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Impact Investing

IPE special report May 2018

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Heading for the Brexit?

The possibility of the UK voting to leave the EU is causing considerable uncertainty among asset managers

At a glance

• The debate between the EU and the UK rests on different visions for the future of the EU.
• The shift towards full political integration does not have majority support within the UK and arguably in many other European countries.
• For the European periphery countries and new entrants the EU represents hope.
• The economic arguments for the UK being either in or out of the EU are essentially indeterminate.

Prime Minister David Cameron fired the starting gun on Britain’s membership of the European Union with the announcement that there will be a referendum on 23 June. The battle lines have become clear. There is much rhetoric and many claims about benefits and future costs by both supporters and opponents of a British exit (Brexit) from the EU. 

If the evidence that has accumulated so far is anything to go by, voters may be as confused at the end of the process as they may be now. “The debate is highly polarised and a lot of the debate is relatively low quality, more about rhetoric than facts,” says Stephen Macklow-Smith, head of European equity strategy at JP Morgan Asset Management. 

Ultimately, the gulf between the UK and the rest of the EU lies in differing visions of what the supranational organisation represents. The mainstream view in the UK is that the EU should be a trading body rather than a political entity with a commitment to ever-closer union and a common currency. But for continental Europe, led by France and Germany, it represents a political union. The prevailing view there is that the EU should, among other things, help eliminate the causes of European wars that have dogged the continent for centuries. 

The EU is the latest and the most far-reaching of a series of initiatives designed to promote closer relations between European nations. The first, the European Coal and Steel Community (ECSC), was established in 1951 with the stated goal of contributing to economic expansion, developing employment and improving the standard of living of participating countries. However, it was explicitly set against the backdrop of safeguarding world peace in a continent that had been engulfed in bloody carnage only a few years earlier. Its members were Belgium, France, West Germany, Italy, Luxembourg  and the Netherlands.

The Common Market or European Economic Community (EEC), established by the Treaty of Rome in 1957, established more extensive ties with its emphasis on trade integration. In the preamble to the treaty there was also a reference to “ever closer union among the peoples of Europe”. Its founding members were the six participants in the ECSC. Over the years other countries joined; Denmark (1973), Greece (1981), Ireland (1973), Portugal (1986), Spain (1986) and the UK (1973). The Single European Act of 1986 revised the treaty to strengthen initiatives in relation to research and development, the environment and a common foreign policy.

The EU, which was established in 1993 under the terms of the Maastricht Treaty of a year earlier, explicitly opened the way for political integration. It also provided the basis for the creation of the euro-zone with economic and monetary union stated as a key goal. However, the UK had established its right to opt out of the euro in the negotiations over the treaty. Over the years, the EU has expanded to 28 member states to include some countries of the former Eastern Bloc.

The shift towards full political integration does not have majority support within the UK and arguably in many other countries as well. Cameron seems to have achieved a fudge to the long-standing commitment to create an “ever closer union” of the peoples of Europe. But demands for maintaining the sovereignty of the UK’s Parliament over EU legislation are completely at odds with the direction of change within the EU, whereby every crisis has been used to establish closer links within member states.  

Germany, France and the UK are the heavyweights of Europe. “It is important to keep them within the same group,” says Laurent Ducoin, head of European Equities at Amundi Asset Management. “Brexit would be an issue. From a political standpoint it would be a historical disaster and everything should be done to avoid that,” he says.

But what may separate the UK is this fundamentally different vision of what the EU should represent. “What continental Europeans want to do is to create real integration. It means the euro; the Schengen passport with free mobility; armies that are integrating like the Netherlands and Germany, although not France for the moment. So the ideal of a unified Europe is much more advanced and ambitious in continental Europe,” says Jean-François Boulier, CEO of Aviva Europe. 

For the European periphery countries and the new entrants, the EU represents something else. It means hope – hope that individuals can escape from the burdens imposed on them by a dysfunctional state such as Greece, beholden to special interests, no matter which party governs. 

In the case of Greece, as part of the EU, Greeks see Greece’s security as enhanced against what it perceives as aggressive and unstable neighbours surrounding it. For Greece, and to a lesser extent some of the other peripheral countries, the EU’s institutions and rules represent an escape route from the craziness of a country that aspires to be a developed western European democracy, but remains wedded to practices that are dependent on patronage and privilege.

The dilemma for the UK, as many continental Europeans argue, is that Britain has always been an island stuck between Europe and the US, culturally as well as physically. 

Ducoin sees a lot of misunderstanding in the UK regarding how Europe is managed. “I think both continental Europeans and British ones are both responsible for this to some extent,” he says. But he argues that Cameron’s decision to call a referendum was geared towards managing the eurosceptic MPs in his own party. 

“The situation is serious. It is necessary to talk about the relationship with the EU in the UK, but the referendum? I am not so sure it was really necessary. I don’t see what it brings, to be honest. I understand that if the UK can get some new agreements like control over migrants, more guarantees of independence regarding the City of London, these things are some pluses. Is it worth it? Really, I don’t think so,” Ducoin says.

A key concern has been to maintain the position of the City of London as Europe’s financial centre. There is a real threat to this in the case of Brexit. 

“It is bad enough for the continentals to have their currency traded in a country where this currency is not used. So the British complain a lot about how much they have lost through the EU, but there are some areas of frustration for the continentals as well. Quite a big one – especially for Germany. The French do not care too much about this, but the Germans are very unhappy,” says Ducoin. He adds that it is difficult for the continentals to just make a gift to the British. “Having that already in place with no attempts by the French or the Germans to change that forever is already a nice win for the British.” 

Macklow-Smith agrees. “Given that Europe is likely to proceed down the path of further integration and given it is our largest trading partner, what is the most appropriate stance to deal with that?” he asks. “The notion that we can leave the EU and then be given a massive sweetheart trading deal where we get all the benefits and none of the costs is fanciful. I certainly cannot see the Europeans going for that. It would not be in their interests to do so. It would set a precedent for a whole lot of nations within the EU; a very disturbing precedent.”

The economic arguments for the UK being either in or out of the EU are essentially indeterminate. There is no overwhelming case either way and that is one reason why the decision is difficult. “When people talk about how we should leave and it is a business owner, you should look at the person’s business and see how he can benefit or lose out,” says Nick Samuels, head of manager research at Redington. “If he is not going to lose out, he can quite confidently sit there and say we can go. If you have a very domestically focused business you can quite confidently say that. But will you have a guy exporting 90% of his goods to Europe saying we should leave Europe? It is a very personal thing and a lot of times people are just looking at their own self-interests and not others’. A politician is meant to represent their constituencies which represents a wide range of interests. A businessman does not have to do that.” 

If the question were to join from scratch, the answer might be a strong negative. But the UK embarked on the path decades ago. Changing the arrangement may or may not be required. But what can be guaranteed is that by doing so it will cause immense uncertainties. 

Laurent Ducoin

“Brexit means instability, which is always a bad thing,” says Samuels. “For someone who focuses on equity markets, any sort of uncertainty is bad. I think people will worry about this in the run-up to it and unless there is a ‘no’ to Brexit, that uncertainty will rumble on.  How we unravel ourselves, how we divorce from Europe – who is getting the CD collection, and custody of the kids and all that will take some time to unravel. The UK’s bargaining position will be quite weak. That will be a concern for markets and will not be good news, I think, for UK equities. The longer-term issues are: to find new trading partners; how we influence geopolitics; the UK’s permanent seat on the UN Security Council; any sorts of decisions made at a European level; and our general influence in the world,” says Samuels. 

For Ducoin the referendum brings unnecessary risk – certainly for the UK but also for everyone else. “There is a debate about who could lose more in Brexit, the UK or Europe? I would answer the question by saying both will. Just because of the stress to start with, and then how difficult it will be for Europe and the UK to move on.” Would the supposed benefits of Brexit really outweigh the revised arrangements within the EU? 

No one knows the answer. It is reminiscent of an exchange made during the visit to China by US President Richard Nixon in 1972. Chinese Premier Zhou Enlai, when asked for his take on the French Revolution of 1789, was widely reported as saying: “It is too early to tell.” If it happens, a similar response may still be appropriate for Brexit even in decades to come.

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