A Short Guide to Leaving the EU (Brexit)

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Unless you have been living on Mars for the last few months…

In a cave, with your eyes shut, and your fingers in your ears…

It will have come to your attention that there will soon be a referendum on these shores.

Depending on your political hue, this referendum is one of two things:

An opportunity for the United Kingdom to unshackle itself from an ossified bureaucracy, to protect its borders, and to finally Make Britain Great Again.

Or…

A grave threat to the prosperity of the British people, which has been seized upon by political opportunists for personal gain.

A threat which could cause the disintegration of the European Union and a global financial shock similar to 2008.

This piece shall sidestep that debate.

Instead, it will focus on the more sober issue of European legislation (hurray!). In particular, it will describe the legal process by which the UK would remove itself from the European Union.

With the legal requirements and likely time line established, we can discuss the potential market impact, and how investors might respond (that market impact will be the subject of a second blog, keep an eye out for that.)

In the event that the UK votes to leave the EU, the UK will be subject to the process described in Article 50 of the Treaty on European Union.

The process is as follows:

1. The Member State notifies the European Council of its intention to leave the Union The Prime Minister is expected to notify the Council immediately once the result is known. There is a European Council meeting on the 23rd and 24th of June, so it is likely that it would be raised then.

2. The Member State negotiates the terms of exit with the European Commission The European Council (excluding the UK) agrees guidelines for the negotiation, which will then be undertaken by the European Commission. These negotiations will last for a maximum of 2 years.

At the end of this period the EU Treaties would no longer apply to the exiting Member State, whether agreement has been reached or not. Trade relations, for example, would revert to WTO rules.

The negotiations could be extended, but only with the unanimous support of the European Council and the Member State.

3. Agreement Both the European Parliament and the Council of the European Union (not to be confused with the European Council!) must give their consent for the agreement to be final.

A more detailed discussion of this timeline can be found in this report from the Treasury.

The negotiation between the Member State and the Commission determines the nature of the UK’s future economic relationship with the EU*, and given the size of the economic links between the UK and the EU, is the most important part of the exit process.

The outcome of this negotiation would have a major effect on the UK economy for decades to come. I won’t speculate as to whether these negotiations would be positive or negative for the UK in the long run.

What I am interested in is how long these negotiations would last…

First off, there is no exact precedent.

The most similar case was Greenland’s request for Overseas Country and Territory status, which was not a full exit, in 1995. This also occurred before the current Articles were in place. That negotiation took three years, despite only one issue at stake: fishing rights. Without other precedents, trade negotiations would perhaps be the most similar comparators.

Negotiations between the EU and Canada began in 2009 and took 5 years to reach agreement, yet today that agreement has not been ratified by either side. Meanwhile, the EU-Mercosur Association Agreement was launched in 2000 and has yet to conclude.

On the flip side, one could take a more optimistic perspective.

The UK, as a smaller, less-threatening country, may be easier to negotiate with than the entire European bloc. Switzerland, for example, was able to reach a trade agreement with China after only two years.

Independent of either perspective, there are additional complications:

  • The UK would have to manage a stronger separatist movement in Scotland while negotiating with a European Union facing its own nationalistic issues.
  • There will be elections in Germany, France, the Netherlands and possibly Italy during the negotiation period.
  • The UK has not negotiated individual trade deals for 40 years, and may lack the necessary skills. Australia and Canada each employ 200-250 for exclusively this purpose.
  • Other countries are currently negotiating with the EU. They may wish those negotiations, in addition to the UK-EU negotiations, to conclude before they enter into negotiations with the UK.

While it is possible that the negotiation period may last only 2 years, the risks are clearly to the upside. And the length of the negotiation, independent of the outcome, matters for investors. As long as the negotiation continues, uncertainty around the final outcome would increase market volatility as markets attempt to price every announcement and rumour.

We can now see our potential Brexit timeline…

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From here we can suggest what the market impact will be in these periods for both election outcomes.

But we will leave that for our next post.

*More precisely, Article 50 outlines the process for leaving the EU. It doesn’t discuss the Member State’s future relationship with the EU. Seemingly this would be an additional agreement requiring additional negotiations. There is no guidance as to whether both negotiations should be simultaneous or consecutive.