Three years and seven months after 52% of Britons voted to leave the European Union (EU), the United Kingdom (UK) ceremonially cut ties with the EU on the evening of 31 January 2020. Like all protracted divorces there are still negotiations to be had, and while those take place the UK will remain in both the EU customs union and single market for a transition period ending on 31 December 2020. But the die has been cast.
The question for South African investors is: How will this affect me?
Sizwe Nxedlana, CEO of RMB Private Bank's Wealth and Investments, believes that "if Great Britain wants to become Little England, the economic impact on SA will be negligible."
Fundamentally, explains Nxedlana, the South African economy is driven by three main things: domestic macro-economic reform (such as action on state-owned enterprises, labour flexibility and the ease of doing business), the state of the Chinese economy (since we need them to hoover up our commodity exports) and foreign investment inflows (which make the actions of the United States Federal Reserve all important).
"So, the Goldilocks scenario for South Africa is that if China does well, a reform agenda that is gaining traction domestically and if United States (US) interest rates are low, then the South African economy will fly. What happens in the UK, quite frankly from a South Africa macro-perspective, is not that important. However, for an investor who wants specific UK exposure then it does become more important," he admits.
The uncertainty factor
Two big issues dominate the concerns around Brexit currently, explains Chantal Marx, from Wealth and Investments: An UK-EU trade deal and the issue of financial equivalence.
Both will likely be on the table until 31 December, says Marx. "And it's probably going to be a last-minute signature or an extension at the end of it. And that will mean further uncertainty in the markets, which does add an element of risk around the UK and Europe, which are still among the largest economies in the world. Even if they aren't growing as fast as a China or in line with the US, they still have a meaningful impact on sentiment which could influence the direction of global markets and by extension, the JSE."
A contentious trade deal
All indications are that the EU plans to play hard ball in the trade deal negotiations, says Marx. "The UK said it did not want a bespoke deal, rather something similar to that of Canada, South Korea and Japan. But the EU is being very sticky and they want to negotiate from scratch, because the UK isn't quite like Canada, South Korea and Japan due to its proximity to Europe and the fact that it manufactures many of the same goods [as Europe]. So Britain is a much bigger competitor to EU products than the other three."
For the UK, which imports about 30% of its food from the EU, according to a 2018 paper published by the House of Lords, issues such as tariffs and customs barriers could potentially impact food security. But the leverage is not all one sided. "That's quite a substantial number and it would also indicate that it would be important for the EU to maintain that relationship from a trade balance perspective, so they wouldn't want to sever those kinds of ties, either" she says.
Both sides have much to gain - or lose - from this process, but currently both are playing political games, adds Marx. So its brinkmanship that's catching the headlines.
In mid-February the EU's chief negotiator in Brussels, Michel Barnier, said the UK should not kid itself that it would achieve a general, open-ended and ongoing equivalence in financial services. "We will keep control of these tools, and we will retain the free hand to take our own decisions," he said.
What makes this such a critical point?
Marx explains that in order to do business with the EU, countries require special permission and certain requirements in place for money to flow freely across borders. "This mostly relates to norms and standards on issues like, anti-money laundering and anti-corruption. The UK wants financial equivalence to the point where the EU accepts that their financial system works more or less in the same way and that their norms, standards and controls are at the same level as that of the EU," she says. "The problem is, if they don't get this financial equivalence, they will be subject to other conditions for money to flow freely between Britain and the EU and this would impact quite a lot of business, not only from a transactional perspective but an investment perspective."
Japan, the US and Singapore have been granted close to financial equivalence by the EU.
In addition, the UK also appears to want the power to grant financial equivalence to other countries; hence Barnier's sticking point. "I don't see the EU going for that," says Marx, "so they'll probably arrive at a point where the EU grants the UK close to financial equivalence, but they are unlikely to give them the right to grant financial equivalence themselves."
Are the clouds lifting?
While the game playing continues between London and Brussels, there are signs that both business and consumer confidence have improved slightly since the decisive election of Boris Johnson in December 2019 and the exit from the EU at the end of January.
The recent Bank of England-backed Decision Maker Panel survey by Nottingham and Stanford universities "showed an uptick in investment expectations", according to the Financial Times. "In the three months to January, the surveyed businesses [3 000 in total] said they expected investment in the year ahead to grow 4.6% in financial terms, up from 2.4% in the previous three months," reported the newspaper.
Marx adds: "This is quite a big survey and they've said that investment expectations of businesses in the UK have increased - 4.6% is quite significant for an economy as mature as the UK."
Consumer confidence also improved in January, although it's still negative at -9%. "But that could change as things start normalising in the UK economy and once business investment starts coming in," she notes.
Investment implications for South Africa?
First and foremost, says Nxedlana, it's important for any South African client looking for global, offshore exposure to appreciate that RMB Private Bank's approach is to "position ourselves in such a way that we diversify from any regional or national idiosyncrasies. So we'll give exposure to the US, to the UK, to continental Europe and Asia Pacific. Which means that the way we do things means that our clients don't have to worry too much about Brexit-specific issues."
While it's interesting to read the Financial Times and understand the reach of these British issues, "from our perspective and for South African investors seeking offshore exposure there is one word: diversify".
Marx agrees that sticking to your diversification strategy is essential.
"And if that strategy includes offshore investment, and if you have an allocation to the UK, then there is no need to change that now as you will already have taken the pain. But you might not necessarily want to up your exposure yet, due to lingering uncertainties."
Over and above keeping a close eye on how the relationship between Britain and the EU plays out, Marx believes South African investors should be mindful of the exposure South Africa has, from a markets' perspective, to the UK economy.
"Some companies won't see an impact, because they are just dual listed, but a company like Quilter, which specialises in personal finance and investments in the UK market, will be heavily impacted if things deteriorate further. Conversely, it will also be positive for them when things start going better," says Marx. "South Africa also have a lot of retail exposure to the UK. Brait, for example, owns New Look and Iceland Foods, Foschini Group has Phase Eight and Truworths has Office where exposure is almost purely to the UK."
Finally, South Africa has notable exposure on the JSE to the UK property market, making an improvement in confidence critical.
While these are telling issues for South African investors with UK exposure, fundamentally Nxedlana believes that - relatively speaking - "there are much bigger elephants in the room, for us, than Brexit".