The Brexit Complex: Why US Businesses Need to Be Concerned About a No-Deal Scenario
Ever since the monumental June 2016 referendum that saw the UK vote to leave the EU, news about the ongoing turmoil surrounding Brexit has dominated headlines around the world.
Now, just over two and a half years and a rejected trade deal later, the exit deadline of March 29, 2019 is right around the corner and a no-deal Brexit scenario is quickly becoming a more likely probability. And with every passing day, news about the potential impacts facing UK citizens and businesses is increasingly filled with doom and gloom. There have been reports of people stockpiling food, UK businesses scrambling to hire customs agents, and warnings from some sectors of ‘catastrophic’ outcomes.
But things aren’t exactly all rosy for US businesses either where Brexit is concerned.
That’s because the US is perhaps more vulnerable to fallout from Brexit than any country outside of Europe.
In its December 2018 annual report, the US Financial Stability Council (FSOC) for the first time listed Brexit as a potential risk to the US economy. Noting that a no-deal Brexit could negatively impact financial flows and contracts, as well as a general deterioration in economic confidence, the FSOC report states: “A no-deal Brexit could create risks that may have immediate and significant spillover effects into the United States.”
And US businesses that haven’t already need to start paying close attention to what’s at stake.
Let’s go back a few years to the peak of the Greek debt crisis in 2012.
The country’s debt crisis provoked massive concern that there would be a worldwide systemic financial disaster. At the time, some experts even argued that if Greece were to default on its debt and exit the EU, the situation could create global financial shockwaves more severe than the collapse of Lehman Brothers. As a result, the EU put safeguards in place to limit any potential “financial contagion,” in an effort keep the problems of Greece’s debt woes from spilling over to other countries.
Keep in mind that while the situation resulted in significant financial concern, Greece accounts for a relatively tiny part of the EU economy.
Now consider the UK.
And, yes, a no-deal Brexit will be most disastrous to the UK than anywhere else, but the potential implications for the global economy could reach crisis levels that might even rival last decade’s financial crash.
The Bank of England has suggested that the UK’s GDP could fall by 8% in a single year immediately following a “disorderly” no-deal Brexit (referring to the absence of any transition period), which could push the UK into the worst recession the country has experienced since World War II.
And with the UK being one of the largest financial centers in the world (if not the largest), that projection is concerning for a global economy that is already weakening.
In January, the International Monetary Fund (IMF) released its updated World Economic Outlook, which saw the agency cut its global growth forecast for 2019 to 3.5%. During a press conference, Christine Lagarde, IMF managing director, cautioned that the “risk of a sharper decline in global growth has certainly increased.”
One of those risks is a no-deal Brexit, which the IMF report claimed “could spark a further deterioration in risk sentiment with adverse growth implications.”
Access to the EU
In addition to being a financial hub, the UK also serves as a gateway to the rest of Europe for many US businesses.
In fact, US companies based in the UK export more to the rest of Europe than US businesses based in China export to the rest of the world.
According to a report by the American Chamber of Commerce to the European Union, “Many US companies have invested in the UK… to gain access to the much bigger EU Single Market.”
Aside from employing 1.4 million people, US businesses account for $593 billion in direct investment to the UK — more than double the combined US investment in South America, the Middle East, and Africa ($244 million).
But following Brexit, that seamless access to the EU is going to come to an abrupt end.
In absence of a trade agreement with the EU following a no-deal withdrawal scenario, the UK will automatically revert to World Trade Organization (WTO) rules. That means tariffs will be imposed on goods sent from the UK to the EU, and vice versa. Duties would likely be around 2% or 3% for industrial products and rising to more than 35% for dairy products.
If you’re thinking the UK could just extend an olive branch to the EU by lowering tariffs, I’ve got some bad news for you.
Under the WTO’s “most favored nation” rules, the UK can’t simply lower tariffs for any specific country unless it has agreed to a trade deal. Under this rule, the UK has to treat every WTO member around the world the same unless there is a trade agreement in place.
There’s another sticking point for the flow of goods from the UK to the EU. Once the UK and EU part ways, there needs to be a system for recognizing each other’s standards and regulations, and under a no-deal Brexit this almost certainly won’t happen anytime soon.
As a result, the EU Commission has reportedly warned that a no-deal scenario will probably impact European supply chains.
Under WTO rules, the EU will be well within its rights to no longer recognize many products that have been tested, certified or registered in the UK, and insist on additional checks before products can cross European borders. It’s a situation that could have a major impact in highly regulated sectors like pharmaceuticals and chemicals.
What’s more, UK-based financial businesses would lose passporting rights and would need to be separately authorized by each EU country in order to continue providing services across the bloc.
There’s no question that following a no-deal Brexit, supply chains between the UK and EU will see disruption, congestion, and chaos. The implications could have considerable effects on US businesses and, in turn, their investments in the UK.
Given all the uncertainty and volatility surrounding Brexit, it’s hardly a surprise that the situation has already taken a toll on the value of the British pound (GBP).
And things might get a lot worse.
The Bank of England has warned that following a “disorderly” no-deal Brexit, the pound could fall by 25% to its lowest level in history.
A weakened GBP would make US exports to the UK more expensive. And since the UK is the fourth-largest export market for US goods and services, that could spell a lot of trouble for certain sectors in the US, particularly agriculture and manufacturing.
Of course, there is still something of a waiting game with Brexit. No one knows yet whether the UK will be able to renegotiate a deal with the EU, whether it will extend its exit deadline under Article 50, if a no-deal scenario will go ahead, and what any trade situations will look like.
The only thing we know is the clock is ticking.
That’s why US businesses need to start thinking about potential contingency plans to protect their operations and ensure their supply chains remain intact.
Whether the UK leaves the EU with or without a withdrawal agreement, Brexit means the end of business as usual in the UK. That old rulebook needs to be thrown out to make way for the new norm, whatever that will be. The sooner US businesses realize that the better off they will be with waging through the Brexit turmoil.