The civil service has stood down its preparations for an immediate no-deal scenario. This follows the EU agreeing to an extended timeframe, enabling the UK to reach an internal agreement on the nature of ‘Brexit’.
Nevertheless, financial managers’ pessimism about the prospect and implications of Brexit identified in a recent Deloitte CFO survey will not have changed fundamentally. Even assuming a relatively orderly Brexit, the British Chamber of Commerce expects a low-growth trajectory and limited appetite for investment . Unsurprisingly, firms are adopting cautious financial strategies.
While extending uncertainty, the new timeframe does offer an important opportunity to the many firms insufficiently prepared for the consequences of Brexit. Understanding how the various Brexit scenarios, which range from a – still possible – confrontational ‘hard’ Brexit to a more amicable ‘soft’ Brexit, will affect a firm is clearly difficult. There are, however, some areas that can be prioritized for analysis. Key effects of Brexit will differ in intensity, but not in nature, depending on the specificities of the settlement and subsequent trade agreements.
While many firms have rightly focused on the immediate risks posed by a possible hard Brexit, the recent publication (https://ustr.gov/sites/default/files/Summary_of_U.S.-UK_Negotiating_Objectives.pdfi) of the objectives for US-UK trade negotiation s an important reminder of the longer term challenges ahead.
As Jonathan Haskel, member of the Monetary Policy Committee of the Bank of England, has emphasized – “Brexit is a process, not an event”(https://www.bankofengland.co.uk/-/media/boe/files/speech/2019/will-uk-investment-bounce-back-speech-by-jonathan-haskel.pdf). It is a process that will significantly shape the evolving competitive environment facing UK firms.
The changes will most immediately be felt in the organization of supply chains and distribution channels. Unless a close relationship, involving a customs’ union at the very least, between the UK and the EU is established, the highly efficient nature of current supply chains means that any increased friction in trading relationships (generated by tariff and non-tariff barriers as well as associated enforcement bureaucracy) as well as the operation of rules of origin for exports from the EU will lead to structural changes.
The integration of supply chains between the remaining EU countries and the UK (post Brexit) will be rolled back, increasing inefficiencies and costs. Firms will need to consider how to respond to such changes.
In some cases UK business may need to explore opportunities to set up subsidiaries in the EU if retaining their established participation in the supply chain is a strategic priority. This is most likely the case in instances where supply chains are firmly international and focal firms are located in the EU.
Such moves may be particularly relevant for firms dealing in time sensitive supply chains. Price sensitive businesses will similarly be more affected by possible tariff and non-tariff barriers, although this may be offset by currency movements.
There are of course also opportunities for UK based businesses in such realignment (http://www.southwestbusiness.co.uk/sectors/manufacturing/manufacturers-moving-supplier-bases-back-to-uk-in-wake-of-brexit-could-create-opportunities–report-finds-11032019163448/). The opportunities offered by a stronger national orientation of supply chains are likely to be most promising in the presence of anchor firms firmly established in the UK. In a number of industries, including Automotive and Aerospace, the longer term prospects of such firms in the UK are, however, in question. Nevertheless, for some firms such options can help to compensate for losses in international sales in the short to medium term.
Although Brexit is often discussed in the context of the relationship between the UK and the EU, the consequences are more far reaching. Brexit not only changes the relationship between the UK and the EU, but also with third countries.
Although focusing on a no-deal scenario, recent work by the United Nations Conference on Trade and Development thus suggests substantially increased UK imports from China and the US. In addition, trading arrangements with third countries, including such key economic partners as Japan, which will be lost by an exit from the European Union need to be (re)-negotiated.
Early signs from negotiations with Japan indicate the complexity of such undertakings. Negotiators are seeking to extract more favorable terms from the UK than established in the agreement between Japan and the EU.
Given the even weaker bargaining position the pressure for substantial concessions by the UK is likely to be even greater in any negotiations with the US. The direction of travel here points not only towards tariff and not-tariff barrier free access of US firms to the UK market but also to substantial pressure on the UK to align its regulatory mechanisms with those of the US. For UK businesses this may lead to complex decisions about the extent to which they attempt to satisfy multiple, possibly divergent, regulatory requirements.
Although debates in the UK have often concentrated on the access of UK firms to international markets, Brexit will involve a change in the competitive environment in the UK, including in politically sensitive sectors such as agriculture and health. New international competitors will arrive.
A change in the way the UK relates to the EU and other international partners will therefore affect the pattern of competition facing many firms in the UK. For some this may involve weakened competition from EU based firms, for others competition will be intensified as new actors (e.g. US healthcare providers) open up markets in the UK. Notably, a further decline in the value of the pound may facilitate such developments by making UK firms more attractive take-over targets.
Uncertainties will therefore not end with an exit agreement between the UK and the EU. The more fundamental the separation, the greater the subsequent changes in the competitive environment facing UK firms will be.
What can be done at this point? With changing competitive patterns and trade flows on the horizon UK business must be proactive. Those firms that have not yet done so should take the opportunity offered by the recent extension to explore how alternative scenarios (both regarding the agreement between the UK and the EU and with regard to subsequent trade deals) might impact their strategies.
Although costly, firms may, for example, choose to put into place options (e.g. setting up subsidiaries and moving resources to EU countries if the market is of importance) that ensure the ability to respond to significant impediments to trade.
As international business is easier lost that won, UK businesses with significant ‘European’ exposure must be proactive in order to sustain and develop relationships with partners in the EU. Paradoxically, competitive pressures may therefore lead some firms to intensify their engagement in the EU at the same time as the economies drift apart.
At the same time the groundwork for more intensive engagement with non-EU countries must be laid. UK business of course has significant experience of such international involvement so capabilities and networks are in place. Beyond more narrow economic concerns the need for such international engagement is underlined by the negative effect of recent events on the UK’s international reputation. Business must counter these negative reputational effects.
Any form of Brexit that does not retain continued involvement in the single market, or at least participation in a customs union, will generate substantial changes in the UK’s competitive landscape. While current defensive financial strategies are understandable and appropriate in the face of profound uncertainties, the longer term challenges of ‘Brexit’ and its aftermath suggest that some more proactive and aggressive strategies may be needed to address its competitive implications. This may not be the time to be timid.