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Brexit Day: what next for investors after January 31?

By Elena Berton

Even though the UK ceases to be an EU member on January 31, it will enter an 11-month transition period that will shape the future relationship. We look at what's at stake for the UK's main business sectors

Once the UK formally leaves the EU at 11pm on January 31, the focus will shift on the likely fraught negotiations that will shape the future relationship between London and Brussels.

The talks on a new deal will begin in early March, with Prime Minister Boris Johnson promising an agreement will be in place by the end of the year.

The UK has time until July 31 to request an extension of the December 31 deadline, although Johnson has ruled it out despite the EU’s scepticism that such a far-ranging deal will be achieved in just a matter of months.

This means the possibility of the UK leaving the EU without a deal has not been taken off the table.

If no trade agreement is reached by the end of 2020, the UK will leave the transition period without a deal and revert to trading under WTO rules.

To avoid this, during the next 11 months the UK and the EU will have to unravel a 47-year partnership and discuss deals covering everything from trade to civil aviation, medicines and fish, putting pressure on businesses to adjust supply chains, relocate operations and review costs.

We look at what’s at stake for the UK’s major business sectors.

FX markets

Sterling may have faced a rollercoaster between the Brexit referendum and Boris Johnson’s landslide victory in December 2019, but it’s likely to face calmer markets as trade talks get under way.

Silvia Dall’Angelo, senior economist at Hermes Investment Management said Brexit is not a one-off process and will probably take the best part of a decade to pan out until a new equilibrium emerges.

“[Sterling] has been stable between $1.30 and $1.40 and I think it will continue in the next few years. There is a good incentive for both sides to reach a good trade deal but, still, the UK has more to lose,” she said.

A Reuters poll of forex strategists has shown by the end of 2020 EUR/GBP rates would be little changed at 84.5p, compared with the current 85.16p.

The uncertainty around the future relationship between the UK and the EU, as well as trade talks with other countries, could also weigh on the currency.

“There is a tight window of opportunity for the trade talks and if they don’t start well the market may look at it as an opportunity to reprice,” said Jane Foley, senior FX strategist at Rabobank.

The prospects for cryptocurrencies are likely to be far rosier, based on a recent survey by market intelligence firm Cindicator.

The study found that 62 per cent of financial analysts polled reckon Brexit will lead to higher cryptocurrency prices, while around 74 per cent said they are considering holding cryptocurrencies in their financial portfolios.

The Cindicator poll found that 44 per cent of the analysts thought a post-Brexit UK “could be inclined to take a progressive stance towards cryptocurrency regulation”.

Automotive

Already feeling the pinch of the global auto downturn and the costly shift to electrical vehicles, the UK’s biggest exporter of goods hopes to reach the closest possible relationship with the EU, where it sends around 58 per cent of its exports, and avoid customs barriers.

Tariffs on imported parts and exported vehicles under WTO rules would spike manufacturing costs by £3.2bn, forcing prices to rise and global demand for UK-made cars to shrink, the UK’s Society of Motor Manufacturers and Traders (SMMT) has warned.

Any potential tariffs would be on top of a shrinking manufacturing output, which last year dropped 14.2 per cent to 1.3 million cars, the third consecutive fall and lowest level for a decade, partly as a result of disruption caused by Brexit.

It’s expected to drop a further 2.3 per cent in 2020 to 1.27 million units, according to the SMMT.

“It is essential we re-establish our global competitiveness and that starts with an ambitious free trade agreement with Europe,” said SMMT chief executive Mike Hawes.

Peugeot has warned that the future of its Ellesmere Port car factory in Cheshire, where production dipped 20 per cent in 2019, is dependent on Britain’s future relationship with the EU.

Japanese car maker Nissan is going ahead with production of its Qashqai vehicle at its plant in Sunderland, where output has shrunk 22 per cent, but has warned that any duties threaten its entire European business.

Any customs barrier and tariffs would also impact auto parts companies, which supply components like seats, dashboard, windscreen, wipers, and locks, employing thousands of staff in the UK.

Ian Dormer, managing director of Newcastle-based Rosh Engineering, told the FT that the company has included “Brexit clauses” into contracts to make sure any tariffs imposed as part of a future trade deal between the UK and EU are passed to customers.

Airlines

The UK has the largest aviation industry in Europe thanks to its geographical position, with around 80 per cent of all North Atlantic traffic passing through the UK or Irish controlled airspace.

Any major changes to the relationship between the UK and the EU could have a considerable impact for this key market.

Last year, approximately 160 million airline passengers flew between the UK and the EU.

The European Regions Airline Association has said that all 50 of its member carriers would be directly or indirectly hit by a No Deal Brexit and 46 per cent of them would be directly impacted.

Still, the aviation industry has defied the catastrophic scenarios of grounded flights and failing airlines that were predicted in the aftermath of the Brexit referendum in June 2016.

Much of the UK’s aviation legislation is intertwined with EU law, covering everything from commercial pilot licences, airline operating licences as well as maintenance and safety certifications.

However, the UK and the EU have said they would negotiate a Comprehensive Air Transport Agreement, and each side has said that even if the UK leaves without a deal, flights will continue.

In addition, UK airlines have taken steps to either meet EU ownership rules, which allow them to fly between member states, or have set up EU subsidiaries.

Low-cost airline easyJet has moved several aircraft to its Austrian-based unit, while IAG – the parent of British Airways, Iberia, Aer Lingus and Vueling – is now majority-owned by EU investors.

The International Air Transport Association, which represents around 280 airlines, believes the picture for airlines, whatever the outcome of Brexit, will be similar to the expected impact on the wider UK economy, anticipating lower growth in terms of passenger numbers than if the status quo was maintained.

Pharmaceuticals

The pharmaceutical industry is one of the UK’s most productive sectors, generating a turnover of £41.8bn every year and employing around 70,000 people across 543 companies.

The UK is the home of two of the world’s largest drug makers, GlaxoSmithKline and AstraZeneca, along with the subsidiaries of major international pharma companies.

For this sector, Brexit means major complications in terms of regulatory approvals, research and staffing.

The industry regulatory body, the European Medicines Agency (EMA), has already relocated to Amsterdam from London.

If the UK leaves the EU without any agreements, British pharmaceutical companies that hold a centralised market authorisation from EMA will no longer be allowed to market their medicines in the EU.

Even in the case of free trade or bilateral agreements between the EU and the UK, the pharma and life sciences industry may still be affected in a broad range of areas from product development to market approval to the shipping of medicines and medical devices.

The UK would need to approve medicines and grant clinical trial authorisations separately from the EU. It could recognise the quality of pharmaceuticals manufactured in the EU and vice versa, thus ensuring quicker market access,

Under any Brexit scenario, UK pharma companies would no longer have automatic access to EU research programmes such as Horizon 2020. Under a bilateral “Swiss style” scenario, the UK could become an associated country in the programme in order to continue to be eligible for funding. However, this comes with the condition that the UK would still contribute to the programme, and its share of funding may well fall, PwC chief economist Willem Velthuijsen said.

According to the Association of the British Pharmaceutical Industry, the UK is the EU’s most popular location for phase-one trials. It also ranks second, after Germany, for phase-two trials and third, behind Germany and Spain, for phase-three studies.

Once the UK exits the EU, the UK clinical trials industry may see a drop in the number of trials run in the country. As a result, drug makers and medical device suppliers may favour running trials in EU member states, as it will give them access to a larger market.

Brexit could also threaten the presence of US and Asian life sciences companies, which have invested in the UK as a foothold to enter the EU market. Depending on the negotiation outcome, the UK could become less attractive for accessing the EU market.

Financial services

London’s financial district handles trillions of dollars, euros and pounds worth of currency and derivatives trading each day, and the UK’s financial-services industry accounts for 11 per cent of all taxes and 7 per cent of GDP.

The country’s biggest tax earner faces being cut off from its main export market after Brexit.

The EU has said that it would allow access to the British financial sector based on the bloc’s “equivalence” regime if UK financial rules are closely aligned with those in the EU.

In case of a deal, the EU could fast-track approval of UK equivalence in 2020 to avoid a gap in trading terms after the transition period ends at year end.

However, equivalence would require the UK to stay aligned with EU rules, which is something the UK government is not keen on.

In addition, access through equivalence is not straightforward, which is why many UK-based firms have set up offices in the EU.

According to consultancy EY, UK financial services companies have racked up a Brexit bill of near £4bn in their move to shift staff and capital to the EU.

Some firms have disclosed £1.3bn in relocation costs, legal advice and contingency provisions since the Brexit referendum, plus an extra £2.6bn in capital injections as they set up non-UK headquarters, EY’s quarterly Brexit tracker said.

The outlook for the financial services sector would be further muddled by data protection regulations. The cross-border swapping of personal data could be disrupted because the EU doesn’t seem to think UK privacy regulations meet the bloc’s standards.

Without a privacy agreement, it could be illegal for an EU firm to do business with a UK counterpart if it involves customers’ personal data.

Energy

The UK energy sector is varied, which means the impact of Brexit will be different for different players depending on their market focus, energy products traded and their cost base.

Although the impact of Brexit on electricity prices remains undetermined, energy bills are likely to go up as transportation costs increase due to tariffs set by the EU.

"The wholesale market is likely to be in a state of flux. With the risk of a depreciation of sterling, there is a real possibility of higher prices in both the electricity and gas markets,” said Craig Lowrey, a senior consultant at Cornwall Insight.

In 2017, the energy sector created £83.7bn in economic activity and supported 682,000 jobs. The UK is a net importer of electricity and gas, importing around 4.2 per cent of its electricity demand and 36.8 per cent of its gas, according to Deloitte.

There will be no danger of blackouts or supply shortages in the UK and in the short-term both consumers and companies will see little day-to-day change, according to energy consultancy Energy Intelligence Centre.

For starters, oil and gas markets are traded on an international level and the EU has little influence over the make-up of a member state’s energy mix.

However, the longer-term outlook for post-Brexit energy may change when it comes to the EU’s Internal Energy Market (IEM).

IEM is a borderless network of gas and electricity transfers between EU member states that allows energy to be transferred between countries tariff-free.

Continued access to the IEM is a key priority for the UK Government in its negotiations.

The offshore wind sector is expected to get hit the hardest, because new tariffs will likely hit the supply chain for wind turbines, raising the risk for the cost of wind energy in the UK.

The UK power sector is currently facing a shortage of skilled workers and Brexit could worsen the situation if visa restrictions in the UK make it difficult to hire staff from outside the UK.

FURTHER READING: UK must retain financial regulation role after Brexit, says advisory group

FURTHER READING: Brexit bounce sees UK house prices grow at fastest rate since 2018

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