Brexit - where are we now?
Jai Lakhani, London UK, Investment Strategist
With the EU and UK agreeing a Brexit trade deal, just what has been agreed? While the deal makes UK assets more investible, caution still seems warranted when investing in UK assets.
The EU and UK agreed the Trade and Corporation Agreement in an impressive ten months. Compromises from both sides on contentious issues, such as fishing and the level playing field, were key to this.
On fishing, the EU will forgo 25% of the value of stocks taken from British waters, to be phased in over five and a half years. On level playing field requirements, Ursula Von Der Leyen has claimed an “effective tool” is in place to react when fair competition does not occur.
Agreeing a deal was arguably more important in terms of how the future trading relationship between the two regions develops. The deal also appears to indicate a reluctance on both sides for diplomatic tension.
Time to allocate to UK assets?
The questions many investors find themselves asking are “What now?” and “Is it finally the time to invest in UK assets?”.
It would be fair to say that Brexit uncertainty has weighed heavily on sentiment towards UK equities. With a deal, visibility has improved relative to a World Trade Organisation (WTO) type of exit and exposure to the region remains low, leaving room for further inflows and a potential re-rating.
It is worth noting that even with a trade agreement that avoids harsh WTO terms and ensures “zero tariffs and quotas on all goods that comply with the appropriate rules of origin”, many would argue that this Brexit deal is a relatively hard one with businesses needing to adapt to changes in processes and procedures.
The deal secures a tariff-free, quota-free trading relationship. Despite this, non-tariff barriers for goods and especially services will increase.
Rules of origin
The “rules of origin” point is the main regulatory barrier, with finished goods having to be predominantly produced in the UK or EU in order to avoid tariffs from the other one. For instance, clothes taken from China by the UK and sold in EU member countries are not considered UK goods, but Chinese goods and would therefore be subject to tariffs.
This could also be an issue in the future for electric cars which, as it stands, from 2027 would need to have at least 45% of their production based in the UK or EU to avoid 10% tariffs. Electric car battery cells account for 35-50% of the production process and predominantly originate from outside Europe in China, South Korea and Japan.
Furthermore, some reports suggest that UK fishing exporters may be struggling to access the eurozone market. These teething issues will probably take time for businesses to adjust to.
The deal seems notably thin with regards to trade in services. It goes beyond the WTO provisions in some respects (such as facilitation of short-term business trips and temporary secondments of highly-skilled employees).
However, talks on the (automatic) mutual recognition of professional qualifications, passporting rights for financial services and data adequacy remain areas that need to be agreed. Furthermore, the deal has no provisions for collaborative financial regulation in the financial services sector. Such a provision is, however, in place for Canada and Japan with the EU.
More to do
On the one hand, the deal offers a platform for the UK and the EU to cooperate in a new relationship for years to come. It also provides much needed clarity for businesses and leaves room for further improvement with review clauses, joint committees and ministerial partnerships. On the other hand, there are still decisions to be made and the trade deal will allow the UK-EU relationship to evolve.
When answering the question “Is it finally the time to invest in UK assets?”, investors should probably tread with caution and lean towards active management and a tilt towards quality companies as we enter a new trading paradigm between the two regions.