Today in Brexit, Day 1,538

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With COVID-19 dominating 2020, one of the past few years’ biggest headline grabbers had taken a backseat eight months in. But now Brexit is back—and stealing headlines with a vengeance. Some are going so far as to claim the UK government has introduced legislation that violates the exit agreement it struck with the EU last year, rekindling the risk of a messy, de facto no-deal Brexit. However, while the specific twists that bring it back to the fore are new and lead many to project potential damage to Britain’s economy, we believe the takeaway remains the same: However it plays out, stocks should gradually gain clarity as the year progresses, and even a no-deal Brexit shouldn’t bring disaster.

With free-trade negotiations between the UK and EU restarting, Prime Minister Boris Johnson introduced legislation called the Internal Market Bill. His government portrayed it as a “legal safety net” for the UK in the event that the country fails to ratify a free-trade agreement with the EU by year-end, when the post-Brexit transition period expires. The aim was to set out the legal framework (including customs rules) for trade with the EU if Brexit happens without a trade deal in place—injecting more clarity for businesses and investors.

But things got thorny on Tuesday, when it emerged that the government’s plans differed from parts of the Withdrawal Agreement finalized last year. When questioned, the UK’s cabinet secretary for Northern Ireland stated the customs rules would “break international law in a very specific and limited way,” touching off a worldwide frenzy and resurrecting no-deal Brexit fears. To us, this super-charged bluster seems like politicking, and with many members of Johnson’s Conservative Party speaking out against the bill, we would be a tad surprised if it were to pass without amendment. Moreover, that presumes the bill even needs to pass at all—this could just be a way of trying to nudge along free-trade negotiations.

We will spare you an extended discussion of the Internal Market Bill, which would end up riddled with legalese and probably be quite sleep-inducing. But in short, it is a fall-back position. The UK’s main goal is still to sign a free-trade agreement with the EU, but Johnson doesn’t want to surrender sovereignty over regulations and state-aid rules in order to do so—a red line for both sides, reportedly. Yet since Brexit began, both sides have drawn, erased and redrawn red lines, so this isn’t new. Setting out strongly worded policies explaining the “or else” in a standard accept our terms or else sparring match is also the norm. So we don’t think the risk of a no-deal Brexit got significantly higher today.

The principal dispute is over customs on goods crossing the Irish Sea. When the UK and EU signed the Withdrawal Agreement late last year, many saw its protocol on Northern Ireland as something of a pipe dream. It kept the border between Ireland and Northern Ireland open and frictionless, in keeping with requirements under 1998’s Good Friday Accords that brought peace to the divided island. It also accepted customs checks for goods traveling between Great Britain (e.g., England, Wales and Scotland) and Northern Ireland, and affirmed Northern Ireland’s unfettered access to the rest of the UK. This sounded like a win for all sides, but as policymakers hashed out the details, it became clear that it was an impossible trinity, with a high likelihood of Northern Ireland becoming economically isolated from the rest of the country. After all, how can Northern Ireland really have unfettered trade access to Great Britain if companies have to file export declarations every time they cross the sea? What the government now proposes are effectively amendments to the agreement to ensure there isn’t a de facto border down the Irish Sea.

Observers are divided over whether this is a treaty violation. A draft EU working paper circulating Wednesday says it is, warning the UK could be subject to EU sanctions if it passes.^[i] Johnson, for his part, claims the new bill seeks to insure against “extreme interpretations” of the Withdrawal Agreement and isn’t a bait and switch. Writing in Wednesday’s Telegraph, one UK legal expert stated the case for legality is “strengthened by section 38 of the 2020 [European Withdrawal] Act which expressly asserts the sovereignty of Parliament. This section specifically enables Parliament to introduce legislation to amend the Withdrawal Agreement.”^[ii] Some argue no country will sign a free-trade agreement with the UK—including a much-hyped US-UK deal—if it doesn’t keep its word, but there seems to be enough wiggle room here to mitigate that risk despite global politicians’ bluster now.

More broadly, there seems to be a disagreement over which approach endangers the Good Friday Accords. Some argue the new bill does, as it gives the UK government power to amend or waive export declaration requirements for shipments from Great Britain to Northern Ireland, raising the risk of border checks between Ireland and Northern Ireland to prevent British goods from entering the EU tariff-free. Johnson’s argument is that the original Withdrawal Agreement stood a higher likelihood of jeopardizing peace by isolating Northern Ireland from the rest of the UK—not to mention raising the probability of Scotland and Gibraltar splintering off. To us, it all just smacks of political disagreement, with all sides using unclear treaty snippets to make their case as they jockey for leverage in Brexit talks and domestic politics. In our experience, these matters end up being sound and fury, with little substance.

We won’t hazard a guess on how this all plays out. The UK and EU are still pursuing a trade deal, and both sides have every incentive to get one done. If they don’t get one, we already know a great deal about what a no-deal Brexit looks like. We know the default tariffs on UK imports from the EU—and any other country with which the UK doesn’t sign a free-trade agreement. Those tariffs are not high and, in many cases, amount to reductions. We know regulators are already rounding third on a number of side deals to preserve London’s status as Europe’s financial hub. We know the Netherlands, France and other key export partners are lobbying Brussels to minimize restrictions and customs checks on goods coming from the UK. We even know both sides are dedicated to avoiding a hard border on the island of Ireland, notwithstanding the present political disagreement on what that looks like.

We also know investors have been dealing with no-deal Brexit fears for more than four years now. In the 1,538 days since the Brexit vote, headlines have imagined every possible scenario up to armed conflict. We have seen warnings of blockades and a sudden stop in trade. We have seen fears of a protectionist, isolated UK. We have seen forecasts for deep recession, hyperinflation and a debt crisis in a post-Brexit UK. Whatever reality emerges is likely to  be better than all of these worst-case scenarios, especially as it becomes clear both sides are intent on keeping trade flowing. So while uncertainty may remain a headwind for UK stocks as things go down to the wire, the risk of Brexit driving a market or economic disaster after 2020 ends seems exceedingly low.