On Friday June 24, 2016, the UK and the world woke up to the outcome of one of the most important political and economic referendums to have been held – the UK vote on EU membership, or Brexit as most have called it.
The result was a most unwanted outcome for many politicians and financial players in the UK, the EU and the wider world leading to instantaneous falls in the purchasing power of the pound and stock market values during the initial reaction of financial institutions and investors to the news. Markets are always reacting to news and it is a risk we are forever dealing with in the markets,whether that reaction is well founded through efficient interpretation of the information leading to assets finding a new fair value or alternatively from players holding behavioural biases, such as group think, anchoring, herd instinct and so on, leading to increased volatility in values.
The UK electorate has already reshaped the financial markets and from the result it would seem that large swathes of the population are more likely to listen to their peer groups rather than the wisdom of experts. Warnings from leading politicians, central bankers, economists and the like of financial crises, difficulties, loss of influence on the world stage were widely ignored whereas perhaps in previous times there would have been greater trust in people who seemed to have more authority and knowledge.
In this article, I will focus on whether Brexit is just an initial challenge to a wider anchoring of beliefs held in the markets and if so could the Brexit vote just be the breeze before the storm?
Firstly, in my opinion the UK vote had far more to do with mass migration into England (it is estimated that over 3 million EU nationals are now living in the UK) and to a lesser extent self-determination rather than any other key reason for leaving the EU. The issue was also strongly fanned by some politicians and parts of the popular press in the UK. As such, I would say for many it was more of a protest vote.
Politically, this is the biggest issue to affect the UK since the Suez crisis of 1956. The vote has split the governing conservative party down the middle, pitched old against young (young for in), London in particular against England (London for in), England against Scotland (Scotland voted to stay in) as the Scottish National Party will most probably seek another referendum on independence, and in Northern Ireland (voted to stay in) the Sien Fein party might try to press for unification with Eire but Protestants will reject that out of hand and potentially this could be a match to re-ignite the animosities and conflict there amongst splinter groups.
The new conservative leader and prime minister is in the unenviable position of disappointing half of the electorate whatever course of action is taken. Conservatives, after a honeymoon period for the new prime minister, helped by no credible opposition party at the moment, will eventually start to look very weak. On the opposition side, the Labour party is attempting to depose their leader, Corbyn, and, if handled well, that will open up the possibility of a new strong opposition leader coming in creating a major threat to the conservatives who the electorate will more than likely punish at the next general election.
In effect, the political establishment and the UK civil service will be inward looking for years to come. The wisdom and guidance the UK offers on the world stage will be diminished and it may be given less weight in international discourse than it would have received in the past, particularly from the EU but also others.
The EU has a delicate balancing act for themselves. Other populations are just as discontent with the EU, so it cannot be seen to give the UK an easy ride for fear that others might follow suit, but that will lead to more animosity and longer uncertainty for the markets.
I also think the EU Commission is fundamentally taking the wrong conclusion from the Brexit vote. Many there do not think it is about emigration and self-determination. President Junker of the Commission, in particular, has stated that there is not enough Europe in Europe and not enough Union in the Union. But for too many that just smacks of more centralism from a body which does not seem democratic or accountable enough to the populations of member states.
Combined with poor economic outlooks, in particular for many Southern European states, and high unemployment, particularly amongst the young, the original EU founding ideals are hitting the hard realities of persistently high unemployment and no prospects for too many. In democracies, that is leading to more extreme parties becoming increasingly popular as they seem to be offering an alternative, articulating what they are against although, as in the UK, less clear on what policies they would be for! As such, the alternatives could create uncertainty for markets and turn out to be rather unpalatable.
In France, where a recent Pew Research Centre survey found 61% held an unfavourable view of the EU, the UK vote could influence next year’s presidential election. Until now, Marine Le Pen of the National Front Party had been viewed as vocal but not a core threat, yet now her proposal of giving the French people a vote on the EU has been legitimised by the UK referendum.
Time will tell how Le Pen will fare in the French presidential elections next year. However, I think a bigger risk to the stability of the EU comes from Italy. Unemployment is more serious there, much of the Italian financial system remains in crisis and the EU is blocking the government’s attempts to recapitalise their banking system, which is reeling under the weight of mammoth levels of non-performing loans.
The relatively new political party, the Five Star Movement, is quickly gaining popularity and their leader has called for a referendum on whether Italy should stay in the Euro. General elections, though, are not due to be held until May 2018, but there will be voting on constitutional reform in October 2016.Any failure which leads to early general elections could open up the door to the Five Star Movement. If the UK does not look a particular safe and stable environment for investors at the moment, then what does a large swathe of the EU look like for institutional investors? A second wave of Euro sovereign crises could materialise.
These are just some of the issues facing Europe today. In a few months, there will be presidential elections in America. Only a few months ago, the general perception was that Donald Trump would never become the presidential candidate for the Republicans, and yet he has. Many think he is unelectable, yet for many there is deep dislike and distrust of Hilary Clinton, the establishment and status quo she projects. Whilst many believe Trump is unelectable, most of the establishment and the financial markets never thought the UK would vote to leave the EU!
Trump has perhaps touched a chord with people of their frustration that they have not reaped the rewards of globalisation and the information age, which has hollowed out traditional industries in the West. The establishment does not listen to them and they no longer feel they have the potential to do better than their parents, a cherished American dream. How will the markets react waking up one morning to find the next president of the USA might be Donald Trump? If he should be elected, then consideration needs to be given to his administration’s policy direction. We would likely see an America-comes-first policy with more protectionism, particularly against China, and the death nail to the conclusion of the current negotiations on an EU-USA trade treaty.
The possibility of a Europe in bitter recriminations with a disintegrating Euro and an America putting up walls (both literally and metaphorically) pose major risks to world trade, the financial system and the management of cross-border wealth. At the moment, everything is speculation and I for one certainly hope these possibilities do not come to pass! The world we are in today is more uncertain than at any recent time, probably more so than with Lehmans when, after its collapse, we knew that sensible heads at Central Banks and governments would have to step in. Such uncertainty is the rocket fuel for speculators, which could result in wild swings in the markets in coming months. Businesses on the other hand do not like uncertainty and this will lead at best to a pause in investments, expansion plans, mergers and acquisitions.
Recessions would lead to government deficits growing faster again.Yet, if more austerity measures are implemented by governments,it is only going to alienate even larger parts of the electorates in Europe, which could light the powder keg of discontentment against Germany and the Euro. Added to these potential scenarios is the ease of extremists to organise over the internet, to manage information and influence peer groups and then you have a cocktail which makes the job of leaders and compromise that much more difficult, ultimately creating more risk.
All in all these are very dangerous times for Europe and the world and it needs calm government heads to find a way through this self-created minefield. As the Chinese say,‘may you live in interesting times’.
Simon Ling-Locke was the head of the European leverage finance and corporate teams at UFJ Bank and managed a book of over $2 billion in assets. He has in excess of 30 years’ experience in international markets and has worked for 25 years in the syndicated loan market gaining a wide range of experience across risk management, particularly credit risk and distressed debt, in major banking organisations, including Barclays, Tokai and UFJ banks. He has dealt with risk management across borders and has covered various business sectors, including chemicals, construction, food, hotels, manufacturing, retail, power and project financing.