“I am not a British isolationist. I don't just want a better deal for Britain. I want a better deal for Europe too.”

—David Cameron, 2013

In the UK, there are few things more discredited than opinion polls. The Scottish referendum was to be on a knife edge, but when the votes were returned it showed an overwhelming vote for union. Next, the general election arrived and the pollsters overwhelmingly predicted the impossibility of anything other than a hung parliament, only to be forced to eat “humble pie” as the Conservative Party returned with a clear majority. So, for the third time in recent history, the UK is facing a momentous vote, the referendum on UK membership of the European Union, while the lack of confidence in polling has raised the risk of an unexpected outcome.

Two of our senior fund managers, Simon Down and Holger Mertens examine the possible route to and risks of Brexit from both the UK and European perspective.

The Road to Referendum

A UK referendum on EU membership was a key part of the Conservative party election manifesto at the general election, designed to counter the growing popularity of the UK Independence Party who were campaigning on an anti-European mandate. Winning the election, Cameron provided European Council President Donald Tusk with a list of desired reforms in November 2015 and negotiations began, with a pledge to hold the referendum by the end of 2017. Most commentators expected negotiations to be drawn out and for a potentially long campaign with a referendum most likely taking place in 2017. But instead, after a brief period of negotiations the government set the referendum date as June 23rd 2016.

It is difficult to see that the concessions won by Cameron playing a significant role in shifting opinion in the UK. Turnout is, thus, going to be a critical issue for the referendum. The “Exit voters” in the UK tend to be passionate about their view and see this referendum as a one-off opportunity. They will be almost certain to turn out to vote. This means that a low turnout would almost certainly favour an exit vote. The critical issue will be whether the “Remain” campaign can get sufficient numbers of people out to vote.

Given these highly unpredictable factors, we look at how an exit vote could play out and what the risks are to both sides.

Timeline of Key Dates:

Timeline of Key Dates

Key UK demands vs. EU concessions:

  1. Reform of the benefit rules to allow the UK to exclude EU migrants from work benefits for the first 4 years they are in the UK for the next 13 years.

    EU concession:
    Newly arrived EU workers can have work benefits graduated over four years, receiving zero benefits in the first year, gradually rising each year until full benefits are received after the four years. This will be in place for 7 years.

  2. Reforms of child benefit rules to allow the UK to stop payments for children living abroad.

    EU concession:
    For new claims the UK can pay child support to children in foreign countries at the lower domestic rate available in that country. From 2020 all claims can be paid at the domestic rate rather than the UK rate.

  3. The ability for national parliaments to block European legislation and an opt-out for the UK on future European integration.

    EU concession:
    National parliaments will be able to block legislation but only if 55% of EU parliaments vote to block it within 12 weeks of it being tabled. If this is triggered, then the proposals will be amended or blocked. With current membership, this would require at least 14 countries to combine within a short period which will make it very difficult to implement. The EU has committed to have an exemption for the UK from ‘ever closer union’ written into treaties.

Uk Flag The UK Perspective

Political: For the UK, the political scenarios around the vote are complex regardless of result:

  • Domestically, Prime Minister Cameron is perceived to have negotiated a poor deal and the Justice Secretary immediately questioned whether the deal is legally binding. One problem facing Cameron is that the greatest concern of British people is immigration and, with free movement of labour a key pillar of the EU, this was never an area in which he could achieve much change. This has left him unable to appease his own party, with a large number of his own MPs now voting against him. By taking an authoritarian approach and restricting information given to ministers who are in support of the Exit campaign, he has started a battle within the Conservative party that he may not be able to survive even if he wins the referendum vote.

UK Net Migration Rolling 12 months

UK Net Migration Rolling 12 months

Sources: Office for National Statistics

  • Within the government, a number of key cabinet members have joined the Exit campaign, including the mayor of London Boris Johnson. Boris polls as the most popular politician in the UK and could be a key asset to the Exit campaign, with one poll suggesting that 30% of people would be more likely to vote to exit with his support. If the Exit campaign were to win, then Cameron would likely resign, with Boris most likely to take over as Prime Minister.
  • If Cameron resigned on an Exit vote, or was replaced following a leadership challenge on a Remain vote, the risks would rise for an early election for the new Prime Minister to gain a mandate. Although the polls suggest a 5-10% lead for the Conservatives, the risk is not insignificant that there would be no clear majority. This would leave the Conservatives once again trying to form a coalition similar to the last parliament. One reason for this is the unknown element of what happens to UKIP (UK Independence Party) voters in a post referendum world. UKIP gained over 4 million votes at the last election largely on the campaign of Brexit.
  • The Scottish SNP have stated that if voters in Scotland were to vote to stay in the EU but the UK as a whole voted to exit, that they believe that this would be a trigger for another referendum on Scotland. The UK government’s official position though is that the Scottish referendum was a one-off event that will not be repeated for a generation. So there is another potentially major uncertainty regarding whether a referendum will be allowed, and if allowed, then Scotland could well leave the UK, and if not allowed, then the SNP could attempt to stoke social unrest against the UK government.

Trade: Europe is by far the largest export market for the UK, so the outcome of the vote will have a major impact on various sectors in the UK. For the goods balance, the UK has built up a significant deficit in recent years, close to £90 billion per annum. This should strengthen the UK’s position in negotiations and should soften the risks that Europe would look to impose trade tariffs in order to punish the UK for exiting. Under the Lisbon Treaty, should the UK withdraw from the EU, then it would have up to two years to negotiate its withdrawal and existing free trade agreements would remain in place during this negotiation. So after these negotiations are concluded, then the nature of the UK’s withdrawal would define its future trading relationship with Europe. A similar agreement as Norway’s would keep the UK within the European Economic Area with full trade access but lower contributions. This seems unlikely, though, given that a major focus of the Exit campaign has been to no longer have free movement of labour from Europe. An agreement similar to Switzerland would be more desirable from a UK perspective, allowing free trade but restricted immigration. This could be very difficult to agree for the Europeans, however, not least because numerous other European countries would likely seek a similar deal if this was given to the UK. So, it is possible that the UK could be forced to pull entirely out of the EU and look at a similar agreement as Turkey. In this ‘hard exit’ scenario, in which the UK was forced to trade under World Trade Organisation rules, the Royal Bank of Canada has estimated that the average tariff would be around 5%, which we believe would be absorbed by British exporters.

The UK’s trade situation becomes more complicated with Services. In such, the UK is in surplus by nearly £20 billion, with the majority of that surplus coming from financial services derived by firms operating in the rest of Europe under the passport system. This is a sector in which Europe may be far more reluctant to negotiate.

UK 12 month Rolling Trade Balance with EU (GBP billion)

UK 12 month Rolling Trade Balance with EU (GBP billion)

Sources: Bloomberg

Impact of a Brexit

  • Short term: For the UK, an exit vote would most likely play out via the currency and equity markets at first, with some of this likely to occur in the run up to the vote. The Gilt market should be insulated to some degree as a significant amount of foreign ownership is by global central banks. An exit vote would also push back any Bank of England interest rate rise and there would a high risk of a downgrade by credit rating agencies.
  • Medium term: The potential two-year negotiation period on what form the UK withdrawal would take would clearly be a period of uncertainty. If the UK were to quickly appear to be on the path to a ‘soft exit’ and move to a similar position as say Norway, then this would limit the economic damage, but this is unlikely. So there could be a considerable period in which the outcome was unknown, which would weigh on investment and business sentiment, and damage economic growth.
  • Long term: The major challenge for the UK will be its trade agreements globally. If these can be drawn up very quickly whilst the UK remains in negotiations with the EU and can be implemented immediately on withdrawal, then the impact should be limited. But the risk is that trade agreements can take many years to conclude. Given the international status of the UK, its strong rule of law and already sizeable international trade flows, though, it is probable that the country should be able to forge its own path. In the long term, many of those voting to exit would argue that UK growth will be higher outside of the EU.

EU Flag The European Perspective

Political: The idea of a European union goes back to the time after the 2nd World War. Political and economic integration was seen as a way to overcome extreme nationalism and its devastating consequences for Europe. These efforts have been fruitful and have secured almost 71 years of peace and economic growth in Western Europe. With its economic power of a nominal GDP of 18 trillion USD, which accounts for approximately 24% of global GDP, the EU is able to protect its political and economic achievements inside and outside of its borders. The EU can sanction countries that deviate from the principles of the peaceful process in Europe. Also, the UK as well as France are permanent members of the UN Security Council, ensuring the EU’s influence globally.

An EU exit by the UK, an associate with global influence as well as an economically-important partner (with the 2nd largest GDP of 28 EU member states), would clearly weaken the EU politically and financially. The UK contributes to the EU budget and it will be difficult for the remaining members to make up for this shortfall. Moreover, the loss of a large member that supports liberalisation in the EU would see the voting rights of the liberal block fall from 25% to 15% and have a negative impact on reform effort within the EU.

In addition, the exit would come at a very difficult time, as the refugee crisis and immigration in general presents a major challenge for Europe. A Brexit and subsequent tightening of border controls might pressure other countries in the EU to follow the UK. Although for most countries within the EU, concerns are more about extra- rather than intra- EU migration.

Trade: The EU is a more important trading partner for the UK, than the UK for the EU. The UK accounts for just one–sixth of the EU economy, but for some individual countries (i.e. Belgium, Czech Republic and Hungary, whose trade surplus with the UK are close to 2% of EU GDP), the UK is a significant trade partner. For these countries a Brexit could potentially cause trade disruptions and lead to a period of uncertainty, as new trade agreements will have to be negotiated to replace the Single Market. The EU might have to support these countries during the transition process.

In addition, UK companies are deeply integrated into the supply chain of some sectors, which would be negatively impacted, if the UK would leave the Single Market. A reorganization of the supply chain might put extra burden on these sectors and lead to loss of business for British suppliers.

Furthermore, the UK has received massive foreign direct investment from EU members with concentration around a few countries (France, Germany, Spain and Ireland) and sectors (energy, retail, wholesale trade, transportation and manufacturing). A Brexit might remove the commercial logic behind these investments. Corporates, which have moved their headquarters or important projects to the UK, could have to consider relocating their operations, at large cost, back to Europe. On the positive side, this could create business opportunities for other EU countries.

Some countries in the EU have seen the rise of the financial service industry in the UK with anxiety and would hope to win back business after a Brexit. Europe’s most important financial centre is London and a large number of European banks have major operations in London. Following a Brexit, there is the risk that some banks might relocate their operation into one of the alternative financial centres in Europe, i.e. Frankfurt. Ireland may also be a big beneficiary of financial services business given its low corporate tax rate and English language use.

As it is not possible to quickly replicate London’s skilled labour, infrastructure and legal services, such moves could lead to poorer and more costly products, as well as less liquidity in Europe’s financial market.

Moreover, an EU without the UK might be a less attractive partner for trade agreements and weaken the EU’s negotiation position with other countries or regions.

Impact of a Brexit

  • Short term: European stock markets, as well as the EUR, would very likely be negatively impacted, although probably less than the British stock market and the GBP. But even before the referendum, financial markets will react to the news flow and prices will start to reflect one or the other scenario driven partly by opinion polls.
  • Long term: The UK would have to remain, as mentioned before, a member for the next two years. It is difficult to foresee if two years would be enough to conclude negotiations over difficult topics, like future trade relationships. Discussions could progress only slowly and get extended. Indeed, the EU might be not overly keen on a rapid process, as they hope to win back business from the UK. In particular, the dominance of the UK in financial services will be targeted by the EU members. Uncertainties will exist during the negotiation process for the UK but also the EU. These uncertainties might damage confidence for investments and negatively impact growth. Furthermore, the EU could have to support some countries and sectors heavily impacted by the loss of the UK, as a trading partner within the Single Market.

    Moreover, the impact of a Brexit would not be limited to trade relationships but also impact the EU politically. An exit could cause contagion across Europe and encourage other countries to follow. The EU might have to face requests for exceptions, special arrangements and threats for break ups from other EU countries. An answer could be a pre-emptive push of a core group of EU members for an even deeper integration, and an EU without an awkward partner might in the end be even stronger than before.


Assuming that the UK votes to leave the EU then it will do so at a time when Europe is particularly vulnerable after years of economic crisis management and now with an unprecedented migration and refugee crisis. A vote to exit could have serious consequences for both the UK and the rest of the EU. In the short term, currencies and stock markets in both would likely be negatively affected by an exit vote, with the UK probably more vulnerable than the Euro area. Within bond markets, however, the peripheral European markets will likely be more at risk than UK Gilts.

Once negotiations start post an exit vote, opinions will firm about the path that a UK withdrawal will take and this will also have consequences. The UK contributes £12.9 billion to the EU budget after its rebate, but gets back £6 billion in subsidies and grants, taking its net contribution to £6.9 billion. If the UK moves to a similar agreement as Norway then this payment will be reduced but the UK will still make a significant contribution. More likely, though, the focus on immigration will prevent the UK from taking this position and, thus, the UK’s contribution would drop more meaningfully. This would leave the remaining EU members to choose whether to either share the shortfall or to reduce the overall size of the EU budget. Also, if the UK imposes restrictions on immigration, there is a question mark about what happens to both Europeans already working in the UK and UK migrants working in Europe. If free movement of labour is still allowed whilst negotiations on withdrawal are on-going then there is likely to be an increase in inflows to the UK as Europeans look to enter the country whilst they are able. The UK could thus be forced to freeze or limit new entrants at least for a period whilst it considers its position. Most likely, existing residents would be allowed to remain, as to eject large numbers of people would have negative consequences for the economy and asset markets.

Negotiations on the UK’s future position in Europe will be closely watched by other countries. Denmark, Sweden, Finland and the Netherlands are all potential candidates for countries who may decide that they also want a different deal if the UK is perceived to be in a stronger position. For the UK, the domestic political situation will be highly stressed for a period of time, possibly years. Negotiations with the EU will be difficult and will require much government time. A leadership change and election are possible and although the main opposition party in the UK is in disarray, there is no guarantee that the current government will win a new majority.

In the longer term, however, an exit vote could be a potential positive for both the UK and the rest of Europe. The UK has always been a reluctant partner in the EU project and without it, the rest of the EU may well head more easily for deeper integration, removing some of the vulnerabilities that have been so problematic in recent years. The UK itself has a deep history of trading globally and forging alliances with other nations. A more dynamic, self-governed UK could have stronger growth in the long term.

Unfortunately though, it will be many years before the full implications of an exit vote would be known for either side.