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Financial scenarios 06 Aug 2018

What happens if there is no Brexit agreement?

The European Union is already readying itself for the possible exit of the United Kingdom from the European club without an agreement between the two sides. Although no scenario has been ruled out, Miguel Jiménez, the chief economist for Europe at BBVA Research, argued in a recent article published in El País that “a no-deal exit in March, with no transitional period, is no longer inconceivable”. In his opinion, this would be the worst possible outcome of Brexit.

More than two years after the referendum in which the British voted for the United Kingdom’s departure from the EU, talks on setting the terms of a future relationship remain stalled. Although the pace of the negotiations in the past few months has picked up, Miguel Jiménez points out they have turned quite complicated both from a technical as well as a political point of view in part due to the difficult political situation Britain is going through.

At Chequers, the country residence of the British prime minister, the U.K. government agreed in writing to a proposal for Britain’s future relationship with the EU. The document includes a customs accord, which, according to Miguel Jiménez, would be very difficult for Brussels to accept. Of the ‘four freedoms’ that constitute the pillars of the single market (freedom of movement of people, capital, goods and services), the United Kingdom has put forward a proposal that maintains the free movement of goods but not services, which, therefore, leaves the City of London outside the single market and at the mercy of bilateral accords between Britain and the rest of Europe. The United Kingdom also insists on maintaining control over immigration policy, in breach of the concept of the free movement of people.

The British government’s proposal also includes some concessions in areas such as membership of European agencies but without the right to vote and acknowledgement of the role of the EU Court of Justice would play in certain matters. However, the EU official in charge of Brexit negotiations, Michel Barnier, has raised serious doubts about the viability of such an agreement. Although the EU may yield on the issue of separating goods and services, in the opinion of Miguel Jiménez, European institutions will be more demanding when it comes to immigration on which the government of Prime Minister Theresa May will have to “give up a lot of ground”.

United Kingdom has put forward a proposal that leaves the City of London outside the single market

The BBVA Research economist warns that even though the European Union and the United Kingdom were to reach an agreement, the complicated political situation in Britain could scupper approval of such an accord. The eurosceptic wing of the British parliament has lost two key government ministers (Boris Johnson and David Davis, who resigned a few days after the Chequers meeting) and has flagged it will vote against any agreement based on the current proposal. This could result in the United Kingdom facing a “hard” Brexit without any transition period or trade agreement, the preferred option of the British eurosceptics.

Separately, the Labour Party, which is ahead in the opinion polls, might welcome a defeat of the May government that leads to fresh elections. However, those in favor of remaining within the EU could ask for a new referendum with three options on the ballot paper: exit without agreement, a negotiated agreement or stay.

Demonstrators against Brexit protesting in front of the British parliament.

How would this affect capital markets union?

In the case of the United Kingdom leaving the EU without any sort of accord on March 30, 2019, the country will be exempt from complying with the obligations of European legislation and will cease to benefit automatically from European rights, which would include those deriving from capital markets union (CMU). The possibility of such an “unprecedented situation” has led institutions such as the European Commission and the European Banking Authority (EBA) to give notice of the need to prepare for a hard Brexit.

The City of London has long been the nerve center of European finance, in part because of the advantages afforded by membership of the single market. However, this would cease to be the case when the United Kingdom’s departure becomes a reality. This would mean that as of March 2019, if no exit agreement is reached, ties between the United Kingdom and the EU would come under the aegis of third-party status as contemplated by both European legislation and the respective regulatory frameworks of individual EU member states.

In other words, if no exit agreement establishing the future relationship between the United Kingdom and the European Union is reached and approved, as of March 30, Britain will cease to have access to the single market.

Given the implications Brexit could have for financial stability in the European Union, a working group made up of experts from the Bank of England and the ECB already meets regularly on managing the risks entailed in the United Kingdom’s final exit from the European financial services area in March 2019.

Likewise, the European Commission has flagged some of the other consequences a hard Brexit without an agreement would entail. Among these, the EU executive arm points out that after Britain’s departure, the EU would start to impose custom tariffs and duties as well as border controls as in the case of any other third country, which would particularly disrupt the entire transport sector as a result of delays due to health and phytosanitary controls. The EC assumes that if this situation were to come about, a considerable part of the market integration that currently exists with the United Kingdom would be lost.

In this scenario, the situation of individuals would also be left in the air. In the absence of an EU-U.K. accord, there will be no specific agreement governing the situation of EU citizens living in Britain nor of British citizens living in some of 27 EU member countries.

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