A post-Brexit world

Banking leaders weigh in on an uncertain future

A trader from ETX Capital points to a Bloomberg terminal showing the FTSE 100 index following a speech by Finance minister George Osborne in central london on June 27, 2016. (Getty images)

After 43 years of – often rocky – togetherness, the United Kingdom is leaving the European Union. What sounds like a run-of-the-mill divorce is much more. It is an economic step that will have ramifications for many countries, including Lebanon, at least as far as tourists and traders, importers, investors, migrants and financial workers are concerned. It is a step of segregation that has implications for politics and decision making. It was a step that caused markets to stumble and politicians from the two largest political parties, Labour and Conservatives, to step down or, if they were exit proponents, ramble triumphantly.   

Many of the economic consequences are unclear. Key central banks’ first reactions were tellingly subdued. The Federal Reserve of the United States said in an initial statement on Friday, June 24, the day after the referendum, that it was “carefully monitoring developments in global financial markets” and prepared “to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the US economy.”

The European Central Bank (ECB) commented on the same day and in the same worryingly reassuring tenor (the kind of speak a school principal uses when announcing that your child is unlikely to reach the next level). “The ECB is loosely monitoring financial markets and is in close contact with other central banks,” it said.

The ECB comforted that it would continue to fulfill its responsibilities of ensuring price and financial stability in the euro zone (as if we had suspected that they all had decided to escape to some tropical island) and declared that it has prepared for this contingency. It “stands ready to provide additional liquidity, if needed, in euro and foreign currencies,” it added.

The most elaborate first response was up to the Bank of England (BoE), whose Governor Mark Carney acknowledged in a video statement that “a period of uncertainty and adjustment” would follow the vote to terminate membership in the European Union and that “some market and economic volatility” was to be expected.

The BoE and the Treasury were engaged in extensive contingency planning, including on the night of the vote, Carney said. “The [BoE] will not hesitate to take additional measures as required as those markets adjust and the UK economy moves forward,” he stated, adding that the bank had done its homework in ensuring that the core of the financial system is “well capitalized, liquid and strong”. UK banks have more than GBP 600 billion of high quality liquid assets and the BoE “stands ready to provide more than GBP 250 billion of additional funds through its normal facilities,” he assured. The Bank of International Settlements (BIS) followed suit the next day, on June 25, and said that central bank governors at its Global Economic Meeting on that day “endorsed the contingency measures put in place by the Bank of England and emphasized the preparedness of central banks to support the proper functioning of financial markets.” 

Contingency planning, liquidity assurances and notions of collaboration. Central banks are mightily coordinating their responses, clearly reminiscent of the lessons of recessions past when liquidity posed a big problem. Of course it is nice that they are assuring us of liquidity. But honestly, one is used to the ECB and Fed as moving in discord. The fact that they stand ready to pull with all their power on the same rope, sounds disconcertingly alert of what?

Sudden shock

Earlier in June, the situation looked like it would be all cheers for the status quo. The Swiss had voted no in a referendum that would have mandated a universal basic income. The Fed’s open market committee – in what might prove to be its best move in the sense of stability and confidence support in quite a while – decided on June 15 to keep the prime rate unchanged, i.e. as low as in the past six months. But now this exit vote. Analysts were united in saying that nothing will ever be as before and agreed that Tory leader David Cameron pissed EU membership off by calling for a referendum and Labour leader Jeremy Corbyn delivered a perfect assist by scoring an own goal.

Most of the EU denizens, including the majority of voters in the UK where the average age is around 40, can have no personal history dating back to the days of the UK joining the European Union in 1973. Beginning with the premierships of Edward Heath and Harold Wilson, and lasting through the New Right era of Margaret Thatcher and John Major, and the pro-capitalist New Labour government of Tony Blair and Gordon Brown, it was the one-nation Conservatives Cameron and Boris Johnson who, for whatever reasons, unintentionally facilitated (the former) and championed (the latter) the change that will realign Europe at least in articulating its national identities and/or shared identity.        

The initial signs from the UK were concomitant with what one would expect in any market response to a bad surprise: a double-digit drop in the exchange rate for the pound Sterling from around $1.50 to the pound on June 23 to less than $1.35 on Friday and on Monday and a loss in the shares on the London Stock Exchange. British banks – like Royal Bank of Scotland and Barclays (30 and 33 percent down by Monday, June 27) – suffered harsh share price drops, as did airline stock like easyjet, which lost 500 pence or 33 percent of its share price between the referendum day June 23 and market close two sessions later, on June 27. By the same date, ratings agencies moved to lower their assessment of the UK’s credit worthiness.

Global repercussions

For the citizens of other nations there will be practical – financial, monetary, and lifestyle – consequences even though they had no voice in the decision. How they will be impacted is the first question in this regard that concerns Lebanese investors and local clients of private and investment banks who have invested in the UK or elsewhere in Europe. While the impact is varied and includes a currency shock due to the losses in the value of the Pound Sterling and then in the drop of equity values, Lebanese investors with typically diversified international portfolios face limited exposure as they are commonly “tilted towards the fixed-income space,” said the chief investment officer of Bank Audi Private Bank, Youssef Nizam.

Paul Donovan, economist at UBS and responsible for formulating and presenting the UBS Investment Research global economic view, said that the Brexit’s consequence is uncertainty on multiple levels from local to global. “Middle Eastern investors are no different from any other investors in this situation. They need to adapt to the a less certain environment, and one where political risk is higher,” he told Executive.

Nizam explained that Lebanese are generally more accustomed to investing in fixed income than in equities since local equity markets are not highly developed. “Fixed income is doing well,” he said, but noted that Lebanese investors on the European equity side would be exposed to hits not only because of the currency drop but also on asset valuations because of increased uncertainties translating into higher risk premiums. Lebanese banks with European subsidiaries would on their part “not at all” be experiencing the kind of pressure on their share prices that some British banks have seen in recent days because Lebanese banks are influenced by completely different profitability factors than their European peers.    

The initial signs from the UK were concomitant with what one would expect in any market response to a bad surprise: a double-digit drop in the exchange rate for the pound sterling

Wealth advisors and asset managers from all over the world rushed to publish statements reacting to the Brexit and generally attempted to allay investor fears. The rate of published reactions from Beirut-based financial institutions was slow by comparison and Executive could not locally reach some private bankers and wealth managers in the days after the Brexit, given the summer season, regular business travels, and the time near the end of the fasting month Ramadan.

While the Lebanon representative of Julius Bär, a Swiss bank that maintains an office in Beirut, was not reachable for comment, the same bank’s chief investment officer Yves Bonzon described the Brexit in a phone conference for investors on June 24, which was uploaded on the bank’s website, as an “exogenous event” and as such not predictable. But the bank was prepared to take advantage of it, he said, pointing to an “intriguing opportunity” in subordinated bank debt and in buying of volatility. Banks in Europe will have pressure on equity and investors would not want to be in the equity structure of banks but will find subordinated debt rewarding as price pressure will create opportunities, he elaborated, and described “selling puts and buying reverse convertibles” as another opportunity, within an overall scenario of taking advantage of investors’ overreaction to the shock. 

Union Bancaire Privee (UBP), also a Swiss Bank with an office in Lebanon, said in a brief published on its website on June 24 that near-term uncertainty after the UK referendum’s outcome led to market anxiety but went on to say that “liquidity and falling discount spreads should make Asian equities an attractive asset class to hold”, mentioning equities in India and ASEAN countries.

Regional players were also quickly seeking to evaluate the Brexit’s impact. Emirates NBD Chief Investment Officer Gary Dugan commented on June 28, saying there was “no clarity at all on the magnitude of the impact on either the Eurozone or the UK economies”. He advised investors to watch out for stress amongst European banks and, for those persons willing to get back involved in trading in the markets, to “get a sense of the trading range in the markets before diving in”.

The National Bank of Kuwait comment on the outlook for GCC markets said, “We do not expect anything particularly big or special, barring persistent volatility in international financial markets.” It expects marginally weaker world growth to be “slightly less supportive of oil prices” and assumes that the Fed will be less prone to raise rates more than once this year, similarly for GCC central banks.

All this may be comforting to investors and wealth clients of banks but of less importance for average income earners who are feeling stuck lower on the wealth ladder. At a World Economic Forum event in China, New York-based economist Nouriel Roubini commented that it seemed unlikely for the Brexit to trigger a new recession in world markets but warned of backlash against globalization spurred by the fruits of growth not trickling down to all segments of society. “What we saw in the UK referendum was a division between rich and less rich, young and old, skilled and less skilled. This kind of pressure is becoming severe,” he said according to a WEF press statement.

In which isle is the single malt on sale?

Irrespective of the prospect (assumed by the UK government and many economists already before the Brexit vote) that the British economy could be contracting in the coming years, Lebanon has, macro-economically and in terms of consumption, not much to fear in the short term. Exporters of Lebanese wines to England will negatively feel the impact of lower British purchasing power but Lebanese tourists and entrepreneurs in the overseas programs of UK-Lebanon Tech Hub will sigh in relief that underground tickets will look, in dollar comparison, less overpriced than they actually are. Fans of Tate Modern (free admission but tempting coffee shop) and the British Museum (pricy special exhibitions) can plan more repeat visits. Looking at buyer accounts, less expensive British painkillers, hard liquors and marmalades will increase the margins of some local pharma importers and supermarkets (price drops are likely not going to be passed on in full). Cars made in UK will be more affordable.

Rejection of joining the EU by electorates is nothing new, starting with Norwegians and Swiss in the 1970s and 1990s

The euro, which is of greater importance for Lebanese trade than the pound Sterling, will by all signs not be losing as much of its value. Importers will react in ways that reflect their business models: some will take advantage to gain market share from competitors which are importing dollar-based goods, some will import more from euroland than they could already in recent times because the euro to dollar rate of summer 2008 (1:1.50) or spring 2012 (1:1.30) will not make a reappearance anytime soon, if ever. If the current range of 1.06 to 1.15 dollar per euro will weaken further (early last year it had been predicted to happen by the fourth quarter of 2015 but didn’t) and move to parity, that we shall see but it will probably not change our consumption habits.

Birth defects of institutions?

Finally there is the question of what this means for the concepts of trade blocks and even for the concept of democracy. In the days of the 1960s and early 70s when the block was still understood as the European Economic Community and moved from a puny six member countries to nine (1973) and 12 European Community members (1986) before the fall of the Iron Curtain in 1989, the program behind the European pact was “no more war”. The EEC was rooted in a European idea that previously gained political weight after World War I thanks to a few thinkers such as the people behind the Pan-European Union (PEU) in the 1920s. The PEU was headed by two aristocrats for most of the 20th century, its founder Count Richard von Coudenhove-Kalergi and then Otto von Habsburg. While Coudenhove-Kalergi liked to speak of nobility of the mind and not of the blood (he believed, in line with his own Japanese-European DNA, that the future European would be of mixed ancestry), his movement was not one of the masses.

The European idea was driven further onward in the middle of the century by the experience of two devastating European wars that turned into world wars. Its drivers were a few visionaries and politicians – usually cited are Robert Schuman of France, Konrad Adenauer of Germany and Alcide de Gasperi of Italy, plus personalities such as Winston Churchill, Paul-Henri Spaak, Sicco Mansholt, and Joseph Bech – meaning one or two visionaries per country. 

Rejection of joining the EU by electorates is nothing new, starting with Norwegians and Swiss in the 1970s and 1990s. From the treaties of Paris and Rome to the treaties of Maastricht and Lisbon, the EU was described by its critics as an elite creation. It was supported by many, myself included, but the treaties were not expressions of popular will. Yours truly covered the first European Parliament direct elections in 1979 from Germany and was enthusiastic about the prospect of growing citizens’ participation. The election turnout at the time was 62 percent even as the European Parliament was notoriously described as empowered to do nothing but vote on its own budget.

However, since 1979 in every successive election for the Strasburg Parliament’s five-year terms, the election participation dropped and eroded to 42 percent by 2014 (of course the total voting populations of the nine countries voting in 1979 are numerically different from the 28 countries that were eligible to vote in 2014). But also when the project of a European constitution was on the table in 2004, the project proved less inspirational than administrational and was rejected in referenda before it resurfaced in the Lisbon treaty. Last month’s referendum in the UK brought over 72 percent of eligible voters to the polling stations (despite flooding in some towns) and more than 17 million people voted for an exit from the union.

Masses of people, entire countries, followed their political leaders and thinkers into the union but there were always many who demonstrated indifference and others who remained active Eurosceptics. The skeptics, of which there were many in Europe at all times over the past century, even included people who signed (albeit with procrastination) the treaty of Lisbon, like then Czech President Vaclav Klaus, who described the often cited European democratic deficit “as a chronic disease” and the European institutions’ inability to convince the people as incorrigible “birth defects”. He argued in a speech in 2010 that it would be impossible to create a continent-wide European citizenship. The system-related question posited with renewed intensity by Brexit is if the skeptics are right. This issue is worth considering in Lebanon as a society with a high share of expatriates living abroad, such as Lebanese living in Europe. 

In economic terms, the UK exit creates the question of whether or not trade blocks are as good for the people in them as globalists thought. The European Union was studied by the GCC when they researched the road map for their own monetary and political union, which never happened. Turkey, which was the scape goat of populist anti-EU opinionators in the UK for allegedly being on the brink of accession, according to The Guardian, had its deputy prime minister Nurettin Canikli tweet “The European Union’s disintegration has started”, and say that his country was now less likely than ever to pursue the EU membership route.

It will be several years at least, in which article 50 of the Lisbon treaty (which regulates withdrawals from the EU) will be applied to the UK and this period will show what direction Europe will take. Economically, there (most probably) will be much time for Lebanon to ponder its options.

What does it mean for democracies when diffuse fears and anti-foreigner campaigns trump economic predictions and statements by top professionals?

Does Lebanon, which has been perched on the edge of its chair regarding WTO membership, want to draw conclusions as to if it wants to join any block (like last year’s talk about Jordan and Morocco to accede to the GCC)? Is there merit to the European neighborhood project or any sort of Mediterranean partnership? Or will Lebanon be faced with economic surroundings of rising national interests, in which discussions over a French exit, Dutch exit, Greek exit, or the separation from the EU by other states only grow in the post-Brexit world?   

The continent’s final countdown

Europe has, in the views of union advocates, a chance to pull together after the UK vote and prove the benefits it brings. Or, as others argue, there will be more referendums about this unloved central bureaucracy that the EU has become. For a country like Lebanon that is a historic stakeholder in trade, the question over the viability of trade blocks is worth taking an interest in, not only in Europe but in three continents. 

The second question that seems worth looking into is the role of democracy in interstate blocks. According to different media reports, the UK voters were divided, as the opinion editor of The Telegraph newspaper put it, into tribes within camps. The amazing thing is that, according to the newspapers, two thirds of people who left school at age 16 voted for the exit and two thirds of people with a university education voted to stay. What does it mean for democracies when diffuse fears and anti-foreigner campaigns trump economic predictions and statements by top professionals? It is hardly filling one with confidence in the wisdom of the crowds when premier Cameron steps down with a statement on the need for fresh leadership after admitting failure to convince of his best assessment that, “I was absolutely clear about my belief that Britain is stronger, safer and better off inside the EU.”

The EU was built by visionaries but its appeal is not democratic. In a world where changes of power have limited consequence because the choices are so similar, it has worked to proclaim democracy as the worst form of state management except for all others. Europe may be in the paradox that it only can remain viable when it can mobilize mass support for what has historically been nursed as an elite project. But the Brexit ultimately raises this question: when it comes to matters that are of such economic consequence, do we want to entrust decisions over supranational developments to popular votes?

Thomas Schellen

Thomas Schellen is Executive's editor-at-large. He has been reporting on Middle Eastern business and economy for over 20 years.

*

Top