Brexit: What happened and how it will impact your business

In a referendum felt ‘round the world, UK voters decided it would be best to leave the European Union.  By a vote of 52-48, the “Leave” supporters have won and have thereby disrupted the trend towards progressively greater European integration that has been in place since World War II.  The immediate repercussions of the decision were dramatic:  UK PM David Cameron resigned, global stock markets swooned, and safe haven assets like gold and the US dollar surged.  The answers to the political question of “Why?” run from immigration to globalization to anti-EU regulations.  In 2013, Cameron made a promise to the anti-EU wing of his Conservative party to hold a referendum on this issue.  Cameron campaigned vigorously on “Stay,” but couldn’t convince a majority of UK voters.

Brexit occurred despite dire warnings of major negative impact to the UK economy from a wide range of groups from the Bank of England to the European Central Bank.  The UK Treasury issued a report on Brexit predicting GDP would be 3.6 per cent lower after two years than if the UK voted to remain, unemployment would be 520,000 higher and the pound would be 12% lower. [HM Treasury Analysis (pdf Page 8), May 2016]  Britain must now hold formal talks with the European Union on exiting the group.  While the UK has up to two years to formally request the exit, leaders in Europe are asking to accelerate the process in order to reduce uncertainty.

It should be remembered that Brexit is a predominantly political shock to global financial markets and commerce.   Unlike the 2008 financial crisis, Brexit doesn’t have a financial payment or settlement crisis as part of the event.   Consequently, it is unlikely to have similar, catastrophic ramifications across the globe.  The coming days and weeks will be volatile in the markets due to uncertainty associated with the Brexit decision.  I expect global political and financial leaders to provide some reassurance with public statements and possibly with a central bank easing of financial conditions to smooth out the coming period of uncertainty.

Why does this event impact the US? 

When a major global disruptive event occurs, the world’s currency markets are usually the first global barometers to reflect the economic importance of the event. .   In this case, the British pound fell 11.4% against the US dollar in 24 hours, before recovering to end the day down 8.04%.  This creates major problems for business from several angles.  First, it reduces the value of plants and equipment located in the UK.  Next, it reduces the revenues and profits from sales of products in the UK.  Third, it creates logistical and legal issues in the supply chain for US companies exporting to the EU and to the UK.  For instance, there are likely US companies with contracts that assume an exchange rate on or near $1.50/pound.  Now that the pound has dropped significantly, you could see US companies renegotiating terms.

Here’s a brief list of companies from the Midwest who have either significant operations or sales in the UK:

For example, the UK is AbbVie’s third largest market, with $688 million in sales in 2015. (ChiTrib)  AbbVie could potentially lose $57.8 million in sales value with the drop in the British pound if they were not properly hedged.  Even if companies are hedged for current projected sales, they still lose on the value of their plant investment in the UK and must go through the headache of trying to understand the new legal arrangements between the UK-EU when they eventually take shape.

Clearly, the uncertainty over what a new EU trade relationship will be is critical for the UK.  Prior to the vote, Britain had access to the world’s largest common market with over 500 million people.  Almost 50% of UK exports went to this market and now they will have to renegotiate their relationship with the EU.  While this may not seem too disruptive, the EU may not negotiate terms even remotely similar to those agreed upon under the previous structure.   Moreover, the EU may want to send a signal to other nations inclined toward leaving the union that it would be expensive economically to do so.  France, the Netherlands, and other countries have political factions advocating resignation from the EU.   Scotland and Northern Ireland voted to stay in the EU and they may decide to hold their own referenda on their national status within the UK. The potential for ongoing political and commercial chaos is rising.  And all of this foments the uncertainty that is reflected the markets.

Yet, the markets are not the only feedback mechanism for this event.  The US political world is impacted too.  First, President Obama strongly advocated for the UK “Stay” vote and warned that a new trade pact with the UK “could be five years from now, 10 years from now before we’re actually able to get something done.”  (Guardian)  Also, the Clinton campaign stated they favored the “Stay” camp when senior policy adviser Jake Sullivan said:  “Hillary Clinton believes that transatlantic cooperation is essential, and that cooperation is strongest when Europe is united. She has always valued a strong United Kingdom in a strong EU. And she values a strong British voice in the EU.”  Lastly, Donald Trump took the opposite view and supported the UK “Leave” movement stating, “they took back their country.”  It’s too soon to tell what the long-term impact Brexit will be for the US due to our own elections in November.  Obviously each party has very different tax and economic policies and until we have a winner the total impact can’t yet be understood.”

What’s next?

The confusion created by Brexit will continue in the days and weeks ahead.  There are many problems created by the UK-EU divorce.   No country has ever asked to leave the EU so the process has never been tested.   Meanwhile, the financial markets will be assessing how messy the divorce will be and how much foreign assets in the UK will be worth.  US businesses will be evaluating the potential disruption to their supply chains, the potential decline in value in their UK assets, and the potential hit to sales and revenues resulting from the drop in the value of the British pound.  This is the most troubling part of this event:  companies can only speculate how UK and EU politicians will approach the upcoming negotiations.