One year ago, few business leaders would have put their money on the United Kingdom voting to leave the European Union. Indeed, the June 2016 referendum has been a wake-up call for corporations, showing that voters still have significant power to a country’s economic future, and that massive, rapid geopolitical changes can happen anywhere.
Companies with European headquarters in London now find their regional business models under threat while they wait to see if the “passporting” rights that allow them to operate across the EU are maintained in new trade agreements. So far, however, preserving the status quo does not look likely.
As a result, some organizations have already decided to relocate at least some of their operations. Investment bank Goldman Sachs has said that it will begin moving hundreds of people out of London as part of its contingency plans before any final Brexit deal is even struck. Lloyd’s, the specialist insurance and reinsurance market that is synonymous with London, announced plans in March to set up a new European insurance company in Brussels to start writing EU-based business when the Brexit process is completed in 2019.
Other companies are still cautiously sticking with the U.K. Auto manufacturer Ford has said it will stay in the U.K., although it has warned that its level of commitment may drop, while Toyota, which has announced new investment in the country, has said that “continued tariff- and barrier-free market access between the U.K. and Europe…will be vital for future success.” Nissan announced plans to build its new Qashqai and the X-Trail SUV at its Sunderland plant after receiving “support and assurances” from the U.K. government in the wake of the referendum result. Other companies may be hoping for similar considerations.
The triggering of Article 50 was well anticipated, but the fact negotiations are now live means financial markets may become more vulnerable to commentary from European and U.K. officials.
Since the U.K. voted to leave the EU, there has been little clarity as to how Brexit will take shape, or what it will mean in practice. The imminent general election on June 8 may muddy the waters even further. While Prime Minister Theresa May and the Conservative Party are favorites to retain power (and increase their majority), the country has clearly seen that wildcards can upset elections, and the prospect of a Labour win with Jeremy Corbyn in charge would likely spell a different tack for further Brexit negotiations with the EU.
The only certainty so far is that the U.K. will leave the EU in March 2019 following the March triggering of Article 50 of the EU Lisbon Treaty, which provides companies with a two-year countdown to get prepared. But without any formal announcement from the U.K. government as to what the inevitable legislative, tax and regulatory changes are likely to entail, developing any useful business plans will be difficult, to say the least.
In the immediate short-term, uncertainty prevails—and nothing worries businesses more. Furthermore, with low business confidence comes volatility. “The triggering of Article 50 was well anticipated, but the fact negotiations are now live means financial markets may become more vulnerable to commentary from European and U.K. officials as to how well, or poorly, the initial discussions are going,” said Michael Metcalfe, global head of macro strategy for investment management firm State Street Global Markets. “Headline risk is back, if it ever really went away.”
Nigel Green, founder and CEO of financial consultancy deVere Group, said that investors and companies should prepare for three key issues now that Article 50 has been triggered: increased market volatility due to the uncertainty over withdrawal negotiations, continued swings in the value of the pound, and higher U.K. inflation and interest rates.
How Will Brexit Affect U.S./U.K. Trade Agreements?
In the time between Article 50 being triggered in March 2017 and the Brexit deadline in March 2019, the U.K. remains a part of the EU. Since it will not seek membership in the EU single market, however, the separation is set to be a “hard Brexit,” meaning that the U.K. may not sign any agreements with the trade bloc before leaving.
Currently, the U.K. does not have a standalone trade agreement with the United States, and according to the Treaty on the Functioning of the European Union (TFEU), any such agreement can only be enacted after the “divorce” agreement with the EU has been finalized.
President Trump, however, has moved the U.K. to the front of the line for a post-Brexit free-trade agreement. Naturally, said Patrick De Ridder, partner at U.S. law firm McGuireWoods, “the U.K. government is keen for this to be the case and for discussions to start soon, not least to show that its Brexit strategy is working.”
De Ridder also pointed out that the U.K. government wants to strike free-trade agreements with countries around the world that would be separate from the EU’s current agreements. These would also require difficult and, no doubt, lengthy negotiations.
In the absence of a trade agreement, the U.K.’s post-Brexit relationship with non-EU countries, including the United States, will be governed by the World Trade Organization rules. There is also legal uncertainty in this regard, however, since the U.K. does not have agreed-upon schedules in place to establish specific commitments on market access for goods and services including bound tariff rates and access to services markets.
Although the U.K. government may have informal discussions with non-EU countries such as the United States, it cannot conclude bilateral trade agreements with non-EU countries until its exit from the EU is final. Nevertheless, De Ridder said, “two years is a very short period in which to finalize a trade agreement and thus it seems very unlikely that any non-EU trade agreement will be ready for conclusion at the point of the U.K.’s exit from the EU.”
Planning for Change
U.S. companies that have U.K.-based operations or suppliers should also start thinking ahead about how potential changes may affect them, and how they can leverage such changes to their advantage. There are a number of key steps businesses can take now to prepare. According to Kieran Laird, head of constitutional affairs for international law firm Gowling WLG’s Brexit unit, the first is for companies to audit their supply chains both upwards and downwards to understand the commercial effects of Brexit on their operations. Areas such as currency risk, territorial scope, customs duties, regulatory standards and legal compliance may all be different come spring 2019.
Second, companies need to ensure that their internal systems can handle the potential increase in administrative demands, as well as a possible divergence of standards between the U.K. and the EU. “Consider your flexibility to cope with shorter periods of regulatory misalignment, as greater adaptability will provide an advantage over slower-moving competitors,” he said.
Since market conditions will fluctuate over the next few years and, in doing so, could impact the pricing and availability of goods, companies should stay close to their contracting partners. This will enable them to better anticipate any changes and review major supply chain contracts to ensure that their route to market will survive Brexit, Laird said.
He also advised companies to avoid long-term commitments, if possible. Instead, they should enter into short- to medium-term arrangements that will allow for flexible reassessment and negotiation as more certainty develops around trade deals. With necessary long-term deals, such as vital capital or infrastructure investment, companies need to consider milestones as break or review points for both sides.
Businesses should also create a “Brexit taskforce” to keep up-to-date on the latest developments and to understand the wider political climate. “Risk managers may be used to economic scenario planning—for example, considering the impact of interest rates going up or down or a fluctuation in exchange rates—but now they need to widen their set parameters in order to adapt,” said Brenda Boultwood, a senior vice president at governance, risk and compliance app provider MetricStream. “Companies need to stick to a robust risk program, and also focus on the possible opportunities.”
But companies also must continue to focus on doing what they do best: operating as a business. “Firms shouldn’t stop all activities to focus on Brexit,” Boultwood said. “Instead, they should make a handful of employees responsible for monitoring changes, analyzing their impacts and informing decision-makers.”
Scenario planning is also a key tool for companies to assess their exposure to Brexit, and weigh responses to it. “The full consequences of Brexit, and even the impact of triggering Article 50, are unknown, but with modeled scenarios, a business can be prepared for a number of different outcomes,” said Rob Douglas, vice president for U.K. and Ireland at corporate performance management specialist Adaptive Insights. It is important to know exactly where the business stands, where it is vulnerable, and how agile it can be in a changing environment, he added.
“Whether it is financial or resource commitments to comply with additional regulations, or coping with additional costs stemming from taxes, custom duties and visas, the more scenario models a company can run, the more accurate its forecasts for the year ahead will be,” Douglas said.
While it is nearly impossible to predict how an event like Brexit will play out, companies can gain an advantage by planning adequately for the worst as part of their enterprise risk management programs.
Boultwood also believes that scenario planning is vital. “When it comes to risk management, identifying and understanding the impact of ‘the highly improbable’ lies well beyond the borders of standard scenario analysis, yet can mean the difference between survival and failure in the most extreme circumstances,” she said. “While it is nearly impossible to predict how an event like Brexit will play out, companies can gain an advantage by planning adequately for the worst as part of their enterprise risk management programs.”
She added, “Businesses must learn from Brexit and get risk management teams to broaden their parameters. Suddenly, the outcomes of elections in Germany, Austria and France may have a greater impact on businesses than previously thought, and companies can be better prepared for the outcomes.”
To that end, organizations should identify key people within the business who can act as in-house specialists to develop marketing, production, legal and other scenarios for how the firm will operate when the U.K. leaves the EU. Companies should supplement these internal experts with external specialists to help broaden their view. “Reaction time will be critical,” Boultwood said. “Competitive advantages can close quickly in a fast-changing environment.”
The Immigration Issue
One key issue companies want certainty on is the status of EU nationals who work in the U.K. and of U.K. nationals working in other EU countries. The EU’s freedom of movement policy—one of the key tenets of the single market—allows citizens of any of the 28 member countries to travel freely to work in any other EU state.
A key factor in the U.K.’s decision to leave, however, was that voters wanted immigration restrictions, and the U.K. government is looking to deliver on that promise. Business groups have called for the government to agree quickly on a reciprocal arrangement with the EU that would allow citizens already living in the U.K. to stay and continue working (and vice versa, for U.K. citizens working in other EU countries), but nothing has yet been agreed upon.
Consequently, human resources teams need to engage with employees who may be unsure whether they need to relocate to other EU-based offices or repatriate within the next two years. They also should be conscious of how this might increase the administrative work regarding visas, and potentially incur additional costs. Talent and temporary job transfers also require review. Furthermore, some U.S. companies may wish to take advantage of the uncertainty and bring in American talent to work in their U.K. operations to replace EU workers who decide to leave. So far, at least, it is unlikely that current requirements will change noticeably for workers from the United States and other non-EU countries like Australia, New Zealand or India.
Review your workforce now and determine what proportion of current employees might be affected. Also consider future recruitment needs—where will your staff come from and how might the end of ‘free movement’ affect your hiring strategy?
“Some businesses will employ a far higher proportion of migrant workers than others, particularly in sectors such as construction, hospitality or manufacturing,” said Gary McIndoe, director at Latitude Law, a U.K.-based immigration law firm. “Review your workforce now and determine what proportion of current employees might be affected. Also consider future recruitment needs—where will your staff come from and how might the end of ‘free movement’ affect your hiring strategy?”
If companies want to retain EU nationals in their U.K. operations, they should consider taking simple legal steps to keep these employees. For example, not many EU nationals hold a U.K.-issued residence card because they do not currently need one to either reside or work in the U.K. It would be a good idea to get one now, McIndoe said, as a residence card may give EU nationals more protection. Likewise, registration certificates can confirm that EU nationals are in the U.K. lawfully and have undertaken a “qualifying activity” (such as study or employment) to let them stay longer than the initial 90-day period.
EU nationals who can show they have undertaken a qualified activity continuously for five or more years have earned a right of permanent residence in the U.K., which means they are generally free from immigration control. An official document is not necessary to prove this, but it is highly advisable. Another option open to EU nationals is to naturalize and become a British citizen. EU nationals who have permanent residence and are married to a British citizen can apply to naturalize immediately. Others need to get proof of permanent residence before they can apply, but the process can be complicated and success is not guaranteed.
While two years may seem a tight timeline for some, other experts believe that adapting to Brexit may not be as difficult as first thought. For example, the government has already revealed, under plans for its Great Repeal Bill, that it will “copy and paste” EU laws into U.K. law to avoid a legal “black hole” after Brexit. Only later would the U.K. begin to peel away the EU legislation it does not like.
In the shorter term, Mark Essex, director of public policy at KPMG, believes that very little will happen or be agreed upon regarding Brexit negotiations until after the German presidential elections this September. Even then, he believes that negotiations will only gain traction from September 2018 until the cut-off date of March 2019 when “the proper horse trading will start.” As a result, he suggested that companies use the intervening time to consider how Brexit may impact them. “Anything else can wait for the moment until we get a clearer picture,” he said.
For many international organizations, Brexit may just be another factor among many that they must incorporate into their operations. “They already have multi-country manufacturing, supply chain and distribution operations. Brexit simply layers on some additional complexity,” said Tasja Botha, capital markets and corporate treasury lead for EMEA at financial and risk management software firm OpenLink. “Higher up their list of concerns tend to be issues such as geopolitical uncertainty affecting currencies, trade tariffs and commodity prices, as well as shifting regulatory requirements.”
Ultimately, regulatory changes do not necessarily mean the end of a market’s attractiveness. Companies will still want to invest in the U.K. as they did before. “Our treasury and CFO clients at multinational corporations are telling us that Brexit is more of a bend in the road than a major hurdle,” Botha said.