Is Brexit a Tail Risk Event?
It has been more than a year since Britain voted to leave Europe and we are still trying to figure out what it all means. Countless economic studies have been commissioned and countless arguments have been made. Unequivocally, it seems a highly emotional issue, with many different trends, events, and beliefs colliding in an almost perfect storm. Far be it for us to judge what is right and wrong, or take views based on what law, rule or regulation is applicable. But we do have a very keen sense of risk and, as such, what are the central issues in this debate?
For starters, it is quite clear that Brexit was a rather random event. Lest we forget, that at the heart of it all was a vote amongst millions of individuals from all backgrounds, faiths and ages with different agendas, circumstances, and feelings at the time. Scientific, empirical and anecdotal studies have confirmed that many people just voted one way or another, entirely because they were simply fed up with the whole debate and didn’t think their vote mattered anyway. Now again, we are not here to discuss the merits of democracy and the voting system, but fact remains we now have a random event and, as such, there should also be no blame to pass one way or the other.
So now looking at this highly contemptuous and complex undertaking, taking all the emotions and agendas out and just looking at the obvious facts, it actually becomes quite simple:
For one, the EU is bigger than the UK by a large margin (460m people and 13.5 trillion USD of GDP versus 60m people and 3 trillion USD of GDP). That means, that whatever negotiations lie ahead, the EU will have more leverage. End of story.
Two, the UK and its European partners have spent more than 40 years investing and working together in an integrated system. Think trade laws, taxation of goods and free movement of labour. To now break out of it, in two years, seems ambitious enough, but think of all the nuances this change of direction will entail. If you have been doing something for 40 years and now all of a sudden start something completely new, wouldn’t you also think that it may take another 40 years to just get back to where you are now? At the very least, we can all agree that this is not an efficient use of resources, whether throwing away 40 years of work or reinventing the same mouse trap for the foreseeable future.
And finally, and certainly not last, there is uncertainty. Until we figure out what the consequences are of unravelling and negotiating thousands of laws, rules and regulations, there will be a lot of unknowns. How much do financial markets like uncertainty? Turns out, not very much. And who can blame them? The flow of capital will divert into areas where there is visibility. No one wants to invest where you have no idea what’s going to happen one day to the next and, worse, having to follow the endless political debate about who is at fault and who is being unreasonable could drive anyone insane.
So, what do we think about Brexit? We have no idea. However, from looking at the long and complex list of issues to resolve, the risks have most certainly increased and could be catastrophic. If you are running the same portfolio as you were before the referendum, you should have a serious look at your risk management.