1. What is Brexit?
On June 23, 2016, the United Kingdom held a referendum. Voters were invited to give their opinion on whether or not the U.K. should remain a member of the European Union or leave. "Leave" won, 51.9% to 48.1%. "Brexit" is a combination of "Britain" and "exit." While not everyone voted, the turnout (at 72%, or more than 30 million votes) was much higher turnout than general elections.
2. When is the U.K. due to leave the European Union?
Per the rules of the treaty, the U.K. has two years to leave the European Union. British Prime Minister Theresa May started the clock for this process on March 29, 2017, meaning the U.K. is scheduled to leave by the end of the first quarter of 2019. While it's possible to extend that time frame, both sides are currently proceeding as though that date is the deadline.
3. What is the European Union?
The European Union is a political and economic union of 28 member states covering 1.7 million square miles, with an estimated population of about 510 million people. It functions as a single market with laws and policies intended to promote peace and freedom of movement among its member states. It functions as a trade bloc and the majority of member states have adopted the euro as their official currency. Like the U.S. Federal Reserve, it also aims to promote economic growth, price stability, and full employment.
4. What is "soft" Brexit?
"Soft" Brexit would mean that the U.K. would remain closely aligned with the European Union without being an actual member state. A softer Brexit is anticipated to have a much smaller impact on the U.K. economy because the U.K. would essentially remain a member of the trade bloc (it would pay to remain a member of the customs union). If the U.K. chose to go the route of soft Brexit, it could still be bound my some of the rules (especially with regard to immigration and tariffs).
5. What is "hard" Brexit?
In contrast, under a "hard" Brexit scenario the U.K. would leave the European Union completely. Therefore, it would have more control over its immigration policies and could negotiate its own deals with trade partners.
6. What is the likely outcome?
May has proposed an exit agreement that starts with a soft Brexit but transitions to a hard Brexit by year-end 2020. During the transition, the U.K. will still pay to have access to the market, and the U.K. will also settle its debts during this period. U.K. borders will remain open during the transition period.
During the transition period, negotiators will outline a new relationship, which includes new trade arrangements. Decisions have yet to be finalized on whether Europeans currently living and working in the U.K. will be allowed to continue to do so.
May's proposed exit also avoids a physical border separating Northern Ireland, which is part of the U.K., and the Republic of Ireland, which is a member of the European Union.
Britain's House of Commons will vote on May's Brexit plan on Tuesday. Speculation is that the plan as is will fail in the House of Commons as it has failed to gain sufficient political support. This opens the door to the potential of a softer Brexit or possibly even a second referendum.
7. What should investors do about all of this?
Not much. Though investors will probably be tempted to trade based on expected outcomes, we don't see a strong connection between political developments and investment fundamentals.
"As long-term investors, politics doesn't play much of a role in how we view our portfolios. We want to know the range of possible outcomes and position accordingly, but we must resist speculating," says Morningstar Investment Management's Dan Kemp.
