While there has been no shortage of news in late 2020 and early 2021, Brexit, an ongoing saga dating back to a 2016 referendum, looks to be staggering to the finish line. For better or worse, we will soon be talking about Brexit in terms of history rather than as an ongoing concern thanks to a deal completed in the last weeks of December 2020. We'll look at the Brexit deal now being implemented and what it means for the markets and global trade.

Key Takeaways

  • The recently signed Brexit deal brings some certainty to the EU-U.K. relationship going forward.
  • Unlike a traditional trade agreement, this one marks a step back in the free flow of goods.
  • A large amount of uncertainty remains in the financial services industry, and this may be the larger risk to London's economic outlook.

Brexit: The Good

The best thing about the Brexit deal is that it is the beginning of the end after nearly five years of uncertainty. Companies know that they will be facing more red tape at the borders, but they can now begin to adjust their plans accordingly. Many of them would have preferred a bit more time to make the necessary adjustments, as the deal came mere weeks prior to implementation, but they can still buy from and sell goods to the EU with zero tariffs and zero quota.

Beyond certainty, the other potential win for the U.K. is its new ability to negotiate trade agreements around the world without the EU. This could allow the U.K. to sign agreements with countries that have yet to reach agreements with the EU. That being said, much of the U.K.'s focus in the coming months will be re-signing agreements with countries that it previously had access to through EU-negotiated agreements.

The agreements with Japan and Mexico are both aimed at re-establishing access following Brexit, but there is a potentially huge trade deal with the United States that London will be eager to sign as soon as possible. The hope of Brexit supporters is that growth in global access will offset any drop in EU trade.

Brexit: The Bad

The deal between the EU and the U.K. isn't a traditional trade agreement by any measure. Rather than negotiating for better terms and freer trade, the U.K. was seeking freedom from regulations while still maintaining a high level of market access. The EU, for its part, was seeking to ensure that its member nations could still trade with the U.K. without creating an incentive for members to leave in order to skirt standards and regulations to undercut the EU nations while still enjoying access.

So it is not surprising that both sides won't be entirely happy with the deal. For one, businesses have to rapidly adapt to the re-imposition of customs friction when shipping goods to and from the United Kingdom. This will slow the flow of goods as companies and the bureaucracy re-adjust to new requirements.

There is also the issue of a fractured U.K. in the future. The status of Northern Ireland's checkpoints given Ireland's status as an EU member was a significant concern throughout Brexit, and it overshadowed discontent in Scotland over Brexit. In keeping with portmanteaus, the possible exit of Scotland from the U.K. to join the EU is being referred to as Scexit.

Scexit is yet another political hot potato for Prime Minister Boris Johnson to juggle along with a pandemic, a domestic stimulus plan, and renegotiating the trade deals the U.K. left as part of Brexit.

Brexit: The Ugly

The most troubling aspect of the deal is that London's financial services hub is essentially still waiting for a deal. The complexities of the financial services market left it largely out of negotiations mainly focused on physical trade and the flow of people. While EU regulations and standards on physical goods and stemming the flow of people were key issues for supporters of Brexit, the impact on financial services could overshadow any small economic gains or losses in terms of exports, imports, and labor.

Prior to Brexit, London was an attractive place for financial firms to base their European operations because licensing in London gave a company automatic access to sell across the whole EU.

The EU-wide access that the U.K.-based firms have enjoyed up to now is far from guaranteed. Somewhere around 40% of the U.K.'s financial services trade is dependent on the EU currently, and that number will likely take a hit. Equivalence can be granted by the European Commission without going to member nations for ratification, but so far the only equivalence is an 18-month term given for clearing euro-denominated derivatives. The U.K. Treasury seems to be hoping for equivalency in most areas and has proactively granted it to EU firms.

The problem is that, even when equivalency is granted by the commission, it can be revoked with 30 days' notice. This level of uncertainty may push more financial firms to move services to the European continent, thwarting London's plans of catching up to New York as a global financial center. We can expect a strong push from the U.K. to formalize some type of agreement in financial services, but the question is what the U.K. is willing to give up to stem financial investment outflows and secure stable EU market access.

The Bottom Line

It is much too early to classify the Brexit deal as a success or failure. The U.K. undoubtedly benefited during its time in the EU, but the driving force behind Brexit was never solely economic. The U.K. wanted more control over immigration and freedom from EU regulations. It may achieve the former, but it will still have to stay the line with the latter to access its most important market.

In return for greater control over immigration and freedom to sign trade deals with the rest of the world, the U.K. is going to pay in terms of red tape and reduced economic growth in the near term. Whether that trade-off is worth it in the long-run remains to be seen.