On January 10 in the year 49 BCE, Julius Caesar led his troops across the Rubicon River into Roman territory, defying a direct Senate order that prohibited generals from bringing military force into the homeland. Caesar’s action was tantamount to a declaration of war, and he knew that there was no turning back from the consequences of his decision. According to the historian Suetonius, as Caesar crossed the Rubicon, he uttered the phrase, “alea jacta est,” or, “the die is cast.”
On March 29 in the year 2017 CE, the United Kingdom crossed its own Rubicon by invoking Article 50 of the Lisbon Treaty, making formal and irrevocable its intent to leave the European Union. In alerting the House of Commons that she had signed the official notification triggering Article 50, Prime Minister Theresa May characterized this as “an historic moment from which there can be no turning back.”
This follows last June’s referendum, in which British voters decided by a slender margin of 52% to 48% to part ways with the EU. The delay between the June referendum and last month’s official notification reflects the lack of precedence for any of this. It was unclear who within the United Kingdom had the authority to instigate the split with the EU, and the question eventually rose to the Supreme Court, which ruled that Parliament had to grant such momentous authority to the prime minister. Importantly, the court also ruled that devolved legislatures in Scotland, Wales and Northern Ireland had no veto power over an act of Parliament on this matter. On February 1, the House of Commons voted to give Prime Minister May the authority to invoke Article 50, and a letter to that effect was hand-delivered to European Union President Donald Tusk last week.
Now comes the hard part. Great Britain and the European Union are both sailing into uncharted waters, and the text of Article 50 won’t provide much help. Indeed, the entirety of Article 50 comprises fewer words than this commentary, so both parties will necessarily have to improvise the process and terms of the separation. One clear point is that the United Kingdom has two years to negotiate its new relationship with the European Union. After that point, “the Treaties shall cease to apply to the State in question,” unless the other members of the EU unanimously agree to extend the two-year period.
Nothing concentrates the mind like a deadline. Bureaucrats in Brussels and London have already circled March 29, 2019, on their calendars, while acknowledging that serious progress might have to wait until after the German federal election this September. Although the details of re-establishing British law and defining a new relationship with Europe are complicated, at the philosophical level, negotiations will revolve around the so-called “four freedoms” that lie at the heart of the European Union: the free movement of goods, services, capital and people. The United Kingdom would like to retain the economic benefit of free trade with the EU, whereas opposition to the free movement of people (read: immigration) was a primary factor in the vote to leave. Trade is an important part of the British economy. In 2015, exports were 27.2% of gross domestic product (GDP), and imports were to 29.3%. As the nearby pie charts demonstrate, the European Union is by far Britain’s most important trading partner.
In addition to negotiating with the European Union, Britain may find that it has to negotiate with itself as well. In last year’s referendum, 56% of voters in Northern Ireland preferred to remain within the European Union, as did 62% of Scottish voters. First Minister of Scotland Nicola Sturgeon has called for a second referendum on Scottish independence from Great Britain, and just last week the Scottish Parliament ratified that proposal. Northern Ireland poses a similar challenge, as voters who prefer to remain within the EU might find reunification with the Republic of Ireland a means of accomplishing that goal. Furthermore, the 310-mile frontier between Northern Ireland and the Republic of Ireland is the only land border between the United Kingdom and the EU. At present, this border is marked by little more than a change in road signs from metric to English measures. The politically troubled history of Irish independence makes the creation of a physical border with passport and customs controls deeply unappealing, but perhaps necessary depending on the outcome of negotiations.
Financial markets reacted to the triggering of Article 50 with a shrug, given the U.K. government’s steadfast commitment to act on the outcome of last June’s referendum. One of the benefits of the protracted process of separation is that it gives financial markets time to digest developments. Over the past nine months, however, markets have moved in distinctly different directions. The nearby graph illustrates the performance of the British pound, FTSE equity index and FTSE real estate investment trust (REIT) index, with each indexed to 100 on the date of the referendum vote. After a short sell-off, U.K. equities rallied and now stand about 15% higher than the day of the Brexit vote. The pound has moved in the opposite direction and is about 15% weaker vs. the U.S. dollar over the same period. Real estate has suffered as well, with the REIT index down about 10% since the referendum.
The United Kingdom survived and thrived long before the formation of the European Union, and we are confident that it will do so once again. It is ultimately in the interest of both parties that the United Kingdom remain on good economic and political terms with the rest of Europe, and we believe that common sense will prevail over the temptation to punish the U.K. for its decision, or to blame Europe for fostering an environment that prompted the Brexit vote in the first place.
Divorces, however, are messy, and this one is likely to be no different. It will be a few years at least before the details of Britain’s new relationship with Europe become clear, and there are sure to be setbacks along the way. As global investors, we appreciate that disruption creates opportunity, and when prices diverge too greatly from value, we will act to take advantage of that disruption.
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