How Will the Brexit Work?

A Look at the Mechanics of the Brexit

River Thames, London Eye, London, Great Britain
Sebastiaan Kroes / Getty Images

Voters in Great Britain opted to leave the European Union and venture out on their own in a historic referendum that passed 52% to 48% on June 24. Pro-Brexit politicians campaigned on the message that the EU imposed too many rules, charged excessive membership fees, and enabled anyone to live and work in the member countries. The decision to leave was met with immediate market volatility, however, with many warning of an economic contraction.

In this article, we will take a closer look at the mechanics behind the ‘Brexit’ and what’s in store for the future as Great Britain prepares to leave the EU.

Legal Matters

Britain must invoke Article 50 of the Lisbon Treaty to begin the process of leaving the European Union. Since Article 50 has only been in effect since 2009, it has never been used in practice, and nobody knows how the process will work with any certainty. Prime Minister David Cameron announced that he would step down in October of 2016 in order make way for a pro-Brexit replacement to step in and begin the process.

The primary clause of Article 50 of the Lisbon Treaty outlines the process:

“A Member State which decides to withdraw shall notify the European Council of its intention. In the light of the guidelines provided by the European Council, the Union shall negotiate and conclude an agreement with that State, setting out the arrangements for its withdrawal, taking account of the framework for its future relationship with the Union. That agreement shall be negotiated in accordance with Article 218(3) of the Treaty on the Functioning of the European Union. It shall be concluded on behalf of the Union by the Council, acting by a qualified majority, after obtaining the consent of the European Parliament.”

Additional clauses state that Britain must adhere to EU laws until the separation is complete, but it shall not participate in in the discussions of the European Council. Britain could decide to rejoin the EU after leaving, but it would be subject to the same procedure as new applicants.

Potential Challenges

The referendum to leave the European Union has caused a lot of anger among certain regions and politicians that don’t want to leave the region.

Northern Ireland and Scotland voters opted to remain in the European Union, but they were outnumbered by other voters across Britain. These parties believe that they should be able to vote on a separation from Great Britain and a rejoining of the EU before Britain can separate in order to retain their ties. It’s unclear whether or not these countries would be able to do so without leaving Britain and applying for individual membership.

There’s also the matter of British MPs blocking the legislation necessary to exit the EU since the referendum was a non-legally binding vote. While this is possible, MPs that voted to remain in the EU would face the wrath of voters that wanted the opposite during the next election. MPs could force a new general election, however, with MPs campaigning on a promise to keep Britain in the EU and see if they could reach a majority.

Investor Considerations

The market responded to the ‘Brexit’ referendum in an unexpected way, with markets plunging initially and then recovering all of their losses and more. Many experts attribute these movements to bets that central banks would continue dovish monetary policies in response to the vote, which is widely considered to be bullish for equities.

Economists were quick to warn, however, that the global economy is likely to face negative consequences from a split.

International investors should be aware of a couple of different factors in play. First, the ‘Brexit’ process is expected to take some time and is not a certainty by any means. Second, the downward pressure on earnings and upward pressure on equity prices could increase equity valuations at a time when the global economy could contract. And finally, it’s important to watch central bank rhetoric to see how they’re likely to react to the situation over time.

The Bottom Line

The ‘Brexit’ caught a lot of investors off-guard, but it’s likely to be awhile before the market has any real visibility. Until then, investors seem to be glad that Federal Reserve is holding off on hiking interest rates and the ECB is keeping a dovish tone.