And where in this new global market will Australia find its place?
Britain leaving the EU (or Brexit as it is commonly known) has been a constant news item ever since 52% of the UK voted to leave in June 2016. This has caused large scale changes in the European financial services industry. The likes of BlackRock, BNP Paribas, Citigroup and Credit Suisse moved parts of their UK businesses to mainland Europe, whereas others such as Barclays have chosen Dublin, Ireland. Relocations on this scale are not cheap; based on the public announcements of the 222 largest UK financial services companies, EY has found that the industry has spent at least £4bn to June 2019 alone. This included £1.3bn of relocation costs, legal advice and contingency provisions and £2.6bn of capital injections to non-UK headquarters.
So, what has led to these wide-scale changes and, more importantly, where does the UK go from here?
Article 50 (the notification to the EU of a country’s intention to leave) was triggered in March 2017 which should have led to a two-year countdown to Britain leaving the EU in March 2019. In that time two Prime Ministers as well as three Secretaries of State for Exiting the European Union (Brexit Secretaries) have resigned.
In January 2019, just two months before the deadline, the then PM Theresa May suffered the worst defeat in UK government history when her Brexit deal was quashed by 432 votes to 202. As a result, an extension to the deadline was agreed to 31 October 2019. A further two attempts were made to get the deal passed by the UK government, both of which were defeated.
After May resigned in July 2019, Boris Johnson took over as PM. Britain’s exit from the EU was meant to occur on the 31 October 2019, deal or no deal. However, in September the Members of Parliament voted on a bill that blocked a no deal Brexit. The UK then asked the EU for a second extension to 31 January 2020.
This deadline has been met and the UK has now left the EU and entered an 11-month transition period. The question is; what happens next?
What we do know is that during this period the UK remains in the EU’s Single Market and Customs Union and will continue to obey EU rules in this space. However, the UK is no longer part of any political institutions, including the European Parliament.
The first priority is trade talks. The UK government has already stated that there will be no extension to the transition period. Talks officially began in early March but were cancelled mid-month due to COVID-19. If required, there is scope under the Withdrawal Agreement to extend the transition period by 12 or 24 months. However, an agreement on an extension would need to be reached by 1 July 2020. This scenario seems unlikely as the UK government has already passed legislation ruling out an extension, a sentiment echoed by Boris Johnson.
Assuming a transition extension does not go ahead, the UK has two options come 31 December 2020: Have a trade deal agreed in place and commence this deal, or exit the transition without a deal. In the event of no trade deal being in place, the UK will automatically resort to World Trade Organisation trade rules. This would mean both tariffs and quotas would be placed on exports to the EU. Further complexities also exist – ‘non-tariff barriers’ would need to be in place to protect product standards and safety regulations, for example. The EU could also impose additional checks and regulations, that do not exist today, on imported goods from the UK.
It is easy to focus solely on trade, but that is only one piece of the puzzle. Agreements on other areas such as security and law enforcement also need to be made. The UK is set to leave the European Arrest Warrant scheme (a warrant that is valid throughout all member states that once issued, requires another member state to arrest and transfer a criminal suspect or sentenced person) so an alternative will need to be found.
What is very apparent is that there is a significant amount of work to do in a very short timeframe. This has been significantly more challenging due to COVID-19 and the lack of ability for face-to-face talks. Whether the UK and the EU can organise remote negotiations will be critical if the timelines have any chance of being adhered to.
How will Brexit affect Australia’s relationship with the UK and EU? It is fair to say there have been tensions between Australia and the EU in the past. Clashes over the EU’s Common Agricultural Policy’s ability to distort world markets is a prime example. Despite this, the EU is Australia’s largest investment partner and second largest trading partner after China. The strong relationship with the EU is reflected in the decision to commence negotiations on a free trade agreement.
It will be interesting to see how Australia will rank the UK compared to the rest of Europe. In 2014 the UK was Australia’s 8th largest export market (37 percent of Australia’s total EU trade exports went to the UK). With the remainder of the EU receiving the larger portion of these exports, Australia cannot afford to shift its focus mainly towards the UK and away from the rest of Europe. Furthermore, using the UK as a gateway into Europe (Australian companies have done so in the past) will no longer be available. A shift may occur to Ireland or a European mainland nation.
Whilst Brexit will cause financial market volatility; a report by the Australian Treasury predicts that the effect on economic activity and financial sector within Australia is likely to be small. There has not been a large reaction to commodity prices and the links between the Australian and UK banking systems have declined in recent years, particularly after early 2016 when NAB sold Clydesdale Bank, the last of its overseas acquisitions. The result is that the Australian Treasury estimates (on an ‘ultimate risk basis’) the exposure to the UK is just under $100 billion – one quarter being UK-resident banks and the other three quarters to private and public non-bank institutions.
Furthermore, Australia has a history of being resilient in past periods of financial market volatility and this period seems no different.
Australian banks have reduced UK exposures and UK banks have been retreating from Australia. That being said, if the concerns regarding the viability of the Euro area escalate then funding and operating conditions could deteriorate for Australian banks. This should however not raise cause for concern. Post financial crisis, Australian banks increased their funding and capital positions as well as raising their liquidity buffers. Furthermore, in the event of significant restriction of funding, the Reserve Bank facilities can maintain Australian dollar liquidity.
Maintaining Australia’s strong relationship with the EU, which has lost a major state with very close ties, will be a priority.