What would Brexit mean for investors?

On June 23, 2016, voters in the United Kingdom will decide whether or not to remain part of the European Union. The possibility of a British EU exit has caused lots of noise in the press, but what would it mean for investors?

Let’s take a look at three key factors.

1. Economic impact

Post-Brexit, the U.K. would lose the favourable trade tariffs that come from EU membership. And firms may decide not to establish a U.K. presence to access the British market, as they’d have less incentive to invest. The U.K. may also choose to restrict the number of EU citizens who can work there, something that has boosted the U.K. economy and tax revenues in recent years.

Read: Snapshot: International economic data

Some have argued that Brexit would increase U.K. GDP. That assumes its trade outside the EU (particularly with Commonwealth countries such as Canada) could increase, even though such trading opportunities already exist. The anti-EU camp also argues that removing what they see as burdensome EU regulations would allow stronger economic growth. But the U.K. is already one of the least regulated economies in the EU. What’s more, many EU regulations were actually initiated or supported by the U.K. government. In some cases, the U.K. government has introduced rules over and above those that apply elsewhere in the EU.

The U.K. economy

The U.K. boasts the world’s fifth-largest economy by GDP, according to the World Bank. As of 2015, it ranked fourth among Canada’s trading partners, behind the U.S., China and Mexico, accounting for more than $25 billion in total trade, according to Statistics Canada. Canada’s trade with the European Union as a whole (the U.K. included) amounted to more than $92 billion.

Finally, it would still be possible for EU citizens to live and work in the U.K. post-Brexit, but the choice of who could do so would be up to the U.K. government. This could be an improvement over unrestricted access to workers of all types, since the U.K. could choose to only bring in workers who have strong job prospects. Any restrictions on the free movement of labour would mean the U.K. losing preferential, zero-tariff access to the EU single market. (For example, Norway and Switzerland are outside the EU, but have to accept EU citizens because of their trade deals.)

Overall, the consensus view of economists suggests that EU membership is positive for the U.K. economy, but there are considerable uncertainties, especially over the long run. And while an economic downturn in the U.K. would not carry the global weight of a downturn in, say, the United States or China, there could be ripple effects for countries around the world.

Read: Don’t panic about Brexit, say economists

2. Costs of doing business

For U.K. residents, Brexit would probably mean higher investment costs. U.K.-based asset managers would likely lose access to arrangements that currently allow them to distribute investment products in EU markets. This might compel them to set up additional offices in continental Europe and pass the costs to the end investor.

On the other hand, the cost of investing within the U.K. could fall due to the removal of regulatory costs imposed by the EU. These costs, however, are often exaggerated. Many rules imposed on EU members are designed to remove non-tariff trade restrictions, for example by harmonizing production standards. And other regulations were supported or initiated by the U.K. government (e.g., anti-discrimination or environmental protection), so it’s unlikely they’ll cease. And within the EU, the U.K. is one of the least regulated countries.

As such, the net effect is still probably an increase in cost.

3. Market volatility and investor uncertainty

Speculation about the U.K. leaving the EU has already caused increased volatility in European and global markets, especially for assets denominated in British pounds. Some studies have suggested that Brexit could cause the pound to weaken further, perhaps by up to 20%. This might suggest that investors should avoid allocating assets to the U.K. However, the markets have already priced in this possibility to some extent. And if Brexit doesn’t happen, sterling-denominated assets might end up representing good value. Brexit-sensitive sectors include those with a high propensity to export to the EU, with the financial sector being the most sensitive.

The short-term impact, then, would be market volatility and disruption. But it’s difficult to predict how significant the impact would be for a long-term investor holding a well-diversified global portfolio.

Read: Time to turn to safe havens

So, what’s the answer?

Taking all these factors together, there’s evidence that EU membership provides benefits to investors in the U.K. However, it’s impossible to say definitively that Brexit would ultimately be good or bad for the U.K. For Canada and other parts of the world, the implications are even less clear.

If the U.K. votes to stay in, one might expect an immediate recovery in sterling markets and the prospect of a BoE rate rise this year. And, more generally, risk sentiment globally will recover as the prospect of this disruptive event recedes.

If Brexit occurs, we will see immediate falls in sterling and prolonged uncertainty relating to the U.K.’s new trading regime. That will likely generate a downturn in activity and a possible increase in headline inflation as the exchange rate falls, but also probably a rally in sterling fixed income as policy rate increases get pushed further into the future.

Peter Westaway is Vanguard’s chief economist for Europe
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