, so it doesn’t make any sense to wait until October to try to negotiate the terms of their departure. I would like to get started immediately. ”

However, it does seem that Britain and Europe may be held hostage to leadership struggles within the Conservative party over the next two months (the party has proposed a schedule so that new leadership is in by September 2nd). It remains to be seen who will emerge out of the chaos to lead Britain, let alone the path they will take to mitigate the effects of Brexit.


Buyers Remorse?

Meanwhile, we are already seeing some back-pedaling in Britain by supporters of the ‘Leave’ camp.

Boris Johnson, one of the lead campaigners for ‘Leave’, and possible front-runner for Prime Minister, acknowledged in an opinion piece for The Telegraph that the result – 51.9 percent to 48.1 percent – was “ not entirely overwhelming “. He stressed that Britain would always be part of Europe, with access to the single market. Yet it is unlikely that Britain can achieve this status without allowing for an open door immigration policy with the EU and contributing to the bloc’s budget.

We have also seen a surge in Google searches about the impact of Brexit, suggesting that people are only now coming to grips with the consequences of leaving, after the official results were announced.

Google trends search results on the European Union after Brexit referendum results were announced. Source: Google Trends .

Further anecdotes include those saying they voted to leave solely as a protest, without actually intending for Britain to leave the EU. All this post-referendum consternation, let alone billions of dollars of losses across financial markets, has led to the obvious question as to whether Brexit will actually happen.

Will Britain really leave the EU?

Britain’s vote to exit the European Union is NOT legally binding. It is, for all practical purposes, an advisory. Also, once Article 50 of the EU Treaty is invoked, Britain cannot back out. So David Cameron’s successor can simply dither on invoking Article 50 or just ignore the referendum – though it is hard to see these as politically feasible options.

Note that it is not unusual for governments to sidestep the results of a referendum on questions about Europe:

– France in 2005 on the EU constitution – 54.9% rejected but were ignored

– Netherlands in 2005 on the EU constitution – 61.5% rejected but were ignored

A second referendum on EU related questions is also not unprecedented:

– Denmark in 1992 on the Maastricht Treaty – 51.7% rejected but they were made to vote again

– Ireland in 2001 on the Nice Treaty – 53.9% rejected but they were made to vote again

– Ireland in 2008 on the Lisbon Treaty – 53.2% rejected but they were made to vote again

However, Cameron ruled out a second referendum on Monday despite a popular petition that has already garnered more than three million signatures. The other option is for the Prime Minister to call for a general election – again, a highly unlikely proposition since the Conservative party (which is in power till 2020) then risks the prospect of losing to the opposition Labour party, even while their own side remains deeply divided on the issue of leaving the EU.

Can Scotland bail out Britain?

An interesting option being hotly debated in legal circles is whether Scotland can bail out the UK. Based on a reading of the Scotland Act of 1998 , it appears that the Scottish Parliament has to consent to measures that eliminate the application of EU laws in Scotland – effectively, a seeming veto. Now, the British parliament can pass its own laws to amend/over-turn decades of law giving Scotland (and Northern Ireland & Wales for that matter) local control over their affairs. Whether or not the Conservative party will be willing to do so is yet another open question.

Scotland and Northern Ireland voted overwhelmingly to remain in the EU, and any attempt to over-ride their vote and move forward with Brexit, will trigger calls for independence from the UK. This is already happening, with Nicola Sturgeon, the First Minister of Scotland, saying that a second Scottish independence vote is “highly likely”. She said it was “democratically unacceptable” that Scotland would be taken out of the EU against its will.

In short, we could be looking at a splintering of the United Kingdom if Brexit actually goes through. This is yet another issue the next leader of Britain will have to immediately grapple with, amongst everything else.

More uncertainty

Some events are true black swans – for example, the September 11th terrorist attacks or the Tsunami in Japan – one-off events that create immediate financial panic, but may or may not exacerbate underlying economic vulnerabilities. However, Brexit is different in that it is a manifestation of underlying forces of populism that have been building for years amid low economic growth and loss of faith in traditional institutions, which have promoted liberal immigration and trade policies, let alone monetary policy that seems to have lost its bite.

Britain accounts for less than 4 percent of world GDP, but the forces made stronger by Brexit is what makes the situation more than just an immediate economic threat. The resulting political upheaval creates a much wider range of possible outcomes, creating ever more uncertainty for the global economy and financial markets.