After three years of political jockeying over the U.K.s place in the European Union and two days of marathon negotiations with other EU leaders, a relieved and confident David Cameron appeared before the media at the Consilium, the blocs Brussels headquarters, to declare victory late in the evening of February 19. His EU counterparts had agreed to grant most of the concessions he had demanded, including the right to restrict welfare benefits to migrants from other EU countries, tighter guarantees that the U.K. and the City of London wont face discrimination or unfair regulatory pressure from the euro zone, and an exemption from the integrationist declaration in the unions founding treaties committing member states to creating an ever closer union. In London the following day, the Conservative prime minister set a June 23 date for a referendum on Britains membership in the union and appealed to his fellow citizens to vote to stay in, insisting that they would be safer, stronger and better off inside the EU.
We will be in the parts of Europe that work for us, influencing the decisions that affect us in the driving seat of the worlds biggest market and with the ability to take action to keep people safe, Cameron said. And we will be out of the parts of Europe that dont work for us. Out of the open borders. Out of the bailouts. Out of the euro. And out of all those schemes in which Britain wants no part.
Barely 24 hours later Camerons task suddenly got tougher when Boris Johnson, the charismatic mayor of London, broke ranks with his party leader and came out in favor of a British exit from the union, or Brexit. At stake, he argued, was nothing less than the preservation of British democracy. The Common Market that the U.K. had joined back in 1973 had grown out of all recognition into a bureaucratic beast that controlled everything from economic policy to immigration to safety measures for cycling, one of the mayors passions. The referendum provided a once-in-a-lifetime chance for Britons to say enough: This is the only opportunity we will ever have to show that we care about self-rule, Johnson wrote in a column in the Telegraph. In addition to the mop-haired mayor, six members of Camerons cabinet came out in favor of exit, and they are expected to be joined by as many as 150 of the Conservative Partys 331 members of Parliament.
After a generation of rising tensions in the U.K. and particularly in the Tory party over the countrys relationship with its EU partners, Britons are finally going to have their say. The stakes couldnt be higher. Europes second-largest economy does half of its trade with the union, regularly receives the lions share of foreign direct investment flowing into the EU and has attracted millions of workers from across the bloc, spurring a growth rate that most euro zone members envy. The City is by far the preeminent financial center in Europe and has actually strengthened its dominance since the launch of the euro, even though Britain has never adopted the single currency. Mario Draghi tailors his message more to traders in Mayfair, Moorgate and Canary Wharf than to those in Frankfurt or Paris to ensure that the European Central Banks monetary policy decisions are transmitted effectively through financial markets to the real economy.
Leaving the union could jeopardize many of those advantages. Recent opinion polls indicate that the public favors staying in the EU by a margin of 54 percent to 46 percent, but those figures dont yet reflect the outcome of the Brussels summit or the opposition from Johnson, whose popularity ratings far exceed those of any other British politician. Any turmoil in the euro zone or surge in refugees into the union from Syria and the Middle East could sway opinion in the coming months.
Uncertainty ahead of the June vote could dampen investment and growth, and put pressure on the pound, analysts say, just as it did before Scotlands 2014 referendum on independence. A vote for Brexit would almost certainly entail bigger losses than in 2014, they say. The pound, which briefly rallied on the news of Camerons EU agreement, fell by more than 2 percent against the dollar after Johnson joined the Brexit camp, then drifted to new seven-year lows of less than $1.40. The currency has fallen by a little over 10 percent against the dollar since late August and has suffered a similar decline against the euro.
The consequences of exit, I think, are highly damaging for the economy, says Michael Saunders, head of Western Europe economic research at Citigroup in London. The options range from bad to awful. Jacob Nell, chief U.K. economist at Morgan Stanley, believes a Brexit vote would knock 1.3 percentage points off U.K. growth this year and next and reduce the countrys long-term rate of growth by half a point, to 1.6 percent.
Douglas Rediker, a former investment banker who is founder and executive chairman of International Capital Strategies, a Washington-based consulting firm, says a significant amount of financial business will head for the exits if Britons vote to leave the EU. The City of London is not going to be the same City of London if the U.K. is not going to be a full member of the European Union, he says. HSBC Holdings, which just decided to keep its headquarters in London after a yearlong evaluation, could move 1,000 bankers and traders to Paris if voters endorse Brexit, CEO Stuart Gulliver said in February.
Financial market participants are betting that the referendum uncertainty will further delay any monetary tightening by the Bank of England, perhaps until 2017. Such thinking supported British stock and bond prices in the immediate aftermath of the Brussels summit meeting. But central bank governor Mark Carney warned that U.K. assets are vulnerable to a sudden spike in risk premia because the country relies on capital inflows to finance its big current-account deficit. The global general environment has become much more febrile, much more volatile, and relying on the kindness of strangers is not optimal in that kind of environment, he told the House of Commons Treasury Committee in January.
The stakes the EU are arguably even greater. The blocs unity and effectiveness have been sapped by a series of economic and political crises in recent years. The debt troubles have eased but not gone away. Greece has yet to implement its latest bailout program convincingly, and Portugal risks backsliding. Spain, although growing, remains in political limbo after voters in Decembers election dealt a big setback to Prime Minister Mariano Rajoys Partido Popular and gave the anti-austerity Podemos party a chance of sharing power. A wave of refugees from the Middle East has sparked a nationalist backlash in many countries, torpedoing a burden-sharing agreement among EU members and leaving German Chancellor Angela Merkel isolated. Populist governments in Poland and Hungary have challenged EU tenets on central bank independence and media freedom. Dutch voters are threatening to block an EU association agreement with Ukraine, which would give Russian President Vladimir Putin a fresh EU fissure to exploit. Marine Le Pen, leader of Frances right-wing National Front party, is openly rooting for the British to exit the EU, believing it would boost her chances to win the French presidency in 2017 on a nationalistic, anti-immigrant, anti-EU platform.
At a time when the forces of fragmentation have the upper hand over those of integration, a messy divorce from Britain is the last thing the EU needs. That explains why union leaders were willing to concede so much, offering the U.K. a separate status that would entrench the principle of a multispeed Europe and run the risk that other members will demand similar concessions.
It would be a very, very, very, very sad day if British people voted to leave, Virgin Group founder Sir Richard Branson said in a television interview after the referendum was announced. In addition to being very, very damaging for Great Britain, he said, Brexit would be the start of most likely the breakup of the European Union.
David Folkerts-Landau, chief economist at Deutsche Bank, fears that the departure of the U.K., with its more global outlook and diplomatic weight, would diminish the EUs influence in the world. The forgotten dimension of the Brexit debate is the cost to the Continent, he said in January. I strongly believe that if Brexit were to occur, continental Europe will be relegated to second-rank status. Europe will lose its important claim to global significance if it loses London and the Anglo-Saxon connection.
Policymakers in Washington are also concerned. The Obama administration has encouraged Brussels and London to reach an accommodation but has little ability to influence the referendum campaign, especially with transatlantic relations already at a low point because of tensions over Syria and Russia.
Britain has become and is widely perceived to be a less dependable and less capable ally, and reality and perception would intensify if the U.K. were to take a step that would marginalize its role on the continent, Richard Haass, a former State Department official who heads the Council on Foreign Relations, wrote in a recent opinion column. It is hard to envision Brexit resulting in anything other than a more parochial and less influential U.K. Such a vote would also produce a weaker Europe at a time when the U.S. needs a stronger one, he added.
Senior business executives have largely stayed out of the debate so far, but that is changing now that the formal campaign has begun. The chairmen or chief executives of nearly 200 U.K. companies, including a third of FTSE 100 Index constituents, such as aerospace company BAE Systems, oil major Royal Dutch Shell and telecommunications operator BT Group, signed a letter in the endorsing continued membership in the EU. But the letter was as notable for its omissions as for its signatories: Three leading food retailers, as well as Lloyds Bank, Barclays and Legal & General Group, the insurer thats the U.K.s largest asset manager, declined to sign. Supermarket chain Tesco explained that the referendum was a decision for the people of Britain.
Most bankers and commercial people dont want to play politics, says Sir Howard Davies, chairman of Royal Bank of Scotland. He estimates the likelihood of a stay vote to be roughly 65 percent. Citis Saunders, who initially estimated the probability of a Brexit vote at 20 to 30 percent, raised those numbers to 30 to 40 percent after Johnsons entry into the fray. Johnson is one of the few politicians able to tap into an antiestablishment mood while also presenting an outward-looking, optimistic case for Brexit, Saunders says. Adding spice to the contest is Johnsons open ambition to succeed Cameron as prime minister, which gives his bold challenge the air of an attempted palace coup. Boris Goes in for the Kill, screamed a headline in the Daily Mail, whose parent company also owns Institutional Investor.
Most political oddsmakers like the prime ministers chances of winning his political gamble. Several online bookmakers were rating the prospect of a stay vote odds on at 4 to 11, meaning a winning bet of £11 would return £15; they rated Brexit at 21-to-10 odds against, which would return £31 on a bet of £10.
One of the ironies of the campaign is that Londons financial community, which has the most to lose if the U.K. withdraws from the EU, may have little influence over the outcome. Nearly eight years after the financial crisis, bankers and brokers remain pariahs with much of the public. The government has only begun to sell off its big stake in RBS and still holds 10 percent of Lloyds, and politicians rarely pass up an opportunity to bash the City for its risk-taking, big-money ways.
To campaign that EU membership is vital for the City is not a great way of putting it, acknowledges Mark Boleat, chairman of the Policy and Resources Committee of the City of London, which governs the traditional financial district. The pro-EU camp, he says, has to make its argument about jobs: Over time if Britain is not in the EU, jobs would move to other centers. It wouldnt happen overnight, but thats what concerns us.
Yet big City firms are stepping up their support for the U.K.s ongoing EU membership. Goldman Sachs Group recently contributed a substantial six-figure sterling sum to Britain Stronger in Europe, a business lobbying group for the stay campaign, a bank spokesman confirms. Although executives havent commented publicly, Richard Gnodde and Michael Sherwood, co-CEOs of Goldman Sachs International, two years ago urged the government to remain in the union, writing in a newspaper column, Large international and European companies see a Britain divorced from the EU as a much less attractive place.
Another factor that adds to the uncertainty surrounding the referendum campaign is the tenor of the times. EU advocates can marshal powerful arguments for remaining an active member of the union. In a complex global world, every country faces an increasing number of challenges that transcend its borders: terrorism and immigration, pollution and climate change, trade and volatile capital flows. Countries need to cooperate to tackle those challenges, and the U.K. has no more natural allies than its EU partners, supporters say.
But rational, nuanced arguments may land on deaf ears at a time of rising populism in Europe and around the world, when emotional appeals to the gut can overwhelm the call of reason. The British establishments complacency, until very recently, about the risks of Brexit has a distinct echo across the Atlantic in the unprecedented race for the Republican presidential nomination, says consultant Rediker. The same people argued for nine months that its absurd to believe Donald Trump could get the nomination, for the same reason, he notes.
In Britain as in America, everyone is scrambling to assess the odds of once-unthinkable political scenarios.
BRITISH AMBIVALENCE TOWARD EUROPE is the product of centuries of history. England was last invaded successfully in 1066, by William the Conqueror. It traces its democratic traditions back to the signing of the Magna Carta by King John in 1215 and takes pride in having bequeathed parliamentary democracy to countries around the globe. The U.K. needs to quit the EU to preserve those traditions, and the stability and democratic legitimacy they provide, rather than ceding more power to Brussels bureaucrats, Camerons Justice minister, Michael Gove, wrote in February, explaining his decision to break with the prime minister over the referendum: We showed the world what a free people could achieve if they were allowed to govern themselves.
Its no small irony that Winston Churchill, the political lodestar for euroskeptics like Johnson, who has written a biography of the wartime leader, laid the philosophical foundation for the EU. In a speech at the University of Zurich in 1946, the former prime minister called for the creation of a United States of Europe to ensure that the Continents nations would never repeat the horrors of the two world wars. But tellingly, Churchill didnt see a role for the U.K. beyond acting with the U.S. as friends and sponsors of the new Europe. In 1957, when the leaders of Belgium, France, Germany, Italy, Luxembourg and the Netherlands signed the Treaty of Rome to create the European Economic Community, Britain stayed away to preserve its Commonwealth ties and full measure of sovereignty.
The countrys decline relative to the EEC economies, which recovered rapidly from the ravages of World War II, prompted a quick rethink. Thenprime minister Harold Macmillan applied for membership in 1963, only to be vetoed by Frances Charles de Gaulle, who saw Britain as an insular maritime state that would undermine the EECs common agricultural policy and open the door to U.S. domination of Europe. The U.K. finally gained admission in 1973, alongside Denmark and Ireland, and the British public endorsed membership by a two-to-one margin in a 1975 referendum. But the country remained a semidetached member. It refused to join the European Monetary System, an exchange rate mechanism (ERM) launched in 1979 that presaged the euro, and focused its energies on the single market for goods and services, which was championed by prime minister Margaret Thatcher and largely built through the efforts of two British commissioners, Lord Cockfield and Sir Leon Brittan, in the 1980s and early 90s. Thatcher grew increasingly hostile to Europes political ambitions, particularly the drive for monetary union to anchor Germany in the bloc after the fall of the Berlin Wall in 1989. She was brought down the following year by pro-Europeans in her own party who protested her refusal to peg the pound to the ERM. The Conservative schism over Britains role in Europe has never healed.
Whats changed over the past quarter century is the nature of the European experiment and the U.K.s relative economic strength. The Treaty on European Union, signed by leaders in Maastricht in 1992, gave the bloc its modern name and committed members to developing a common foreign policy and common citizenship, and launching a single currency, the euro. The EU expanded in two major waves, bringing in Austria, Finland and Sweden in 1995 and admitting the formerly Communist countries of Central and Eastern Europe a decade later. The EU has eliminated internal border controls among the so-called Schengen group of countries, which now covers all 28 members except the U.K. and Ireland.
The union has effectively fulfilled the worst fears of both Thatcher and de Gaulle. The EU has developed an ambitious political agenda extending far beyond the original Common Market. At the same time, it has stretched its own cohesiveness to the breaking point by opening its arms to so many members of diverse political and cultural traditions. Romano Prodi, a former Italian prime minister and European Commission president, bemoaned the concessions EU leaders made to Cameron at the February summit meeting, writing in a newspaper column, Brussels has officially enshrined a multi-speed Europe.
Many EU insiders rate recent developments as game, set and match to the British, and they struggle to understand why the country would want to leave now. Few countries have ideas of ever closer union, says one senior Brussels official, who spoke on condition of anonymity because of the political sensitivity of the issue. Especially since enlargement, the very idea of a federal Europe is off the table. The U.K. is not at the core of EU policymaking, and it should be the most comfortable one of all.
For Brexit supporters like Gerard Lyons, Johnsons chief economic adviser, the hapless state of the EU is all the more reason to leave. The euro zone has struggled to respond to the debt crisis, and its bailout programs have inflicted deep pain on peripheral countries, especially Greece, he says. EU leaders have failed to promote the kind of growth-oriented reforms that could revive their economies and bring down unemployment. And the bloc has so far proved unable to police its own borders and manage the flow of refugees from war-torn Syria.
The EU is clearly dysfunctional, says Lyons. It fails to address any of the big issues. So you can clearly make the case why you should back out.
WHAT WOULD AN EXIT ENTAIL? If Cameron loses the referendum, he will have to invoke Article 50 of the Treaty on European Union, informing other capitals of the U.K.s intention to withdraw. That would trigger two years of negotiations to redefine Britains relationship with the union, including the critical question of access to the EUs single market.
Cameron would have three basic options in those talks. He could seek the same status as Norway, which is not an EU member but enjoys full access to the single market. But Norway has to accept the EUs rules and regulations without having any say in shaping them, and it contributes to the Brussels budget in other words, taxation without representation, not exactly a winning motto for 21st-century Britain. Second, he could pursue the Swiss option: Switzerland has a web of sectoral agreements with the EU that give its companies access to the single market, and it isnt bound by EU court decisions, but the arrangement doesnt cover services, and that makes it a virtual nonstarter for the U.K. with its massive banking, insurance, accounting and consulting industries.
Camerons only real option is to negotiate a customized deal. Brexit advocates insist the U.K. should have nothing to fear. Continental companies like Bayerische Motoren Werke and Volkswagen have too much at stake in the British market to allow the EU to erect trade barriers, they say. And globally, the U.K. should be able to negotiate trade pacts with the U.S. and major Asian economies that are at least as favorable as the EUs existing arrangements, Brexit supporters contend, pointing to Singapore and South Korea as small but dynamic role models. Outside the union we will remain a liberal, open trading nation, says Ryan Bourne, director of public policy at the Institute of Economic Affairs, a free-market think tank long critical of the EU.
Union supporters dismiss such talk as wishful thinking. Its a mistake to think once you are out you can have a pretty good agreement on trade with the EU and the rest of the world, says Jean-Claude Piris, a Brussels-based consultant who served as chief legal counsel to the EUs Council of Ministers from 1988 to 2010. It will take a number of years, and it will be awfully difficult. Although Britain enjoys far more economic and political clout than Norway or Switzerland, the unions fragile condition will prevent Merkel, French President François Hollande and other EU leaders from cutting Cameron a sweetheart deal. You would open the door for Sweden, Denmark, the Czech Republic, Hungary and Poland to ask for the same things, Piris says. They will never accept that because that would be the end of the European Union.
The prospect of a contentious referendum campaign and potentially protracted Brexit process is stoking concern in the City of London. You will have two to three years of intense negotiations and massive uncertainty, which will affect the U.K. economy, Daniel Pinto, the London-based CEO of JPMorgan Chase & Co.s corporate and investment bank, said at a February 23 investor presentation in New York. It may be good or bad in the long term, but in the short term the amount of uncertainty will be really bad for everyone.
RBSs Davies worries about the domestic political fallout of a Brexit vote. Anti-EU sentiment is largely an English phenomenon, and a vote for Brexit would prompt Scotland to hold a fresh referendum on independence, the regions first minister, Nicola Sturgeon, has said. Former prime minister Tony Blair recently predicted that Scottish independence would carry the day. In his mind a vote for Brexit is tantamount to a vote to dissolve the U.K.
For RBS, which is based in Edinburgh but has major operations in London, the Brexit referendum threatens to revive the issue of where the bank should be domiciled. That would be a material risk for us, says Davies.
City opinion is far from monolithic on the subject of Europe, though. For some executives warnings that Brexit would trigger market turmoil and economic losses sound eerily familiar to arguments that establishment figures made in favor of adopting the single currency in the late 1990s. The City thought that if Britain didnt join the euro, London would lose out, Johnson adviser Lyons says. These guys really dont have a track record.
Helena Morrissey, CEO of Newton Investment Management, a £47 billion ($66 billion) London-based arm of Bank of New York Mellon Corp., is one of the more prominent Brexit supporters. She began advocating withdrawal three years ago, saying the EU lacked democratic legitimacy, and she regards fears about Londons future as overblown. There are lots of reasons why companies come to London and to the U.K. to do business, she said at a public forum on Brexit last fall. We live in a global world; we dont live in a little European neck of the woods. We have to compete globally.
Other executives express ambivalence about EU membership even as they acknowledge its importance for Londons financial institutions and the broader U.K. economy.
Im fairly torn myself, says Charles Dumas, chairman and chief economist of Lombard Street Research. Most EU endeavors, from the euro to the common border policy, have turned out badly, he contends. Although Britain could suffer trade losses outside the union, he says, the stakes are far lower than they were in the late 1990s, when the Blair government was pondering whether to join the euro and decided wisely, in Dumas view to demur.
For Dumas the referendum is more a question of political and cultural affinity. He has little time for strident nationalists like Nigel Farage, the U.K. Independence Party leader and a longtime advocate of British withdrawal from the EU. I dont want this country to be run by the sort of people who hate Europeans, he says.
Which way will Britons swing? If the Scottish referendum of 2014 is any guide, voters will stick with the status quo and vote to remain in the union, says David Page, an economist at AXA Investment Managers in London. Although some polls during that campaign showed a surge in support for independence, spooking markets and knocking the pound and British equities, the initiative was defeated comfortably, with 55.3 percent of voters rejecting it. Page cautions, though, that polls proved very unreliable before the Scottish vote and during the U.K.s general election campaign last year, and they could generate serious market volatility between now and June.
Geopolitical events could be a wild card. Sources say Cameron was eager to hold the referendum in June, before migrant waves from the Middle East and North Africa typically crest in Europe, but theres no guarantee that Syrian refugees will respect his timetable. The debate about the EU really boils down to how you feel about immigration, says Citis Saunders. People who put immigration first want to get out. People who put the economy first want to stay in.
Voter participation could play a big role in whether Brexit succeeds. Sergio Ermotti, CEO of UBS, worries that a low turnout will favor the exit camp because anti-EU voters are more motivated. This could be a turnout election, and in that case we could be in very dangerous territory, he said at a recent discussion panel in London.
Lord Levene, a City eminence who is vice chairman of insurer Starr International Co. and sits as a Conservative member in the House of Lords, is putting his faith in David Cameron. The prime minister played a blinder in last years general election, he says, exceeding all expectations to win a resounding majority when many polls had suggested a hung Parliament was more likely.
Yet Levene regrets that Cameron got into this situation in the first place by promising a vote on EU membership back in 2013. I would rather that we wouldnt have a referendum, that we just carry on as we are, he says. Levene sits on the board of Eurotunnel Group, operator of the Channel Tunnel between England and France, and marvels at how the system transports millions of people between the U.K. and the Continent. More and more U.K. companies are doing business in Europe, and foreign companies see Britain as a good place to operate because of its links to the EU. Do we want to disturb all that? he asks.
For Britain and the EU, theres no bigger question.
Follow Tom Buerkle on Twitter at @tombuerkle.