The Brexit Risk Impact

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This summer’s UK vote to leave the European Union (EU) threw the political world into a state of turmoil, not just in the UK and the EU but around the globe. The fallout from Brexit has been political, economic and social, despite the consequences being as yet not fully understood.

What is known is that the resulting uncertainty sparked a fall in the value of the pound and foreign exchange rate volatility. Both spell risk for the global public and private sector. The impact on risk professionals is real and far-reaching. They have had to broaden the scope of their scenario planning and face the prospect of change to come in the already evolving regulatory landscape.

It was often said in the immediate aftermath of the vote that, whatever changes were going to occur as a result of Britain’s exit, it would be uncertainty that would cause the most disruption. It was true then and it’s still true now.

The markets hate uncertainty and 2016 has given economies around the world plenty to feel uncertain about. Aside from the Brexit, there has also been significant change in the UK government; a US presidential election; and increasingly polarized national governments.

Despite UK Prime Minister Theresa May setting a target date of March 2017 for an Article 50 notification to be given (triggering the start of the two-year exit process), the details of the separation — including the all-important trade approach — are still unclear.

Political Outcomes; Economic Consequences

Among the consequences of Brexit has been a change in political dynamics, a big shift in exchange rates and tension in the banking world. Political instability is always a threat to business stability, and the impact on the exchange rate has been significant.

After the recent Conservative party conference, when May made the Article 50 announcement, sterling experienced what the Guardian referred to as a “terrifying plunge,” plummeting to levels last seen in the 1980s. There has even been speculation that the pound could achieve parity with the euro. While others believe the pound will strengthen and bounce back, clarity on the post-March situation would surely be required for this to occur.

Globally, Brexit has caused, and is causing, disparate national views and heightened reginal tension. A year ago, the political forces impacting the economy were more internationally aligned, but now there are divisions and a new emphasis on national interests.

Without the UK’s vote to leave, there may have been more agreement between central banks. As it is, there are strong signs that political and social tides are turning away from centralization and toward polarization. Headline-grabbing political opinion reflects an apparent public mood for independent, national identities, which create tricky divisions for the global world of finance.

Domestic and international pressures on central banks are affecting interest rates, and speculation over which way they will go is adding to the uncertainty that threatens business growth. Although interest rates are currently low, there is pressure on central banks to raise them. This would have consequences for individuals and businesses, as it would impact debt levels.

Current world debt levels already stand at a record high $152 trillion, as revealed by the latest fiscal monitor from the International Monetary Fund (IMF). The IMF cited the risk of such a debt level to the “fragile economic recovery,” describing it as follows: “The political climate is unsettled in many countries. A lack of income growth and a rise in inequality have opened the door for populist, inward-looking policies.”

Big Unknowns

For risk managers, political turmoil and subsequent economic uncertainty makes it extremely hard to run scenarios on market risk and credit risk — as well as to understand the likely impact their business will experience.

Risk managers may be used to economic scenario planning — for example, considering the impact of interest rates going up or down or a fluctuation in exchange rates — but now they need to look harder at the driving forces of change and understand the wider political climate. To adapt, they’re having to broaden their situational planning to include a far wider set of parameters.

The outcome of political elections in Germany, Austria, Switzerland and elsewhere, for example, suddenly stand to have a greater impact on businesses not previously monitoring those markets. All election results provide an indication of the influence that the wider political temperature is having on individual nations. Each outcome can fuel further speculation over the future of the union, shared legislation and regulation.

Therefore, risk planners are having to broaden their perspective to include more diverse views within the political machine. They need to take into account the situation in each country, and to consider them individually, as distinct entities as opposed to an aligned group.

They must consider how strong drivers for certain outcomes are, and what the economic consequences would be should they come about. Moreover, they need to understand a broad range of events and stress-test a wide range of political and economic situations.

Operational Risk Impact

All of this has an impact on time, budgets and the skills set of those that have to monitor markets, make forecasts and predict business impact. It has created a bigger divide between those with advanced analytical capabilities and those without. Indeed, companies that are missing the analytical skills they need now must look outside to bring in external expertise.

A significant impact of Brexit will be seen on the regulatory landscape. Where the EU strove for alignment, more rules post-Brexit will be made in the UK for the UK. The degree to which they may differ from EU legislation is unknown and, of course, it will take time before rules are set or implemented locally. New regulatory bodies may be created, and there could potentially be a whole new set of rules for non-UK banks operating in the UK.

For companies trying to manage the impact of regulatory change, not having to make immediate changes is no consolation at all. Here we see uncertainty again — over what may change and when. More rules — and more disparate rules — will inevitably mean more to manage. This includes more changes to implement and an increase in operating costs to make the changes and to keep on top of a new, larger set of rules.

Parting Thoughts

Post-vote, a new term — Bregret — was coined to reflect the view that many leave voters were dismayed at repercussions of the outcome that were unexpected. It was felt that many voters wanted to make a statement — largely about immigration — and didn’t believe they’d be a part of a majority driving extensive change.

Ramifications of a leave outcome have led to unforeseen and unintended consequences. Political divergence has resulted in uncertainty and, with that, increased business risk, which has to be managed if companies are to preserve and protect their direction and the delivery of their objectives.

In times of uncertainty — and 2016 has most certainly been that — companies need more than ever to have an enterprise focus on risk; to improve their risk oversight; and to maximize their business performance by providing reliable business intelligence to decision makers. The need for expertise (sometimes external) and the analytical capability to determine outcome probabilities for scenario plans has never been greater.

As the political situation plays out, the businesses that emerge strong out of these turbulent times will be those that demonstrated robust risk management.

The original article was published by GARP. You can view it here.

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