Aberdeen Standard Investments: Brexit: now what?

The UK government’s failure to successfully pass the Withdrawal Agreement yesterday was in line with our expectations and the path remains as challenging as ever, with a motion of no confidence in the government tabled for this evening. This note highlights the implications of the last 24 hours and the key elements that would need to change to move discussions forward towards a solution from here.

We don’t believe the EU will alter its position on the backstop and other controversial aspects of the withdrawal agreement enough to make the deal acceptable to hard Brexiters. Even if the backstop did become time limited, passage in this febrile environment would not be guaranteed with potential for concerns among pro-remain MPs about ‘No Deal’.

Meanwhile, a cross-party solution that reconciles the Conservative party’s dual desire to restrict free movement and independently negotiated free trade agreements and the Labour party’s position on customs union and single market will be very difficult not to achieve as it would require one or both parties to alter its current red lines.

Key waymarks for such a compromise are legislative attempts by MPs to refer power to parliament writ large and more conciliatory rhetoric from the leaders over the coming days and weeks. And even if such a solution were possible, it would likely exacerbate the already large fissures within the parties, creating the potential for party realignment.

In the absence of such change, a second referendum remains the main option for breaking the gridlock; though we acknowledge the clear challenges to such a vote. Whatever the outcome, an Article 50 extension looks to be necessary. The symbolic deadline for the deal, which had been December/January has been moved out, contrary to our initial expectations. Consensus has moved to accept that a deal may be presented at the March meeting of the EU Council.

In the absence of a deal that has both UK and EU buy-in, we continue to think extension of Article 50 would only be allowed in the context of a change in government, the red lines for negotiations or a second referendum.

We are in the process of updating the market impacts in our scenario analysis and will send through in the coming days but the risk of no deal has reduced to orange from yellow in our probability analysis while our chunky probability of EEA or EU membership has been reinforced.

The Vote of No Confidence in the Government
Labour leader Corbyn has called for a vote of no confidence in the government to take place this evening. In spite of the resounding defeat of May’s Withdrawal Agreement (202 votes in favour, 432 votes opposed), both the DUP and Conservative Brexiteers have indicated that they will back the government. The true numbers here are somewhat opaque; individual Brexiteers in May’s party may opt to take the nuclear option to express their dissatisfaction but they would do so knowing they put their jobs and the future of Brexit at risk given Labour’s softer Brexit policy. On balance, we expect that the government will survive.

If May does win the no confidence vote then we are going to essentially be in the same place as if the vote had happened four weeks ago but with a tighter timeline to Article 50 ending, with May obligated to articulate a path forward on Monday next week. The same challenges remain as we have discussed over the past two years and were illustrated last night: both parties are deeply divided on what the right Brexit outcome looks like, with little genuine desire at the leadership level to work cross-party.

However, what the last month has illustrated is that there is a mobilised majority against No Deal in parliament and we expect that momentum to remain, reducing the risk of No Deal from yellow to orange in our scenario table in spite of the seeming chaos regarding the path from here. We also think it is unlikely that May herself would pursue such an option given the enormous costs. A hard Brexit is also not in the EU’s interests, especially in the context of the already slowing economy.

If May loses the vote, there would be an opportunity for the Labour party to try to form a government but majority support is unlikely given current parliamentary arithmetic. The existing government and opposition parties would have two weeks to try to win a no confidence vote before a general election is triggered. While polls currently show Labour and Conservatives neck and neck, the 2017 election illustrates that campaigns can move polls substantially. Key to this campaign would be each party’s solution to Brexit being clarified.

The Labour party position on a second referendum
If May retains her position, the Labour party leadership appears still reticent to call for a second referendum, in spite of clear preference from the Shadow Brexit Secretary and much of Labour’s membership for a so-called People’s Vote. Again, this reflects the deep divisions in Corbyn’s support and own ideology on Brexit, as well as the potential challenges that EU membership would pose to Corbyn’s domestic policies.

However, multiple votes of no confidence in the government that Corbyn has signalled may wear thin. In the absence of a clear mobilisation of cross-party forces to a single outcome, a second referendum therefore presents an opportunity, although likely disruptive, to break the gridlock in parliament.

As discussed before, it is very unclear what the options posed to the public will be. The substantial loss last night makes

It harder to include May’s deal on the ballot. Still, for government support, a tweaked version is probably necessary. The two other likely options are a no deal Brexit and remaining within the EU, though there is also support for the option of a permanent customs union and Norway+.

The Conservative party’s Brexit red lines
Following the failure of the vote last night, May indicated a desire to work cross-party to find a solution. However, she also flagged that this approach would require that any solution was consistent with May’s red lines, which seek to end free movement and create an independent UK trade policy. These factors are inconsistent with Labour party policy supporting a customs union and single market access so compromise would be needed to reach a cross-party solution.

Assuming the backstop remains fundamental (see next section), compromise would need to come on the Conservative side. This would likely cause huge conflict with the party and heighten risks that hardline Brexiteers trigger the nuclear option of abandoning the party and threatening the future of the government. However, visibility is very low; these MPs would have to trade off the risk of a softer Brexit against the risk of a Labour party government that delivers a soft Brexit anyway. This is a highly febrile political environment and the path, as highlighted before Christmas, is challenging.

The EU position on the Northern Irish backstop
The reason for the failure of the Withdrawal Agreement within Conservative party ranks is the so-called ‘Northern Irish backstop’. This guarantees that in the absence of a free trade agreement that provides for continuity at the fluid Irish border, this border will remain free with Northern Ireland embedded in the EU customs union and single market. This challenge to UK unity has become a red line for much the Brexit wing of the Conservative party, hence last night’s result.

One option that has been discussed is whether Brussels would soften its tone on the backstop. While language may be added to the political declaration (which is not legally binding), the actual WA seems less likely to change. Barnier’s comments yesterday confirmed the EU’s commitment to this clause. However, it warrants watching in case Brussels’ view is moving more than we expect; if the EU makes the backstop non time limited (not our base case) it would unlock negotiations and make it easier for May to pass her deal in Parliament. That said, it would not guarantee passage as border uncertainly could create new political issues.

Alternative solutions to the Brexit gridlock
May’s offer to work across party on these issues remains very limited if the red lines are maintained (as discussed above). However, if parliament genuinely took control, a cross party solution would become more viable. This could be achieved through amendments to existing parliamentary legislation or new draft bills, though this would likely take time. Alternatively, May could pose multiple votes on various outcomes – though this would still rely on her moving on the customs union and free movement – to find a compromise capable of majority support. This is a messy approach but is naturally being highlighted as a way forward.

Norway Plus (EEA + Customs Union) is the most obvious option that might arise here, but it poses a lot of issues as discussed in prior notes. On the UK side, it would require a volte face from Conservatives and Brexit supporting Labour MPs on free movement of labour and customs union. On the European side, while Barnier has flagged it as a viable option, uncertainties remain about how the UK could satisfy EFTA membership rules and be a part of the EU customs union. Norway, for example, has indicated some opposition to the UK joining. Nonetheless, there is a degree of support in parliament for this solution and the likelihood has risen in recent months. This has reinforced the likelihood of EU/EEA membership scenario in our scenario analysis. (update/Aberdeen Standard Investments/mc)

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