TIMOTHY HOPPER, Ph.D., CHIEF ECONOMIST, TIAA
WILLIAM RIEGEL, CFA, CHIEF INVESTMENT OFFICER, TIAA INVESTMENTS
On June 23, U.K. voters will participate in a public referendum to determine whether Britain should leave or remain in the European Union (EU). A British exit, or “Brexit,” would put Europe in uncharted territory, as no country has ever left the EU before.
The stakes are high, reflecting a tug-of-war between those who believe EU membership confers the benefits of economic strength and free trade against those who favor greater national sovereignty and independence from the EU, particularly in areas such as immigration policy. British Prime Minister David Cameron has led the charge for the “stay” campaign, while the “leave” movement is made up of various factions representing anti-EU sentiment.
Given the economic, political and social concerns involved, much of the debate over the referendum has been emotionally charged. At its most extreme, this intensity led to the June 15 murder of Jo Cox, a Minister of Parliament and strong proponent of the stay campaign, allegedly at the hands of a far-right British nationalist. Whether and how this event will influence the outcome of the vote is unclear. In the days preceding the tragedy, public opinion polls had become statistically too close to call but showed the leave camp gaining some traction. Subsequent polling has indicated a blunting of that momentum. Whichever side wins, it may well be by a razor-thin margin.
The prospect of a Brexit and its potential impacts has weighed on financial markets and the U.K. economy to varying degrees since the referendum was announced in February. Uncertainty over the outcome—perhaps as much as fear of a particular result—has contributed to volatility and subdued economic activity along the way. In part, market reaction in the wake of the vote will likely depend on the extent to which a “leave” victory has been priced in. We assess some potential market reactions below.
Given the history of interdependence between the U.K. and the rest of Europe under the EU framework, Britain’s departure from the union would create other challenges. One example is the U.K. banking system. London has long been the undisputed banking capital of the region, and the U.K. has been a first stop for foreign enterprises to domicile before entering markets on the continent. Moreover, the financial services sector accounts for 10% of British GDP, and London alone stands to lose important segments of its workforce. Indeed, London’s largest banks have already announced planned layoffs in the event of a Brexit.
That’s not to say there’d be a single, clear alternative to London elsewhere. While Parisian officials have positioned their city as a finance hub for Europe, big banks are indicating they are likely to spread their London operations among several European cities, including Frankfurt, Dublin, Paris, Warsaw and Lisbon. This would take time, meaning London would not lose its global-financial-center status overnight. In addition, though U.K. banks would certainly feel some short-term pain from a Brexit, overall they are well-capitalized and globally competitive.
Another post-Brexit challenge would be heightened political uncertainty. There are factions in other European countries—notably Spain, where a June 26 general election is scheduled—that want to leave the EU and would seek to capitalize on any “leave” momentum from a Brexit. While not necessarily poised for major victories, a growing chorus of “Eurosceptics” has prompted core EU members such as France to consider closer integration of the union as a defense mechanism. France has also vowed to impose harsh terms on the U.K. should it choose to leave the EU, thereby creating a disincentive for other potential defectors.
The June 23 referendum remains a toss-up. However, we believe that when push comes to shove, voters will decide there is too much uncertainty associated with a leave vote, and will opt to stay. While the U.K.’s regulatory burden would be lighter under a fully independent system, the path to get there would be neither short nor simple. Nearly 1,300 regulations and hundreds of thousands of pages of laws would need to be reviewed and renegotiated to effect Britain’s transition to independence. Throughout this process, the U.K. would still be subject to the EU’s jurisdiction.
TIAA does not anticipate material adverse impacts on participants and clients resulting from a possible Brexit. While markets may be volatile in the short term following a leave vote, we believe such volatility can create attractive investment opportunities. Meanwhile, a vote to stay has the potential to spark a substantial upside move, as the uncertainty that has weighed on markets and constrained economic activity would be removed. Regardless of the outcome, we encourage investors to remain patient, diversified and focused on the long term.
This report is prepared by TIAA Global Asset Management and represents the views of Timothy Hopper and William Riegel. These views may change in response to changing economic and market conditions. Any projections included in this material are for asset classes only, and do not reflect the experience of any product or service offered by TIAA. Past performance is not indicative of future results. The material is for informational purposes only and should not be regarded as a recommendation or an offer to buy or sell any product or service to which this information may relate. Certain products and services may not be available to all entities or persons. Please note equity and fixed-income investing involves risk. Foreign investments are also subject to political, currency and regulatory risks.
TIAA Global Asset Management provides investment advice and portfolio management services through TIAA and over a dozen affiliated registered investment advisers. TIAA-CREF Individual & Institutional Services, LLC, Teachers Personal Investors Services, Inc., and Nuveen Securities, LLC, Members FINRA and SIPC, distribute securities products. Annuity contracts and certificates are issued by Teachers Insurance and Annuity Association of America (TIAA) and College Retirement Equities Fund (CREF), New York, NY. Advisory services are provided by Advice & Planning Services, a division of TIAA-CREF Individual & Institutional Services, LLC, a registered investment adviser.