Hannah Boundy, CFA®, CFP®
Understanding Brexit in the Context of the European Union
Updated: Jun 29, 2019
Over the past few years, the United Kingdom has been in negotiations to leave the European Union, a process that has generated a number of headlines in the financial markets due to London's significant role in the investing world. London is home to the London Stock Exchange, the London Metal Exchange, a significant number of public and private financial institutions, and LIBOR (a commonly used interest rate base) calculated by a group of London banks. One of the major concerns regarding Brexit is the affect that it will have on the financial markets as already evidenced by the number of financial firms leaving London in pursuit of a more stable European location. With estimates nearing a trillion dollars worth of assets being relocated, it's worth taking the time to understand both Brexit and the European Union as they pertain to the global economy.
The European Union was officially created in 1993 following an evolution of European alliances after the conclusion of World War II. Today it consists of 28 member countries, 19 of which use the euro as their common currency. The union was created with the signing of the Maastricht Treaty with the goal of creating a political and economic union that made regulating both people and trade easier and more efficient. While there are many advantages that come with being a member, there are also drawbacks - one being that the member states are mutually responsible for each other such that when other countries struggle economically the struggle is shared. This can be frustrating for members that are experiencing significant economic growth and do not want to be responsible for bailing out others.
Despite its founding involvement in the union, the United Kingdom never adopted the euro as its currency and continues to utilize the British Pound. However, the benefits of union membership extend well beyond the use of a common currency and the loss of open borders and fluid regulations will make doing business across borders significantly more difficult for British banks and corporations. Since voting to leave, the British government has been negotiating their exit with the European Union and thus far have failed to come to an agreement, leading many to believe that a "no deal" exit may occur. Should Brexit proceed without any kind of agreement on what the United Kingdom's relationship with the European Union will be going forward, the lack of structure will make the movement of both people and goods difficult.
In terms of the impact that this will have on financial markets, we would expect some volatility as a result of the ongoing uncertainty. The worst case scenario would be for some sort of surprise event contrary to what the markets have been predicting thus far. This is because in their most efficient form, markets process information as it is made available meaning if the markets expect a well structured Brexit to occur, they will factor that information into pricing immediately. Should a no deal Brexit happen down the road, as soon as that scenario looks likely the markets will respond, repricing to factor in that new information. For this reason, it can be incredibly difficult to time the market in response to events as they happen because more often than not the market has already responded. Instead, the best approach is to utilize a well-diversified portfolio. That way, when drawbacks do occur unexpectedly, the other asset allocations are able to absorb the hit as opposed to the entire portfolio falling.
The financial markets are incredibly complex, but investing for your future doesn't have to be. When it comes to saving for your financial goals, having a process in place for choosing effective investments within the context of an appropriately allocated portfolio can make a big difference. At Sherwood FP, we believe that having a good financial advisor can have a legitimate impact on your bottom line and we seek to be a firm constantly searching for ways to increase our Advisor Alpha – both tangibly and intangibly. Wherever you’re at in your journey, we’d love to partner with you to help you find lasting peace when it comes to your finances.
Colchester, Max, and Patricia Kowsmann. "London's Finance Industry Has Decided: Brexit Is Already a Reality." The Wall Street Journal. March 11, 2019. Accessed June 27, 2019. https://www.wsj.com/articles/turmoil-over-brexit-spurs-a-costly-exit-of-assets-talent-from-london-11552318414.