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UK: the impact of a no-deal-Brexit

by Jan Goller It was more than two years ago when the British voted about remaining in the European Union or not. But still there isn’t any certainty about the future of the UK in the EU. Will there be a soft Brexit with an agreement or a hard one without any convention or any Brexit at all? In fact, the withdrawal agreement scheduled the British exit of the EU on 29 March 2019. But untill now the politicans didn’t find any agreement about a soft Brexit. Therefore in the worst case we would have to face a hard brexit whose impact will be omnipresent.

Hope for a last minute agreement

The global rating agency S&P continues believing that there will be an orderly outcome between the EU and the UK (even after a potential delay). However, a no-deal-Brexit could lead to weaker credit metrics and downgrades where disruption is more immediate and material.
In case of no deal, where short-term disruption proves to be material enough to undermine competitiveness and operational performance, then downgrades could also occur, particularly for certain nonfinancial corporates, explains credit analyst Paul Watters.
Let's start from the beginning. Why is the UK leaving the EU? This has decided a referendum held on 23 June 2016 with a quite unclear result. The Leave side won by nearly 52% to 48%. Since then, negotiations between the UK and the other EU countries have been taking place. They have been generally over the "divorce" deal which was about how the UK leaves - and not about its impact afterwards.  It is known as the withdrawal agreement. To find out what it exactly means, watch the clip. In November 2018, the deal has been already agreed by the UK and the EU. But it also has to be agreed by the British Members of Parliament (MPs). Indeed, they have voted overwhelming to reject the deal on 15 January 2019 by 432 votes to 202. This was a huge defeat for Prime Minister Theresa May. And what happens now? Prime Minister May will try to re-open talks with the EU to attempt to get some changes to her Brexit deal. The issue is that the EU says it has already negotiated a deal and so far it won't do so again.

A hard Brexit will have lots of effects

"No deal" means the UK would have failed to agree a withdrawal agreement. That would mean there would be no transition period after 29 March 2019 and EU laws would stop applying to the UK immediately. This would impact lots of different sectors.

Sovereigns - UK will lose its competitive ability

  • The rating agency S&P continues to anticipate an orderly withdrawal of the U.K. from the EU and the implementation of a transition period until at least December 2020. The current negative outlook on the 'AA' sovereign rating on the U.K. reflects their view of the risk of sustained economic weakness and a deterioration in government finances.
  • If merchandise and services exports from the U.K. lose access to key European markets, external financing diminishes, or sterling's status as a reserve currency comes under pressure.
  • Downward pressure could build on the ratings under a scenario where the likelihood of a "disorderly" Brexit appears more apparent. The agency defines a "disorderly" Brexit as one that would either significantly limit UK manufacturing and services access to key European markets. Or subject them to tariffs and nontariff barriers high enough to reduce their ability to compete.

Infrastructure - renewed urgency to develop no-deal contingency plans

  • Brexit-related risks have contributed to negative rating actions on several Europe, the Middle East, and Africa-based corporate and infrastructure companies to date. In a no-deal scenario, there are about 20 (mainly U.K.) issuers that could potentially face a negative rating action.
  • The most exposed sectors are automotive, leisure, retail, real estate, aerospace and defense, and transport infrastructure. Given the ongoing political uncertainty, there is a renewed urgency to roll-out no-deal contingency plans. They are accelerating among businesses and governments.
  • The net effect of these measures will serve to reduce - but not eliminate - the more extreme cliff effects. They could otherwise threaten the short-term viability of businesses heavily reliant on U.K-EU cross-border activity.

Financial institutions - they should be prepared for the worst scenario

  • The detrimental effects of no-deal on the banking system could result in negative rating actions on U.K. banks. In these circumstances in the near term, the agency expects outlook revisions to be more likely than downgrades.
  • A no-deal Brexit resulting in severe macroeconomic weakness would lead to rising personal and corporate U.K. insolvencies and weaker collateral values. In time, this would likely play through to banks' asset quality and activity, undermining earnings and, possibly, capitalization.
  • International financial institutions operating European business from the U.K. are well advanced in implementing their Brexit contingency plans. Similarly, S&P expects banks in other largely open European economies to be able to accommodate the effects of a no-deal Brexit.

Insurance - quite positive outlook

  • Outlook revisions, rather than widespread downgrades, would be more likely to occur within the U.K. insurance sector in the event of a no-deal Brexit.
  • The agency doesn't believe the risk of business interruption, particularly concerning the supply chain for non-life insurance business and claims-paying ability, presents a material risk at this time for the ratings on U.K. insurers.

Structured finance - no immediate impact expected

  • The experts wouldn't expect any immediate rating impact on European structured finance transactions following a no-deal Brexit.
  • Therefore they believe that structural features such as deleveraging or performance-based triggers embedded in these transaction may mitigate any rise in credit risk that would accompany a no-deal Brexit.
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