Increased Brexit uncertainty keeps UK asset classes edgy; keep Sterling exposure hedged

Anubhav Sahu Moneycontrol Research

Highlights: - UK Parliament voted down Theresa May’s re-negotiated deal - Irish backstop remains a thorny issue - Parliament to decide on 'no deal' and deadline (March 29) extension - Heightened uncertainty to further dampens trade and investment in the UK - Investors advised to keep Sterling exposure hedged
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UK Parliament has voted down yet another deal on Brexit with 17 days to go for the current deadline. It’s remarkable that over the last two months, Theresa May’s government had to re-negotiate this proposal with the European Union (EU). Earlier this week, May had ensured legal assurances from the EU on the thorny issue of -- Irish backstop -- but this was not enough.

After the March 12 vote, Asian markets are trading negative this morning with Nikkei down a percent. FTSE 100 futures is trading 1.6 percent lower, while the dollar-pound has stabilised after a sharp volatility through March 12. Read: Brexit in limbo

So, what went wrong? The deal has been weighed down by the concerns regarding Irish backstop. Backstop is an agreement over the Irish border, which separates Northern Ireland and the Republic of Ireland and guarantees that the Irish border remains open regardless of the trade negotiation outcome between the EU and UK. It is noteworthy that current deal involves a 21-month transition period before the final exit in 2020, during which trade relationship would be figured out.

The idea is to keep Northern Ireland (part of UK) under the EU customs union to prevent a hard border within the island of Ireland if Brexit happens without an all-encompassing trade deal. This has been necessitated by UK’s commitments made to Northern Ireland in the late 90s (Good Friday agreement).

Those opposing the May’s proposal see this provision as a key concern as it compromises UK’s ability to struck comprehensive trade deals with other countries.

Legal assurance not enough To overcome this concern, on March 11, UK did get legal assurances from the EU that Irish backstop is temporary. However, UK’s Attorney General opined that risk remains that UK would have no lawful means of exiting the backstop once it gets imposed. In other words, this means EU customs laws on Northern Ireland could continue indefinitely.

What next? In the immediate future there are two crucial steps to be followed. On March 13, UK parliament has to vote on a no-deal Brexit. If it is defeated then on the following day (March 14) Parliament has to vote on Article 50, i.e. whether to extend the March 29 deadline.