With further Brexit-related border controls timetabled for 2022, we consider the impact of possible renegotiation and how investors can manage the continued uncertainty.
"Much of the frictions in trade as a result of the UK being out of the single market have, as the Bank of England rightly pointed out, been lost in the downside of Covid-19," says Jonathan Sparks, Chief Investment Officer of UK & CI Private Banking and Wealth at HSBC. Whilst the effects of the UK’s departure from the EU have been bubbling underneath since the end of the transition period on 31st December 2020, the economic and societal impact of the global pandemic has masked them and makes it difficult to discern a clear cause and effect.
"Although not as obvious as it would have been without Covid-19, it does appear that trade with the EU hasn’t picked up at the same rate as it has with other countries," says Sparks.
New controls pending
But the Brexit story is far from over. Further changes will see full customs declarations and controls imposed from 1st January 2022 (delayed from 1st October 2021), and safety and security declarations required from 1st July 2022. Although long anticipated, which has presumably allowed businesses to prepare for the new import rules, the changes will increase trade friction. The knock-on effect on businesses will be seen in terms of time, cost and profitability.
By far the greatest risk from Brexit remains disputes surrounding the interpretation and implementation of the deal. “There is always the potential for a flare-up,” says Sparks, “and there seems to be ongoing disagreement about the way the deal is interpreted. Whilst there are calls for renegotiation, which may be valid and could remedy some of the practicalities, it is the ideological gap between the two parties that must be bridged.”
Strong UK market fundamentals remain
There are positive signs, however. Recovery from the pandemic effect continues and the strong rebound we’ve seen in the UK economy looks set to continue into 2022. The fundamentals that underpin opportunity in the UK remain – sector strength in areas such as advanced manufacturing, technology and AI, creative industries, healthcare and education, a favourable time zone creating an obvious bridge between the US and Asia, and an open economy.
“The ingredients for growth are still there,” agrees Sparks, “but Brexit does continue to generate uncertainty and is a risk we must have on the radar. The market hasn’t completely taken its eye off Brexit. If we look at Sterling, for example, we can see it’s trading at a discount from where it would tend to hover pre-Brexit. If discussions resume and renegotiations begin, there is a risk that assets will revert to where they were before the initial deal was agreed.”
Understanding potential impact
The impact of that would be felt differently according to exposure. Smaller businesses that tend to trade with the EU could see a greater impact and, as the engine of the economy, this could have repercussions for business and consumer confidence. "The playbooks prepared pre- withdrawal mean that we can already anticipate which sectors would potentially be impacted most, with those leveraged to domestic growth and EU trade more exposed than global multinationals that source a majority of their earnings in USD," explains Jonathan.
"If it looks like things are getting messy, markets will wake up pretty quickly and it’s likely we’ll see a dispersion of returns into those sectors that are more sheltered from the Brexit effect. Ideally, of course, that won’t happen. The parties will reach a compromise and the outcome will be positive."
Investors, he points out, are finding it difficult to pick through this and predict what’s going to happen. "Simply put, we’re not in the room, so there’s a bit of uncertainty." That’s best managed by reviewing your sector and geographic concentration and ensuring diversification of your wealth to reduce vulnerability.
"Investors need to consider the diversity of their portfolios and look at how exposed they are. If more volatility is likely, having a broad spread of global investments can spread risk and help hold value." Regardless of the outcome of the current situation between the EU and the UK, diversification is key.
Investors need to consider the diversity of their portfolios and look at how exposed they are. If more volatility is likely, having a broad spread of global investments can spread risk and help hold value. - Jonathan Sparks, Chief Investment Officer of UK & CI Private Banking and Wealth at HSBC