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UK political risk - it hasn't gone away you know....


Patrick Kelliher

This is my second revision to this blog. I first posted this blog after the Scottish referendum; and then updated it just before the general election. Back then I was concerned about the possibility of a minority Conservative government backed by UKIP calling a referedum on EU membership. I was wrong about the Conservatives being in a minority, but we are now looking at an in/out referendum on EU membership in 2017 and with it the possibility of the UK leaving the EU, the so called Brexit.

This vote would be a much closer contest than Scottish independence (which in the end was unexpectedly tight). Currently most opinion polls have a majority in favour of staying but some polls have a majority in favour of leaving and the polls have up to 20% of voters uncommitted [1]. Support for staying in may improve if David Cameron secures concessions as part of a renegotiation of the UK’s membership, while most businesses will actively lobby to stay in the EU. On the other hand, many Eurosceptic newspapers would support leaving the EU, in contrast to the Scottish referendum where only one paper – the Sunday Herald – supported the yes campaign.

Whereas the three main parties lined up against Scottish independence, the Conservatives are likely to be split on the issue and there may even be some Labour MPs coming out in favour of Brexit with only the LibDems resolutely against this. On the opposite side, UKIP have proven themselves adept at riding popular discontent and could mount an insurgent campaign similar to that of the Scottish yes campaign. The focus on immigration in the May election plays into the hands of UKIP: while in the EU, there is little the UK can do about immigrants from other parts to the EU.

In short, there is a significant probability the UK will vote to leave the EU. Paddy Power are currently quoting 3/1 on a vote to leave, which is well within the probability levels most firms will consider for the purposes of stress and scenario testing [2].

Brexit could cause serious economic disruption, at least in the short term while trade and other matters are settled. Inward investment could collapse, the economy could stall, and uncertainty could lead to a run on the pound and a spike in gilt yields. There may be operational issues. For instance, if the UK is outside of the EU, it may not be possible for EU customer data to be held in the UK.

Exacerbating matters, if Scotland voted to stay while the UK voted to leave, the independence debate would resurface, creating further uncertainty. There may be other such negative feedback loops arising if the UK leaves the EU.

In the longer term, I suspect the UK’s trade deficit with the EU would make the latter amenable to a free trade agreement but I would not be surprised if the UK still has to comply with EU rules in the same way as Norway does through its membership of the European Free Trade Area (EFTA). Worse, being out of the EU, it would not have the same influence in shaping financial services legislation such as Solvency II (or Solvency III !). Like Norway it would probably have to contribute to the EU’s budget, and would probably still need to subsidise farmers, so I would not see a significant fiscal dividend from Brexit.

There may be opportunities from Brexit however. Freed from EU restrictions, the City of London could thrive [3]. UK insurers may be spared from the need to comply with Solvency II [4]. It would be an ill wind if nobody benefitted from leaving the EU with its byzantine rules.

Still, Brexit is a very real threat to UK businesses. There is likely to be considerable economic disruption if the UK chooses to leave the EU, at least in the short term. Business should begin the process of scenario analysis for Brexit without delay, having regard not only to the cost and threats but also the opportunities this may bring.


[1] Wikipedia has a useful list of opinion polls in its entry on the UK EU referendum:  

[2] Disclosure: I have taken Paddy Power up on their offer as I expect the odds to narrow, particularly if the "stay" campaign resort to the scare-mongering tactics which I don't thinked worked for the "no" side in the Scottish referendum given how the "yes" campaign increased its share of the vote.

[3] …though it could also find itself frozen out of Euro denominated transactions.

[4] …though they will have already spent considerable sums in the run up to 2016 to ensure compliance, and will still need to comply with Bank of England / PRA rules which could be just as onerous if not more so.

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