Brexit in 10 Days?

A new poll from the Bruges Group gives the Leave camp a 19 point lead over Remain. According to the poll, 52% of respondents supported a Brexit, while only 33% wished to remain in the EU and 15% were undecided. A decisive victory for Leave is within grasp; even if all of the undecided Britons voted to Remain (an unlikely outcome), Leave would still come out ahead. Adding to the confusion, UK bookmakers are pricing in a substantially lower risk of a Brexit; for instance, bookmakers Ladbrokes and Coral are pricing in a 36% chance of a Brexit. Given the 11th hour ascendancy of Leave in some polls, investors should be seriously considering the fallout of a successful Leave campaign.

  • The UK Economy is heavily dependent on professional services such as banking and legal advice. The World Bank estimates that services contributed approximately 78% of the UK’s GDP over each of the past eight years. Consequently, it will be essential for the UK to retain the firms that currently call the City of London home. These firms will be in limbo following a successful Leave campaign. Should they continue to build out their presence in the UK, or would it be better to decamp for Frankfurt? In order to retain these firms, the UK will need to continue to comply with regulations such as the MiFID passport, which enables investment firms headquartered in the UK to service clients on the Continent. However, it may take several years before technical multi-party negotiations conclude that adhering to these regulations is in the UK’s best interest. In the meantime, the uncertainty may prompt a business exodus for the Continent, or at least curb expansion in the City.
  • There is no precedent for a Brexit and no blueprints exist for how to manage the fallout. The closest model for a post-Brexit arrangement is perhaps Norway, which accepts EU regulations, but has no voice in the European parliament where regulations are drafted. Furthermore, Norway contributes approximately €109 per capita to the EU annually for the privilege of trading with it. As The Telegraph pointed out last week, Norway’s situation is further differentiated from that of the UK due to Norway’s substantial oil and gas production and energy self-sufficiency. With an economy and population at a fraction of those of the UK, the stakes for Norwegian integration in the EU are nowhere near as high as those for the UK.

Although a Brexit would be unprecedented, the creation of such a precedent may well begin the death spiral for the European project, which has long suffered from bipolar imperatives for further integration and the preservation of national sovereignty. Other states may seek to use the Brexit as a source of leverage in negotiations in Brussels, which would further hamstring the ability of the EU to corral its member states behind initiatives such as bailouts for peripheral states or housing migrants. In such a scenario, the EU would be perhaps one economic crisis away from disintegration.

What could sway the vote in the coming weeks? Unfortunately, terrorism remains the dominant risk. Although the UK is not part of the visa-free Schengen travel zone, the Leave campaign would likely use terrorist attacks in its campaign rhetoric. Shortly after the tragic Paris attacks last November, support for Leave jumped 4%.

Markets in the US remain sanguine about the prospect of a Brexit. The S&P 500 is trading near all-time highs while the VIX remains anemic, indicating that investors don’t anticipate much volatility in the near-term. Meanwhile, the Nikkei lost -3.5% yesterday, a drop many analysts attribute to growing Brexit fears. If Leave succeeds, investors will rush for the exits at the same time and crowded names will prove unpopular very quickly.

June 13, 2016