Author: Andrew McClelland, Cross-Border Consultant, IMRG
The world now knows that on the 23rd June 2016, over 40 million people in the UK voted in a landmark referendum on the country’s future relationship with the European Union (EU). By a margin of just over 1.2 million, UK citizens voted for the country to leave the EU. Political turmoil ensued. Some predictable; the Prime Minister resigned, sterling plunged, as did the FTSE 100, 250 and AIM markets. Some not so; leaders of the ‘leave’ campaign also missed out. However, the government has settled down with a new leadership team and new division of responsibilities around handling the exit negotiations and exploring new global trading relationships.
This new stability has been welcomed by the financial markets, which trade on confidence and the Bank of England has held interest rates at 0.5% for July; promising to keep an eye on economic indicators and leaving the door open for further financial stimulus should it be required in August.
Until the EU exit deal is finalised and a leave date agreed, there will continually be ups and downs depending on the news cycle and views of the main protagonists.
Whatever side of the in / out debate people sat on, trade will continue and the economies of the world will adapt as the UK seeks its new place. Businesses already hedge currency as part of their normal operations and those trading into the EU and further afield will continue to do so. No-one yet knows where the new relationship between the euro (€) and sterling (£) or the US dollar ($) and sterling will sit.
Around the 18th July, sterling / euro had recovered to 1.20 while sterling / dollar was trading around 1.32; certainly a long way off sterling’s best but still representing a recovery. In the short-term, this makes products originating from the UK cheaper on the world markets; where the dollar is the predominant trading currency. However, as the majority of products sold by UK-based retailers are produced in other countries, the costs of sourcing will increase; probably introducing inflationary pressures into the UK economy. Inflation is currently running at around 0.3% and the Bank of England has a mandate to keep it under 2%. For global merchants looking to sell into the UK, inflationary pressures might produce an advantage as UK consumers look for better deals.
Foreign exchange pressures will also impact shipping costs, supply chain where fuel is a major element of the cost base and labour costs in producing markets. This may improve the competiveness of UK-produced product. Business models requiring complex financial arrangements, such as franchises, and on-demand type services in a global market will be significantly hit in the short-term.
A key question at the moment is when the UK government will press the button for exit negotiations to commence. The formal process starts when Article 50 is enacted by the government. The process can take up to two years; although extension can be granted if the EU 27 (excluding UK) all agree. The UK is likely to delay.
Disengaging from the EU apparatus is going to keep negotiators and civil servants busy for many years. This work load will involve a lot of prioritisation of effort. For example, the EU passporting system which allows the City of London’s financial institutions to clear trades on the euro, and many other functions, will be a priority. There are more than 3,000 EU regulations and directives that the UK is going to have to replace, adopt or remove. Repealing the European Communities Act 1973 will effectively remove the link that enables EU law to be adopted by the UK. Without this act, much of the current consumer contracts, trading, consumer protection and product safety laws will become void. There is a very good chance that much of it will be copied into UK law and revisited at a future date. Likewise, there is a higher probability that much of it will have to remain if the UK wants to trade with EU citizens. Product safety / labelling is one area (CE Mark). The other is data protection.
Currently, there is a new piece of regulation due to be adopted by all EU 28 countries during May 2018; the General Data Protection Regulation (GDPR). The timing of this means that UK businesses will have to comply with the new regulation, even though the UK will (probably) be exiting the EU during 2019. With the importance of this area to the economy, there is a very good chance that the regulation will be adopted by the UK, particularly with the other priorities in mind, including the desire to continue trading with EU citizens. Issues around safe harbor and privacy shield have shown that data protection is taken very seriously by the EU and any trade deal will involve GDPR.
Where digital marketing is a key element for driving sales in the EU, GDPR compliance will be a major factor in the success or otherwise of brand marketing activities. For example, email marketing, personalisation services and behavioural advertising all rely heavily of good quality consumer data; areas that will continue to be heavily influenced by EU rules.
The EU, according to the European Commission, imports over half of the global total textiles and clothing production. UK fashion retailers will already be very aware of the rules around country of origin and, while currently being beneficiaries of being able to say ‘produced in the EU’ in some circumstances, this will no longer be available. The increasingly global nature of brands means that buying and production functions could be moved to within the EU in order to benefit from more favourable terms.
In the worst case, where the UK and EU cannot agree trade terms, they will fall back on World Trade Organisation terms. These are globally-agreed tariffs on the imports of certain products, but can be significantly higher than those agreed between countries. For example, WTO tariffs on garments range between 9% for the EU, 15% for China and 40% for Indonesia. Free trade agreements limit these tariffs and make import / export much easier and more competitive with local competition. Shortly after the new UK government was confirmed, they announced that 12 countries had expressed interest in negotiating trade agreements; Commonwealth countries such as Australia and Canada were early announcements while the US is also on the itinerary of the new international trade minister, Liam Fox. By way of example, Australia currently exports AUD$8.6bn of goods and imports AUD $12.6bn from the UK; significantly less than the AUD$100bn between China and Australia.
Technically, no new trade agreements can be negotiated until the UK has left the EU; that’s not to say they can’t be ready to be signed quickly after exit following ‘informal discussions’ taking place.
Many businesses will have to review their headquarters arrangements. Once outside of the EU the rules around taxation will get a little more complicated. Will the UK lower corporation tax to tempt more international businesses to base themselves there? The loss of EU member status might make it harder for companies to have financially-beneficial arrangements with subsidiaries and group entities and it will certainly be harder to manage VAT or equivalent sales taxes when trading into the EU.
From a purely trade perspective, the UK will be much more open to the global markets than it is at present. The impact of the loss of its EU membership status is still to be seen. Freedom of movement restrictions will make it harder for international businesses to move labour to where it is needed. Britain will no-longer be an easy entry point in to the EU single market for companies currently trading outside of the EU, but most of this is still guess work.
In purely commercial and economic terms, many countries allow trade with each other. Yes, associated costs might be higher but it can be done. The UK has the fifth-largest economy in the world at the moment and, while it operates a trade deficit with the EU, the goal really isn’t the 500 million EU citizens, it is the main economies that are of interest – Germany, Netherlands, Nordics, Spain and France.
What isn’t so clear is the political situation. Lots of EU member states want the UK to have a tough time ‘exiting’ so as to quell unease at home about the European project.
The UK’s relationship with the EU is undergoing a transformation and only time will tell how good the future relationship will be. In the meantime, the UK is still a member of the EU for at least the next two years. There is a lot of change coming but consumer confidence will grow and with it, the UK’s economy.
This is still an attractive market for international merchants and UK merchants are getting adept at trading into new territories; this is by no-means the end…