The political and economic ramifications of the UK electorate’s decision to leave the EU are wide-ranging. The effect on Gilts, sterling and equity markets was immediate in the aftermath of the referendum. But it may take time before many of the less palatable consequences become evident. Here are five consequences of Brexit for them to consider.
• The downgrading of the UK’s sovereign credit rating will have an uncertain effect on wider investor demand for Gilts, even though Gilt yields fell immediately after the referendum result. While the longer-term economic picture might not be so good for the UK, higher bond yields would, conversely, benefit funds by boosting funding ratios. For many, this would be a Pyrrhic victory, given the evident political and economic downsides of Brexit.
• There are wider long-term implications and uncertainties for UK funds and pensions policy in view of the focus on EU freedom of movement in the referendum. Any attempts by a future government to curb European migration would not only have implications for future demographics at a macro level, but also for the membership structure of funds at a micro level.
• Longer-term uncertainty will also be corrosive for the UK as an investment destination for areas like property, because of the uncertain trading relationship with the EU and the outlook for financial services. Investors from outside the UK are likely to pause their investment decisions – if they had not done so already before the referendum – as they assess the investment case. If banks relocate activities to elsewhere in the EU, for instance, prime property in the City of London and Canary Wharf becomes less attractive.
• Financial and pensions legislation itself becomes more complicated because it is uncertain whether the UK will have to follow the rules of the single market in the future. For instance, will the UK Parliament need to implement the new IORP II Directive? Financial services contributed £127bn (€166bn) to the UK economy in 2014, or 8% of gross value added. Many UK companies have significant EU operations, so Britain is likely to want to continue to have access to the single market in financial services.
• The EU is one the world’s two chief initiators for financial stability legislation, together with the US. The EU’s decisions will affect the UK’s banks, insurers and pension funds with or without the UK’s participation. The current Juncker Commission’s focus is on the Capital Markets Union, involving a radical restructuring of financing and lending for Europe’s long-term economy. But Britain may find itself following the rules and participating in structures over which it has no political voice. For many in the EU, it is baffling that the country, that contributed so much to single market financial legislation over the years, will no longer be involved in the political and legislative process.