Brexit Update: The End of May and an Encroaching Extension Deadline

With Theresa May resigning and a Conservative leadership contest, the UK parliament is no closer to agreeing what form of Brexit it wants.

This update contains three different sections which can be treated as a pick ‘n’ mix depending on your interests:

  1. Westminster: An update on what is going on in Parliament and the decisions being made on how the Brexit process will progress;
  2. Asset Management: Any updates in the period from regulators, government bodies, etc, that have a direct impact on the asset-management industry – including GBP/USD movements;
  3. Beyond Westminster: Any updates in the period from wider business groups and the like on the impact of Brexit, including companies that have announced movement of operations and/or job losses in the UK.

Brexit Countdown: 155 days to go...

Summary:

When last we spoke, the EU had granted the UK an extension to the Article 50 process until 31 October, 2019, and EU Council President Donald Tusk had advised the UK to not waste the time it had been given. As is so often the case in this Brexit story, so much has happened and yet so little has changed. Cross-party talks between the UK government and the opposition Labour party fell apart, with neither side able to compromise without splitting their respective parties. EU elections came and delivered the predicted decline in UK vote share for both the Conservative and Labour parties. Parties at either end of the Brexit spectrum received the most gains, with Nigel Farage’s Brexit Party winning the highest share of UK votes campaigning on ‘Leave’ and the Liberal Democrats winning the second-largest share campaigning on ‘Remain’. The outcome of both of these events was to reveal that not only the UK parliament, but also the electorate, remains as divided on the issue of leaving the EU as they were at the time of the referendum in 2016. UK Prime Minister Theresa May raised the spectre of the EU Withdrawal Bill rising for a fourth vote in Parliament. This was met with fierce opposition from members of parliament (‘MPs’) across the political divide, culminating in the resignation of the 36th minister since April 2018 – Andrea Leadsom, the Leader of the House of Commons. May finally gave in to both the metaphorical writing on the wall and the literal writing in a sealed envelope that would likely have changed the party rules to be able to oust her in a no-confidence challenge. On 24 May, the speech that many had been waiting for was finally delivered: May said she would resign as leader of the Conservative party effective 7 June. So the music has stopped and May no longer has a seat, but 11 candidates (so far) continue the game. All are laying out Brexit strategies, from renegotiating the deal and ruling out a no-deal on one side through to going straight for no-deal on the opposite side. All are pro leaving the EU. As to Tusk’s advice on not wasting the time given? Well, the UK parliament is no closer to agreeing what form of Brexit it wants than when the extension was announced. In addition, the Conservative leadership contest is not expected to result in a new PM until the end of July – just in time for parliament to go on its summer recess until September. Suddenly, 31 October appears to be an awful lot closer than it was at the time the extension was granted (see Westminster section). British Steel becomes the latest Brexit casualty. The company has gone into insolvency citing reduced orders due to Brexit uncertainty (see Beyond Westminster section). UK-based funds continue to see large redemptions. The Financial Conduct Authority (‘FCA’) has started to focus on the future regulatory environment of the UK outside the EU, hoping to reduce the regulatory burden. Sterling continues to decline (see Asset Management section).

The quote of the moment comes from Speaker of the House John Bercow speaking from Washington, D.C.:

 

"The idea that parliament is going to be evacuated for the centre stage of debate on Brexit is simply unimaginable… The idea that the House won’t have its say is for the birds."

– John Bercow, Speaker of the House

 
 

Westminster:

Latest Implied Odds From Betting Markets:

Figure 1. Implied Probabilities of Brexit Outcomes

Implied Probabilities of Brexit Outcomes

Source: Man FRM; As of 29 May. Man FRM calculates the implied probabilities of Brexit outcomes using prevailing odds as priced by UK bookmakers, which are collated on a daily basis. The graph presents the implied probabilities of Brexit outcomes averaged across all UK bookmakers for which data is available, over time. This data analysis is based upon information obtained from third-party sources not affiliated with Man FRM. Man FRM cannot guarantee the accuracy of this data and it should not be relied upon by investors.

 

What Happened Recently?

  • 17 May – Cross-party Brexit talks between the Labour and Conservative parties broke down, despite optimism in early May that these were leading to a successful conclusion. The talks had been divisive in both parties, and predictably, both parties blamed the failure of the talks to reach a compromise on each other.
  • In the week beginning 20 May, there were talks from the UK government that May planned to bring the EU Withdrawal Bill before Parliament in the first week of June. This would have been the fourth time that the deal would be put forward for a vote and the second (and final time) in its current state. May presented this as a ‘new’ Brexit deal, adding in commitments to maintain equivalence with EU employment and environmental laws.
  • Parliament was not convinced this was a new deal and opposition to the deal continued to mount. This reached its crescendo with the resignation of Leadsom on 22 May – the 36th minister to resign since April 2018.
  • On 23 May, the European Parliament elections were held. It had been widely predicted in advance that both the Labour and Conservative parties would be hit hard in these elections. This turned out to be the case. The new Brexit Party (led by Farage) won the highest UK vote share – 31.6%. Farage’s previous party, UKIP, lost 24.2 percentage points in vote share, which should have accounted for some of the Brexit Party’s gains. However, we note that even if all UKIP votes moved to the Brexit Party, this would still give the party a c9 percenatge-point increase in vote share. The Liberal Democrats, who campaigned for ‘Remain’, came in second, with 20.3% of the UK vote – up 13.4 percentage points since the last election. Labour came in fourth with 14.1% (a decrease of 11.3 percentage points) and the Conservatives fifth with 9.1% (a decrease of 14.8 percentage points).
  • It was becoming obvious that the Withdrawal Agreement would be faced with its fourth defeat if presented. Following a meeting by the 1922 committee, a vote was taken on whether to change party rules to allow May to be challenged as leader for a second time within a 12-month period (something that is currently against the rules). The committee sealed the votes, uncounted, in an envelope – which would be opened if May did not announce her timetable to leave office. May finally bowed to increasing pressure and on 24 May announced her intention to resign on 7 June. At that point, she will cease to be leader of the Conservative party; however, will remain PM until a replacement is selected.
  • Eleven Conservative leadership candidates have announced their intention to run so far. All are pro-Brexit, although the degrees of extremity vary between leaving with a deal or no-deal (see the What Happens Next? section).
  • In response to increased talk about a no-deal Brexit, Bercow used a speech in Washington on 28 May to announce that he did not plan to stand down and that parliament would have a say on a no-deal Brexit, regardless of who the new PM is.
  • The EU council met on 28 May to start discussions on who would take key EU roles. Key figures from the UK/EU negotiations are due to be replaced later this year, including Jean-Claude Juncker (President of the European Commission), Michel Barnier (EU Chief Negotiator for the UK exiting the EU) and Tusk. The EU reiterated its unity on the Withdrawal Agreement not being open for renegotiation, regardless of who the new PM is.

What Happens Next?

  • Actual work on Brexit within the UK parliament will probably be at a standstill, at least until the summer parliament recess, but more likely until Parliament returns in September. Focus will now be on the Conservative leadership contest. That timeline is as follows:
    • 7 June – May officially resigns as Conservative Party leader, but remains PM until a replacement is chosen;
    • 10 June – Nominations for Conservative leadership will close at some point this week and official campaigns begin;
    • End June – The Party wants the parliamentary section of the process to be complete by this point. Current rules state there should be two candidates on the ballot paper by this point (but we note that some media outlets are reporting rumours that these rules may be changed to allow more candidates). The vote then passes to the Conservative Party membership – 160,000 people – to choose the new PM.
    • Late July – The members should have cast their vote and picked the new leader of the Conservative Party and PM.
  • There are currently 11 candidates that have declared their intentions to run for leader of the Conservative Party. The candidates, ranked by media odds for success, are shown in Figure 2, along with their announced stances on moving forward with Brexit. (Note that all the candidates are pro-Brexit).

Figure 2: Conservative Party Leader Candidates

Implied Probabilities of Brexit Outcomes

Source: Various media reports; as of 30 May.

  • Following on from the EU elections, pressure is increasing on the Labour Party to officially declare its stance on Brexit. Labour leader Jeremy Corbyn has been walking a fine line, attempting to keep both ‘Leave’ and ‘Remain’ Labour voters happy – Labour MPs seem to be more of the opinion that it is keeping neither happy. There are increased rumours that Corbyn will announce – in the next week – that Labour is officially supporting a second referendum. Whether he does or not remains to be seen – he is not personally a fan of this option and has been resisting pressure to declare support for this for some time.

Preparations for a No-Deal Brexit:

  • Given the varying degrees of willingness to accept a no-deal or not, these will likely be on hold (or at least minimal) until the new leader is chosen.
 

Asset Management and Financial Markets

  • 21 March – The Luxembourg government proposed a draft bill that would allow UK financial service providers to continue providing certain services in Luxembourg for a period of 21 months in the event of a hard Brexit.1
  • 17 April – The FCA said that despite the “considerable” burden of extracting UK financial services from the EU, it also presents an opportunity to rethink how it operates to ensure that regulation keeps pace with changing technology, consumer needs and business models. In comments that followed, the FCA indicated that Britain would favour a “lower burden” approach to financial regulation after leaving the EU.2
  • 18 April – Reuters reported that the London Stock Exchange (‘LSE’) has had only one corporate listing in excess of GBP75 million in 2019. Trading turnover on the LSE in February and March was down by a third since a year ago and the lowest since August 2016. Only 11 new UK-based hedge funds launched in the first quarter of 2019, compared with 35 in the first quarter of 2018.3
  • 2 May – The Financial Times reported on research by Morningstar, which showed that investment funds in the UK had lost GBP30 billion of assets in the 12 months to the end of March 2019, of which GBP5 billion was lost in March alone. Morningstar believes this is partly due to investors culling exposure to asset classes – such as UK companies – that are deemed vulnerable to Brexit shocks.4
  • 28 May – The FCA announced it has extended the notification window for applying for the Temporary Permissions Regime until 30 October.

Interest and Exchange Rates:

The British pound has continued to depreciate over the past month, reaching lows not seen since December 2018, when the currency dropped to around 1.25 against the US dollar.

Figure 3: Sterling Continues to Depreciate

Implied Probabilities of Brexit Outcomes

Source: Bloomberg; between 19 April and 29 May.

 

Beyond Westminster:

  • 22 May – Britain’s second-largest steel maker collapsed into insolvency proceedings, following the rejection of its request for an emergency state bailout. This put thousands of jobs at risk. The company asked for the bailout after a decrease in orders, which it blamed on uncertainty over Brexit. The bailout was refused as minsters concluded that this assistance would breach EU state-aid rules. However, the government has attempted to help British Steel in other ways: Network Rail, which owns and manages UK rail infrastructure, had placed a GBP70 million order with the company.
 

1. https://www.aima.org/journal/aima-journal-edition-118/article/luxembourg-proposes-21-month-grandfathering-period-in-a-hard-brexit-scenario.html
2. https://www.ft.com/content/c4f93be8-60db-11e9-b285-3acd5d43599e;
https://www.ft.com/content/62097db4-65c1-11e9-9adc-98bf1d35a056
3. https://www.reuters.com/article/us-britain-eu-city/brexit-inertia-means-londons-finance-workers-face-summer-slump-idUSKCN1RU2HZ
4. https://www.ft.com/content/831c060c-6b52-11e9-a9a5-351eeaef6d84