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Dummies Guide to Brexit

August 12, 2016 by Dheeraj Vaidya 2 Comments

Whether you like the news or not, you would have come across this word of late Brexit. Because
of the larger than life news it made, it may sound like a terrible thing that happened just like a
bomb blast or an airplane that disappeared midway into a journey. In reality it isnt that bizarre.
Brexit is simply Great Britain leaving the European Union (EU) as it was earlier part of the EU. If you
would like to use another fancy word, you could say that Brexit is the opposite of Bremain. Just for
the record, who is Britains Prime Minister? Not David Cameron as he resigned post Brexit. It is
Theresa May, the rst woman Prime Minister of the UK after Margaret Thatcher (second overall)
and guess what, she vouched for UK to remain in the EU as opposed to supporting a Brexit. Now,
this post isnt on why she was elected to be the Prime Minister when she supported a Bremain.
This post seeks to give thoughts on the basic questions regarding Brexit.
Why did Britain leave the EU? What happened between them? Wait a second, how did UK feature
in the EU in the rst place? We will look at these issues and more as we go along.
The European Union
The Vote
Is the UK out of the EU?
Is Brexit for the good Why did people vote such?
Post Brexit impact Short term

The European Union

In 1967, the European Community (EC) was formed. This was an economic project in Europe that
existed before the EU was formed and UK joined them six years later. This was basically formed to
get over the World War II so that trade binds different nations and thus can prevent future wars
and bring co-operation.

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Many things happened since then and in 1992 the members of the EC signed the Maastricht treaty
which lead to the formation of the EU, the focus being that a single common currency be
established for the member nations. Yes, the topic of economic trade and co-operation was also
an important part of the EU. UK wanted a modi cation on this area of the agreement. They wanted
to keep their currency (GBP Pound Sterling) and not club it with the common currency. Earlier,
each country in Europe had their own currency the French, Francs; the Germans, Deutsche Mark;
the Italians Lira and so on. While nations like these agreed for a common currency UK opted out
of this clause but wanted to remain part of the EC then.
The EU was formed in 1993 and nine years later the Euro was established as the common
currency among the EU member nations. The EU evolved such that member nations became like a
single market where trade/goods and services, and people were freely (without tariffs) able to
move from one country to another as if all nations were a single country.

The Vote
It was decided that a referendum would be held in the UK on June 23rd 2016 and those eligible to
vote would do so. While the media, notable businessmen and political experts had stayed calm
and con dent, they clearly believed that the UK would not vote to move out of the EU. The people
who were the voters having a real say of things to come, did exactly the opposite and shocked the
entire world. Whether they knew what they were doing or not is an entirely different topic, but the
fact is that they had voted 52% for leaving the EU as against 48% to stay/remain.

Is the UK out of the EU?

No. The EU currently has 28 members and since UK had voted out of the EU on June 23rd 2016,
they have two years to leave they have to negotiate certain things before leaving. You know, its
not as if theyre being boxed out of a match and just walk out! The UK is still governed by the laws
of the EU.
The UK still has two years. The current Prime Minister, Theresa May has said that the exit process
will begin in full ow from 2017 onwards. Meanwhile negotiations on trade, immigration etc. will
do the rounds. What is likely to be the outcome no one knows, but it is safe to assume that both
Britain and the EU would lose out on some areas and gain in others they both would take the
best out of the agreement to bene t their nation(s). To make things worse, given that there are 28
members in the EU of which UK is one of them, 27 of them would have to agree on the terms of
UKs exit.

Is Brexit for the good Why did people vote such?

For now, no one knows whether Brexit is for the good or not. If anyone claims they do, it is a lie.
Before the referendum, many knew that Brexit would not happen until it did! Let us try to
understand he possible reasons as to why the people of England voted for them to leave the EU.
This was not mentioned earlier but each member nation of the EU pays an amount to the EU
annually to continue their membership. As regards the UK, the amount is around $12 billion
(converting it to dollars around 9 billion). Well, this would be even more in Sterling Pounds now
since it has depreciated quite a lot since the historic vote. This big annual commitment could be
one possible reason for a leave vote where the money can be spent for domestic purposes. This
would also be able to reduce their budget de cit.
Immigration is another factor. London is the nancial capital of Europe and there are people from
different nationalities working in the UK, not only in London. Many of these would be immigrants
who work there probably live there they are probably residents of the UK as they would have
lived for 5 years in the UK. One of the many principles laid out while forming the EU was that of
being free members where people can freely move and live in another EU nation without the

hurdles of getting a visa. It is believed that almost 1 million people have moved to the UK due to
the free labour laws. Britain also gives child bene ts and it is believed that many of these migrants
are transferring that money to their children who arent living in the UK.
There might be many other reasons due to which the voters made such a choice. One could just
be voting for fun! Believe it or not, quite a number of voters said that if given a chance to re-vote,
they would have voted for the stay campaign since they did not know the rami cations that
would befall.

Post Brexit impact Short term

Regarding the long term impact of Brexit I doubt if anyone is sure about anything yet. As I said
earlier, no one really knows. But we have already seen the short-term impact:
The value of UKs currency plummeted to extreme lows. The GBP was falling ever since the word
about the referendum was made. It was a possible clue we can say in hindsight, about the fear of
an actual Brexit apart from crowded currency trades. Heres a chart indicating how much the
Pound Sterling fell. By the way, such a fall was only expected if Brexit happened which wasnt
expected!

source: bloomberg.com
Stock markets across the globe fell due to panic selling. Not a single stock market was spared in
the process. As regards the bond markets, US Treasury yield dipped to lows not seen for a long
time and fell below 1.50% on the 10 year bond whereas the 10 year German Bund fell into negative
territory. Gold had a massive rally post Brexit and all other commodities fell. Of course, not to
mention that the Pound Sterling had a dramatic fall versus the US Dollar and Japanese Yen in
particular. Anyone buying stocks anywhere in the world got an opportunity to buy the dip as so
called experts say!
Another issue is that UK consists of England, Northern Ireland, Wales and Scotland. Brexit was
supposed to be the leave vote of all the four but Scotland and Northern Ireland had voted to
remain with the EU. Scotland felt it unacceptable to be pushed out of the EU since they had voted
for the stay campaign it is now quite likely that they will have a second referendum so that they
can vote to stay in the EU. Northern Ireland have the choice to go for another referendum to stage
their will to remain in the EU. So, right now only England and Wales have voted out of the EU!
The English economy isnt in good shape. Interest rates have been low with the policy rate at 0.5%
for quite long, in ation being subdued and growth being at. Brexit has caused a cloud of
uncertainty on where their economy is going forward or backward. Rumours have indicated that
a Quantitative Easing (QE) program may be on the cards if UK weakens. If Brexit eventually leads
to a strengthening of the UK, they could be on the verge of higher rates soon affecting mortgages.

Britain lost its sovereign credit rating of being an AAA nation. They were downgraded to AA with a
negative outlook by S&P and to Aa1 with a negative outlook by Moodys, two leading credit rating
organizations. This makes it costlier to raise government debt and in the process leads to a higher
hurdle rate of interest the deeper we go down the risk ladder.
Rumours have also made news by saying that France, the Netherlands and a few others would opt
for their own referendum taking a cue from Brexit. This is worrying because the EU would be at
stake if member nations opt out of it.
Just when so many thought that Brexit has caused a collapse in global growth, harmed Britains
economy and so on, markets have stabilized. After the initial pounding in stock markets world over,
these markets have of late touched record highs. Right from the S&P 500 to the BSE Sensex, we
have seen record highs being touched in a way implying that the repercussions of Brexit fears are
no more whether this conclusion is true or not.
Many big companies have to gure out their plans where they have a business unit in the UK. Tata
Steel, an Indian major had to rethink its plans of selling its UK unit. Several other companies too
have had to gure their plans out.
Students coming from abroad who are studying in the UK would also get affected. This could be
part of the immigration reduction campaign mentioned earlier. Students would have to pay a
higher fee to be international students and visa restrictions would also add to their woes. Also
given that the UK has some of the most prestigious universities like the University of London where
the London School of Economics (LSE) is a part and several other universities, they would also get
impacted apart from the students due to their own reasons. Currently there are more than 100,00
students outside of the UK studying there.

Conclusion
Brexit has affected multiple economies and not just the UKs economy. Although its after effects
seem to have stabilized, it remains to be seen if this smooth and low volatility environment will
prevail for long. Once the negotiations get deeper and as more information comes out in the
media, we are almost bound to see volatile reactions across economic, political and nancial
centres. Given the globalized economy that we all live in, this is a reminder to all of us that one
economy can have implications on other economies. Systemic effects have never been so close
for long. As time progresses we can look at different charts to give us a better indication of what
Brexit has done. Wait for time to give you an indication of what is to come. After all, what we can
do is only to wait rather than make a terribly wrong prediction!

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Dheeraj Vaidya
worked as JPMorgan Equity Analyst, ex-CLSA India Analyst ; edu quali cation engg (IIT Delhi), MBA (IIML); This is my personal blog that aims to help students
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Comments
By Ravi Kiran on August 12, 2016 at 6:38 pm

Excellent article. Very thorough and in a layman language. Keep going Dheeraj
Reply

By Dheeraj Vaidya on August 17, 2016 at 6:14 pm

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thanks Ravi!
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Dheeraj Vaidya, CFA, FRM

worked as JPMorgan Equity Analyst, ex-CLSA India Analyst

edu quali cation - Mech Engg, IIT Delhi + MBA, IIM Lucknow
This is my personal blog that aims to help students and professionals become awesome in Financial Analysis. Here, I share secrets about the best ways to analyze Stocks, buzzing IPOs,
M&As, Private Equity, Startups, Valuations and Entrepreneurship.

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