Time is running out for the UK government to agree a Brexit deal with Europe. As my new analysis for ICIS Chemical Business highlights, companies need to move quickly to prepare for the “No Deal” scenario
Legendary England footballer Gary Lineker best summarised the general sense of disbelief over the state of
the Brexit negotiations when tweeting in July:
“A wealthy nation putting itself in a position where it has to stockpile food, medicine, etc., in times of peace is utter madness. What Are We Doing?”
Lineker’s concern was confirmed last month by the head of the British Chambers of Commerce who warned that “precision is what is required” regarding the Brexit process, rather than “declaratory statements”.
Yet today, with less than six months to go before the UK officially leaves the EU, businesses still do not know if the UK will simply crash out with no deal on 29 March, with no transition agreement in place. This is almost unbelievable, given that the EU is the UK’s largest trading partner, taking 44% (£274bn) of UK exports in 2017, and provides 53% (£341bn) of all UK imports, according to a July report from the House of Commons library.
One problem is that the cabinet only finally agreed on its chosen option for the new EU relationship in August. In turn, this means the civil service is only now starting to be able to advise sector groups, trade associations and other experts on the key issues involved.
A second problem is that the new Brexit department had to be created virtually overnight after the June 2016 referendum, and the average age of its staff is just 31 years. Many have no personal experience of the enormously complex issues involved.
CHEMICALS IN NO-MAN’S LAND
Chemical companies are, of course, right in the middle of this no-man’s-land. They depend on frictionless movements of raw materials and intermediates between their various EU sites, and they are heavily integrated into just-in-time supply chains with key customers such as the auto and food industries.
The UK government has recently warned of possible major disruption if there is a No Deal Brexit, and the Key UK Risks chart highlights the key economic and business risks that lie ahead.
The current gap between the UK and EU positions was emphasised in chief EU negotiator Michel Barnier’s recent evidence to the UK Parliament:
- He confirmed that the EU did not believe key proposals in the Chequers Plan for the Irish border and other super-critical issues can either work or be agreed
- Instead, Barnier proposed the idea of a “Canada plus plus” deal in the form of a Free Trade Agreement covering goods (but not services), plus customs cooperation, plus participation in health, research, Erasmus, aviation and internal security
- He also emphasised that the UK’s £39bn payment was a divorce settlement covering past UK commitments, not an up-front payment for a good trade agreement
THREE MAIN SCENARIOS AHEAD
‘May achieves a withdrawal agreement’
The UK and EU will both lose from a No Deal Brexit and so in principle they could simply “fudge” the trade issue for future discussion during the transition period until December 2020. But although both sides emphasise that 80% of the withdrawal agreement is now agreed, this only highlights that the most difficult 20% still lies ahead – issues such as Ireland, immigration and EU citizen rights, and future trade relations.
‘Markets cause a panic on Tory benches’
What happens if May does stumble at this point and fails either to gain an agreement with the EU27 or to get it safely through the Cabinet, Tory party and Parliament? As the Risks chart shows, this might well lead to financial market pressure on the pound and interest rates. This would also represent more bad news for chemical companies. If even 20 Tory Eurosceptics vote against a deal, then May would have to rely on opposition party votes, and their support looks unlikely given Labour’s “six tests” for approving any deal.
‘No deal’ scenario
Exchange rate volatility could become a critical issue for companies and investors if this scenario is reached, with the pound possibly falling towards parity with the US dollar and the euro, causing interest rates to rise. Foreign investors currently own 28% of the government’s £1.9tn debt, and concern over the value of the pound could lead some to reduce their holdings of government bonds.The Brexit Directory chart from Ready for Brexit shows the scale of the risks involved. It highlights how Brexit potentially involves almost every aspect of business – from Customs & Tariffs through Finance and Legal issues, to Services & Employment and the Supply Chain.
Of course, many major companies have already spent months and millions of euros in preparing detailed contingency plans. Some are already stockpiling key raw materials and products, and revising relevant contract clauses.
But smaller businesses do not have these resources. Surveys show that only one in seven have done any forward planning for a No Deal Brexit, and official government guidance for a No Deal has only just begun to appear. In turn, this creates a clear risk of widescale disruption, as today’s highly integrated supply chains are only as strong as their weakest link. The lack of just one raw material can stop a production line.
As Gary Lineker says, it is hard to believe this is happening. But it is, and so far “declaratory statements” rather than precise detail continue to dominate the process.
It is also easy to forget that a No Deal Brexit will not just impact the UK. US and EU-based businesses involved in a supply chain that involves a UK company face a clear risk of disruption.
This is why I have helped to launch Ready for Brexit with other industry colleagues. As the Scout motto reminds us, to ‘Be Prepared’ could be critical for business survival if a No Deal Brexit does occur.
Please click here to visit Ready for Brexit, and click here to download the full ICB analysis.
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UK voters were never very bothered about membership of the European Union (EU) before the Brexit vote last year. Opinion polls instead showed they shared the general feeling of voters everywhere – that their country was heading in the wrong direction, and it was time for a change. Now, last week’s Conservative Party conference showed that the government itself, and the prime minister, have also lost all sense of direction.
The problem is that nobody has any idea of a what a post-Brexit world would look like for the UK. The Leave campaigners famously told the voters it would be a land where the UK would no longer “give” £350m/week ($455m) to Brussels, and could instead spend this money on improving health care and other worthy objectives. This, of course, was a lie, as the head of the National Statistics Agency has since confirmed. But then-premier Cameron failed to call out the lie at the time – fearing it would split his Conservative Party if he did.
15 months later, this lie has again come centre stage as the Foreign Secretary, Boris Johnson, revived it before the Conference as part of his bid to replace premier May:
“Once we have settled our accounts, we will take back control of roughly £350 million per week. It would be a fine thing, as many of us have pointed out, if a lot of that money went on the NHS.”
As a result, the splits in the Conservative Party are out in the open, with its former chairman now calling for a leadership election and claiming at least 30 law-makers already support the move. Bookmakers now expect May to leave office this year (offering odds of just evens), and suggest the UK will have a new election next year (odds of 2/1), despite the fact that Parliament has nearly 5 years to run.
May’s problem is two-fold:
As the photo shows, she was humiliated in her main speech to the Conference by a prankster handing her a P45 form (the UK’s legal dismissal notice), and claiming Johnson had asked him to do it
Her previous set-piece speech in Florence on negotiations with Brussels over the UK’s exit arrangements had also rebounded, as it made clear the Cabinet was divided on the terms that should be negotiated
Voters don’t like being lied to, and they don’t like governments that are unable to govern because of internal splits – particularly when the splits are over such a critical issue as the UK’s economic future. Unsurprisingly, therefore, the opposition Labour party are now favorites to win the next election, and their leader, Jeremy Corbyn, is favourite to become the next prime minister. This, of course, would confirm my suggestion 2 years ago:
“My local MP, Jeremy Corbyn, won the UK Labour Party leadership election on Saturday with a 60% majority. An anti-NATO socialist, he has represented the constituency for 32 years, and has never held even a junior ministerial post. Now, he could possibly become the UK’s next Prime Minister.
“His path to power depends on two developments taking place, neither of which are impossible to imagine. First, he needs to win back the 40 seats that Labour lost to the Scottish Nationalists in May. And then he has to hope the ruling Conservative Party tears itself apart during the up-coming Europe Referendum.”
Unfortunately, Corbyn would be unlikely to resolve the mess over Brexit. In the past, before becoming leader, he took the Trotskyist view that the EU is a capitalist club, set up to defraud the workers. He has since refused to confirm or deny his views on the subject, but he did take very little part in the Referendum campaign last year. Had he been more active in arguing the official Labour Party position of Remain, it is unlikely that Leave would have won.
Today, he is far more concerned over the likely result of a Labour Party win on financial markets, with his shadow Finance Minister admitting recently they were “war-gaming” in advance of an expected currency crisis. UK interest rates are already rising, as foreign buyers wonder whether they should continue to hold their current 28% share of the UK government bond market. Clearly, it is highly likely that a Labour government would need to return to capital controls after a 40-year break, to protect their finances.
A VERY HARD BREXIT IS BECOMING ALMOST CERTAIN
The confusion and growing chaos in the political world means that the detail of Brexit negotiations has taken a back seat. The UK has still to make detailed proposals on the 3 critical issues that need to be settled before any trade talks can begin – rights of EU/UK citizens post-Brexit; status of the N Ireland/Ireland border; UK debts to Brussels for previously agreed spending. And most European governments are now far more focused on domestic concerns:
As I warned a year ago, the Populist Alternative für Deutschland did indeed “gain enough seats to make a continuation of the current “Grand Coalition” between the CDU/CSU/SDP impossible” in Germany
Spain has to somehow resolve the Catalan crisis, following last week’s violence over the independence referendum
Italy has autonomy referenda taking place in the wealthy Lombardy and Venice regions in 2 weeks, and then faces a difficult national election where the populist 5 Star movement leads most opinion polls. The scope for political chaos is clear, as the wealthy Northern regions want to reduce their tax payments to the south – whilst southern-based 5 Star want more money to go in their direction
President Trump has also undermined the Brexit position. He initially promised a “very big and exciting” US-UK trade deal post Brexit. But since then the US has supported a protectionist move by Boeing to effectively shut-down the vital Bombardier aircraft factory in Belfast, N Ireland, despite May’s personal appeals to him. And last week, it joined Australia, New Zealand, Argentina and Brazil in objecting to the EU-UK agreement on agricultural quotas post-Brexit.
I have taken part in trade talks and have also negotiated major contracts around the world. So I know from experience the UK could never have achieved new deals within the 2 years promised by leading Brexiteers.
Today, it is also increasingly clear that May’s government doesn’t have the votes in Parliament to agree any financial deal that would be acceptable in Brussels. So whilst large parts of UK industry still assume Brexit will mean “business as usual”, European companies are being more realistic. In a most unusual move, the head of the Federation of German Industries spelt out the likely end result last week:
“The British government is lacking a clear concept despite talking a lot. German companies with a presence in Britain and Northern Ireland must now make provisions for the serious case of a very hard exit. Anything else would be naive…The unbundling of one of Germany’s closest allies is unavoidably connected with high economic losses. A disorderly exit by the British from the EU without any follow up controls would bring with it considerable upheaval for all participants. (German companies feel) not only that the sword of Damocles of insecurity is hovering over them, but even more so that they are exposed to the danger of massive devaluation.”
UK, European and global companies are already drawing up their budgets for 2018 – 2020. They cannot wait until Brexit day on 29 March 2019 before making their plans. And so, as it becomes increasingly obvious that the UK-EU talks are headed for stalemate, and that ideas of a lengthy transition period are simply a dream, they will make their own plans on the assumption that the UK will head over the Brexit cliff in 18 months time.
Nobody knows what will happen next. But prudent companies, investors and individuals have to face the fact that Brexit, as I warned after the vote, is likely to be “a disaster for the UK, Europe and the world“.
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Brexit negotiations are likely to prove a very uncomfortable ride for UK consumers as Russell Napier of Eric, the online research platform, warned last week:
□ ”Public sector debt remains at near-historic highs (in peace time!) and for the first time this public sector debt comes with a private sector bubble
□ Credit card debt is rising at its fastest rate in a decade — 9.3% in the year to February
□ Unsecured debt as a whole is rising at more than 10% and some 6,300 new cars are bought on credit in the UK every day”
Companies and investors already face growing uncertainty as March 2019 approaches, as discussed on Monday. UK consumers now face similar challenges as their spending power is further squeezed by the pound’s fall in value since June, as the chart confirms, based on official data:
UK earnings for men and women have been falling in real terms since the financial crisis began in 2008
Male earnings are down 5% in £2016, and female earnings down 2%
Since June, unsurprisingly, cash-strapped families have had to raid their savings to fund consumption
New data shows the UK savings ratio hit an all-time low of just 5.2% last year – and was only 3.3% in Q4
One key issue is that monetary policy has reached its sell-by date, with Retail Price Inflation hitting 3.2% in February as a result of the pound’s fall. Interest rates may well have to rise to defend the currency and attract foreign buyers for government bonds. Foreigners currently fund more than a quarter of the government’s £2tn ($2.5tn) borrowing, and cannot easily be replaced.
Unfortunately, these are not the only risks facing the UK consumer. As I feared in June:
“ Many banks and financial institutions are already planning to move out of the UK to other locations within the EU, so they can continue to operate inside the Single Market
There is no reason for those which are foreign-owned to stay in the country, now the UK is leaving the EU
This will also undermine the London housing market by removing the support provided by these high-earners
In addition, thousands of Asians, Arabs, Russians and others will now start selling the homes they bought when the UK was seen as a “safe haven”
Lloyds, the global insurance insurance market, has just announced plans to move an initial 100 out of 600 jobs to Brussels, so that it can continue to serve EU clients. Frankfurt, Paris, Amsterdam, Dublin and Copenhagen are also lining up to offer attractive deals to companies wishing to maintain their EU passports to trade. And last month saw an ominous warning from JP Morgan Chase CEO, Jamie Dimon:
“The clustering of financial services in London is hugely efficient for all of Europe. Now you’re going to have a de-clustering, which creates huge duplicative cost which is expensive to clients. Nevertheless, we have no choice.”
Dimon’s warning was reinforced on Tuesday by the leader of the powerful European People’s Party in the European Parliament, who told reporters 100k financial services jobs would likely relocate from London due to Brexit:
“EU citizens decide on their own money. When the UK is leaving the EU it is not thinkable that at the end the whole euro business is managed in London. This is an external place, this is not an EU place any more. The euro business should be managed on EU soil.”
Until now, many consumers have been cushioned from the fall in real incomes by the housing bubble. But as I discussed in December, the end of such bubbles is normally quite sudden, and sharp:
Worryingly, UK house prices fell in March for the first time in 2 years
The Bank of England also reported that mortgage approvals are falling
And normally, lower mortgage volume leads to lower house prices
Certainly it would be no surprise if prices did now start their long-overdue collapse, as highly-paid financial professionals start to leave the UK. One key indicator – the vastly over-priced 9 Elms development – now has an astonishing 1100 apartments for sale. And if the housing market does collapse, then recession is inevitable.
The key problem is that consumers do not have many options when the economy moves into a downturn. New sources of income are hard to find if mortgage costs start to rise. All they can do is to cut back on spending, and boost their savings – to help them cope with any future “rainy days”. This in turn creates a vicious circle as consumption – over 60% of the economy – starts to fall.
There are therefore no easy answers when trying to plan ahead for likely storms. But being prepared for a downturn is better than suddenly finding oneself in the middle of one.
Next month sees the start of a process that could change all our lives. Whether we live in Europe, or outside it, the political decisions about to be made have the potential to impact every country in the world – for better or worse.
And yet, nobody has yet begun to put together the various pieces of the jigsaw, and identify the wide range of different outcomes that could emerge. By the end of the year, the EU and the eurozone might have collapsed – with massive impact around the world. Or ‘business as usual’ might continue. Or we might have a revived French-German partnership again, reigniting the energy that first began to rebuild Europe after World War 2. None of us know, and it is very dangerous to keep pretending that ‘business as usual’ is the only option.
The changes are so vast, and so different in their potential outcomes, that I will explore them in two separate posts this week. Today, I will look at Brexit and the current outlook for the Dutch and French elections. On Thursday, I will look at the outlook in Italy and Germany, and draw some conclusions about what may happen.
Brexit is the first unknown. The UK expects to start the process of leaving the European Union (EU) next month. Premier Theresa May has now published the government’s position on the talks. But what will happen when she presents her terms in Brussels? She wants to retain access to the Single Market for critical UK industries such as financial services, autos, aerospace and chemicals – but she doesn’t want to allow immigration to continue on the current basis, and she probably doesn’t want to pay the €60bn bill that Brussels believes she will owe on leaving.
So what will happen? Will it be sweetness and light, with everyone singing “For she’s a jolly good fellow” as she walks out the door? Or will there be furious arguments, and no agreements for UK trade in the post-Brexit world? And what will happen back in the UK while all this takes place? Will businesses simply sit back? Or will some decide it would be prudent to move to France, Germany, Ireland or elsewhere? And what might happen in Parliament, where May only has a majority of 12, if things go badly? Could her term as premier end up being one of the shortest on record?
The Dutch elections are the next unknown on 15 March. Geert Wilders, the anti-immigration, anti-EU candidate for premier, is currently leading in the polls. But will he do better, or worse, when the time comes to actually vote? As we know from the Brexit and US Presidential elections, the polls are not always accurate – if people who have not voted in the past, now decide it is time they went to the polling station. And if Wilders does win, will he be able to form a government? Current premier, Mark Rutte, has said he will refuse to work with him. So it could be a very lengthy process before The Netherlands has a new and stable government.
And what would happen if Wilders did become premier? His main policy is leaving the EU. On what terms would he seek to do this – would he adopt the same positions as Theresa May, or would he have different priorities? And would the EU itself survive the departure of one of its original 6 members? Many people think it wouldn’t.
France’s presidential elections are next, on 23 April. French polls were completely wrong in the primaries – Alain Juppé was defeated by Francois Fillon for the Republican nomination, Manuel Valls was defeated by Benoît Hamon for the Socialist nomination. At the moment, Emmanuel Macron with his new En Marche! movement, and Marine Le Pen of the National Front, seem likely to go through to the final round. Their outsider status is critical to their appeal, but their policies couldn’t be more different. Macron wants to revive the EU, le Pen wants to leave it.
What would happen if Le Pen wins? Almost certainly, the EU would collapse – whether or not Wilders had already begun the process. And what would that mean for the European and global economies? What would happen to the value of the euro? What would happen to the euro itself? Would all the break-up decisions be taken rationally, or would they happen late at night, after bitter argument?
What about the alternative, a win for Macron – who only declared his candidacy in November, and is still forming his new party? He has recognised that the curo cannot survive in its current structure, and has argued the EU should develop “a roadmap for Europe” in critical areas including defence, security and the economy. If fellow social democrat, Martin Schulz, were to be elected Chancellor in Germany in October, the stage could be set for a dramatic reshaping of EU policy – and probably also its membership. The contrast with Ms le Pen’s plans couldn’t be stronger.
GREAT UNKNOWNS LIE AHEAD OF US
These uncertainties would be difficult enough to manage on their own. Brexit itself is a complete unknown, effectively tearing up the last 43 years of UK law and economic policy. But it could easily be over-shadowed by developments in The Netherlands and France. If either or both decide to leave the EU, who really knows what would happen to the European and global economy, the value of European currencies, or Europe’s relationships with the rest of the world?
But these uncertainties are only part of the Great Unknowns now ahead of us.
On Thursday, I will look at the highly uncertain political outlook in Italy and Germany. I will also highlight the very different possible outcomes from Europe’s plunge into the Great Unknown – which has the potential to impact all of us, whether we live in Europe or elsewhere.
Chemistry and the Economy: 2016 Mid-year review
The UK’s decision to leave the European Union (Brexit) is causing major upheaval in financial markets as investors rush to supposedly “safe havens”. This is highlighting the underlying slowdown in demand growth caused by globally ageing populations.
What does this mean for the chemical and pharma industry? Can we still rely on the supply-driven strategies of the past? Or do we need to reinvent our business and investment strategies?
Please join me and Bill Carroll, former Chair of the ACS Board, as we discuss these critical issues in my next ‘Chemistry and the Economy’ webinar for the American Chemical Society.
The webinar takes place on Thursday @ 2pm – 3pm Eastern US Time
Free registration is at Chemistry & the Economy: 2016 Mid-Year Review