Businesses need to prepare for hard Brexit

Two years after its EU referendum, the UK lurches unsteadily towards the Brexit door, with the business community increasingly anxious at the uncertainty surrounding any deal with trading partners.

When European Union heads meet at the end of this month, they are likely to issue a warning to bureaucracies and firms to step up preparations for a no-deal Brexit, also known as a "hard" or "cliff-edge" Brexit, because that is where things appear to be heading in the talks between the EU and Britain.

At this point, it is calming to view such signals in a game theory context. British Prime Minister Theresa May has an incentive to take things to the edge - possibly beyond October, the current deadline for a deal - so she can get her version of any exit agreement through Parliament; she is more interested in a last-second, cliffhanger vote than in a protracted debate.

The EU, frustrated by a British side that has nothing to offer, has been talking about the likelihood of a hard Brexit for more than a year, but that could be just a demonstration of willingness to walk away from the table.

If there is no deal, Britain will drop out of the EU in March next year without a transition period. That will create gaps in regulations and the capacity to enforce them, mainly in Britain.

The Financial Times recently reported that the British government isn't doing much about that because it doesn't consider "no deal" a realistic scenario. But believing that the sides are bluffing can result in nasty surprises because the negotiations aren't exactly poker. It's a game in which the interests of some of those at the table - at least when it comes to many Conservative Brexiters - are not aligned with those they represent.

It is businesses that really need to prepare for trading across the Channel according to World Trade Organisation rules, which mean 2 per cent tariffs on most goods but 10 per cent on cars and 20 per cent on agricultural products. Customs barriers will also spring up, increase costs and slow down deliveries.

Last year, Dr Wen Chen of the University of Groningen in the Netherlands and his international team of collaborators analysed which regions in EU countries were most exposed to Brexit. Because of the deep level of the data, this is probably the best analysis of the exposure to date.

His calculations, however, assume that Brexit will set British-EU trade to zero (there's no other way to get at the full share of gross domestic product that could potentially be affected). In real life, though, a 2 per cent tariff, slightly longer delivery times and the added cost of Customs clearance - estimated, for example, at €500 million (S$785.8 million) a year for Germany, the EU's biggest economy - will not affect trade volumes much. The economic actors who really do need to prepare for a cliff-edge Brexit are primarily in the auto industry, agriculture and finance, where British and European firms would be cut off from operating in each other's markets directly by the end of passporting.

In the financial services industry, a no-deal Brexit is considered a serious threat. In March, the global Association of Chartered Certified Accountants (ACCA), whose members work in the entire range of financial companies and banks, published the results of a Brexit-themed survey. Three-quarters of its participants work outside Britain; 77 per cent of those asked said a hard Brexit would be damaging to their business; and 6 per cent said their firms would no longer have a viable business model.

At the same time, preparations have been going too slowly: 23 per cent of the ACCA members (and 31 per cent of those working in small firms) said their companies had not even begun planning for Brexit. Only 8 per cent said they had begun to implement their plans, a measly 3 percentage point increase from March 2016.

That would appear to make the financial services industry a particularly important audience for the upcoming EU warning. A just-released Organisation for Economic Cooperation and Development (OECD) report on the EU downplays the risk - but still notes the potential that a lack of preparedness can cause adverse consequences.

"EU entities will probably retain sufficient access to wholesale and retail financial services post-Brexit, as most financial services are currently already provided in the EU-27 and relevant UK entities can relocate part of their activities to other EU member states," said the OECD. "On the other hand, moving from wholesale banking centred in London to a potentially more fragmented banking landscape might increase the cost of capital for households and non-financial corporations, as the economies of scale and scope of the London industry may diminish."

It's somewhat harder for industrial and agricultural firms to Brexit-proof their operations. Finding other markets for products can be a tough task. According to Deloitte, a hard Brexit would cut German car exports to Britain by 255,000 a year, worth about €6.7 billion or 5 per cent of sales. About 18,000 jobs would be endangered. European automakers in total would lose about €8.7 billion in sales. Car-part sales would not be hurt as badly because the tariff on them would be 4.5 per cent, not 10 per cent as for cars, but thousands of jobs could still evaporate as imports from the rest of the world become more economically viable for Britain.

A survey of German enterprises by the national association of industry and commerce chambers, published earlier this year, showed that only 14 per cent of firms considered themselves well prepared for Brexit's consequences. In particular, the German car industry, the biggest potential loser, is heavily invested in pushing the government and the EU to make a deal. It has assumed too much, and it should focus more on no-deal preparations.

The Irish government and Ireland's agricultural producers, who stand to lose 39 per cent of their exports - worth €4.8 billion a year - if Britain leaves without a deal, also hope for a favourable outcome, but at least they are working visibly to get ready for a cliff-edge Brexit. The Irish Agriculture Ministry has sent special missions to Japan, South Korea, the United States, Mexico, Saudi Arabia and the United Arab Emirates with a view to shifting some of the exports to those places. And some firms are already changing their product mix to suit new markets, retooling, for example, to produce Norwegian Jarlsberg cheese for the US and Australia rather than cheddar for Britain.

Not believing in the possibility of a no-deal outcome could cost businesses billions of dollars in lost revenue. Regardless of whether Britain and the EU are only playing a game, it is a dangerous one. The quality of the players on the British side and the EU's multitude of other concerns make the worst outcome entirely possible. So all the warnings the parties issue as they try not to blink should be taken extremely seriously. BLOOMBERG

  • Leonid Bershidsky is a Bloomberg Opinion columnist covering European politics and business. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
A version of this article appeared in the print edition of The Straits Times on June 22, 2018, with the headline 'Businesses need to prepare for hard Brexit'. Print Edition | Subscribe