Today in Brexit, Day 1,210

Ladies and gentlemen, we have a deal! A Brexit deal, that is. Again. As with the last deal, the prime minister is gung-ho. European Union leadership is, too. Yet many UK Members of Parliament (MPs) are less so. They might approve it. They might not. The UK might leave the EU on Halloween. It might not. There might be a general election next month. There might not. Read on to see what is in the deal, what Parliamentary math says about its chances of passing, and our three hundredth (give or take) assertion that whatever Brexit looks like, whenever it happens, just getting on with it and ending this uncertainty should be a tonic for the UK economy and markets (and, to a lesser extent, the remaining EU nations).

For those who haven’t followed along^[i] or get their news from the new Brexit-free British news channel, here is your catch-up summary: In the spring, MPs rejected former Prime Minister (PM) Theresa May’s deal, which would have kept the UK in the EU’s customs union until and unless negotiators solved the thorny Irish border issue. The Good Friday Agreement that resolved the conflict between the Irish Republican Army and UK government mandates an open border between Northern Ireland (the UK) and Ireland. Thus, May sought and received a Brexit delay from the original March 29 deadline until October 31. Then May stepped down. Boris Johnson won the Conservative Party’s leadership contest and became PM.

Unlike May, Johnson campaigned for Brexit and has since carved out a niche as champion of a “hard Brexit.” This means strong trade ties with the EU but no customs union membership. He pledged to negotiate such a deal. The EU said nah, no more negotiations, these are red lines, thanks for playing. Johnson, seemingly undaunted, promised he would take the UK out of the EU on Halloween. To that end, he aimed to limit Parliamentary debate by suspending the body, an unpopular move^[ii] that, among other factors, resulted in his working majority going from a handful to -43. (That isn’t a typo.) Anyway, MPs passed a law mandating Johnson seek a three-month Brexit extension if Parliament didn’t approve a deal by October 19. At some point, EU leaders perked up and said ah ok we guess we can try negotiating again. Those negotiations happened last weekend. Now they have borne fruit.

Today is Thursday. On Saturday, MPs will convene to vote on the deal. It will be their first Saturday sitting since 1982, when PMs had an emergency sitting to discuss the Falklands invasion. If they vote for it, the UK probably Brexits on Halloween—or shortly thereafter, if they need a “technical extension” to finalize some paperwork. Then, the “transition period” will kick in. It lasts until December 2020 and exists to give businesses time to get their ducks in a row and to give the government time to negotiate a free-trade deal. If MPs reject the deal, Johnson must then write to EU officials requesting that three-month extension. If they say no, a no-deal Brexit happens on Halloween. If they say ok, then we do this whole song and dance again, potentially with a general election somewhere in the mix.

Before we cover Parliamentary math to play the Will It Pass? game, we must explore why May’s deal didn’t pass and how Johnson’s differs. For May’s deal, the hiccup was the Northern Irish backstop—a trade system that would take effect and last indefinitely if negotiators didn’t come up with a better solution during the transition period. The peace accords between the Republic of Ireland and Northern Ireland mandate an open border between the two with no manned checkpoints. But an EU border requires customs checks. The backstop solved this by keeping the UK in the EU’s customs union indefinitely. Poof, no manned checkpoints. But a euroskeptic faction in Parliament called the European Research Group (ERG) didn’t like this because it was a Brexit in name only that wouldn’t enable the UK to sign its own free-trade agreements. MPs who prefer staying in the EU didn’t like it because it stripped the UK’s ability to influence EU rules, weakening it relative to the status quo.

Johnson’s approach appears to be to fix the backstop enough to win over the ERG and pro-Brexit Labour MPs. For one, it is no longer called a “backstop.” Instead, it is an Irish Protocol. We like to think of it as Schrödinger’s border. It functionally keeps Northern Ireland in the EU’s customs union, ensuring that open border with the Republic. That also means goods shipped between Great Britain^[iii] and Northern Ireland will face customs declarations. However, they will not face tariffs unless they are “at risk” of going from Great Britain to Northern Ireland to the EU.^[iv] While this might seem helpful on paper, the reality will be a lot of bureaucracy and complex trading rules with terms like “red and green lanes.” Other than this wrinkle, however, Northern Irish businesses will receive “unfettered market access” to the rest of the UK (same as in May’s deal). At the same time, Northern Ireland will officially be in the UK’s customs territory, and the whole of the UK will not be in the EU’s customs union. So, the UK can sign its own free-trade agreements, and Northern Ireland can participate in them fully. Northern Ireland will also be free to pick and choose which new EU laws it wants to adopt (matching May’s deal). Lastly, this Irish Protocol is not open-ended. Four years after the transition period ends (and moving forward from there), Northern Ireland’s devolved parliament will be able to vote on whether to extend the arrangement. Should they choose not to, it will sunset after two years from the vote.

Usually, when assessing legislation’s likelihood of passage, it would make sense to look at the party breakdown. With Brexit, it isn’t this simple, because the issue has split the two major parties. So, we will break it down by faction as well as party. Here is a handy table.

Exhibit 1: An Unscientific Breakdown That We Think Is Right?

Source: History, public interviews, Twitter and scratch paper, as of 10/17/2019.

What is the likelihood of Johnson getting those magic 320 votes? Conventional wisdom says he will get the 208 Conservatives who have traditionally fallen in line, plus the less hardline ERG members (52) and the Labour MPs who wrote to the EU pledging to vote for a deal if one was agreed to (19). This brings us to 279 votes, requiring Johnson to scrounge up at least 41 more. Any faction marked above as “Second Referendum” or “Revoke Brexit” is probably in the “nay” column, for obvious reasons. That leaves the hardline ERG members, known as “Spartans,” along with the expelled Tories, potential Labour rebels, Democratic Unionist Party (DUP) and other independents as the swing factors.

All are question marks. The Spartans are the 28 ERG members who didn’t cave when May tried to pass her deal a third time. But some are now in Johnson’s cabinet. Among the rest, an argument along the lines of if you don’t vote for this, the Remainers will take over and we will never leave may be persuasive enough to win their vote. But only time will tell. Moving on to the 21 expelled Tories, 17 of them voted for May’s deal in the spring. All favor a soft Brexit, not staying in the EU. The 31 potential Labour rebels are a wild card, caught between wanting to end the Brexit stalemate with a soft deal and the potential ouster from their party by leader Jeremy Corbyn. The DUP, however, will be the hardest to win over. The party line currently says the Irish Protocol threatens the union between Great Britain and Northern Ireland and is therefore something they can’t support. Whether that stance changes will likely depend on the further assurances and financial provisions Johnson can offer.

In short, whether the deal passes on Saturday will depend on how tired everyone is of the Brexit circus and how skilled a politician Johnson is. Thankfully, we are not political oddsmakers, so we can get away with saying “wait and see.” So, wait and see.

As for UK stocks, there is no shortage of research and evidence showing businesses have put off long-term investments and devoted most of their energy to planning for Brexit deadlines. Take all the precise calculations of lost output with a grain of salt, but the ongoing slide in business investment speaks for itself. It is down in five of the past six quarters.^[v] The only positive quarter, Q1 2019, is when businesses were stockpiling for a no-deal Brexit that never arrived. If MPs keep kicking the can, we suspect UK businesses will remain in this vicious circle of risk aversion and short-term moves. Risk aversion will probably keep hanging over UK stocks, too. However, if and when Brexit finally happens, and businesses know the rules they will be dealing with for the foreseeable future, they can get on with life and start launching long-term projects. Even if they don’t like the rules, they can still calculate eventual returns. They can decide simple things like where to put new factories, offices and distribution centers. Ending the Brexit uncertainty can unleash investment. Stocks may have some hiccups along the way, since sentiment is impossible to predict, but in time they, too, should benefit from falling uncertainty.

That’s it for this installment of “Today in Brexit.” See you next time, in all likelihood, on Monday.