With Brexit In Chaos, Here Is What Goldman Thinks Will Happen Next

With Theresa May suddenly facing a fresh rebellion from within her cabinet, one which many speculate could result in a vote of no confidence as soon as tomorrow, ending her career and pushing the UK and Brexit in chaos, traders are once again asking what happens next.

One answer has just been published by Goldman strategist Adrian Paul who lays out how he sees the next steps in the Brexit withdrawal agreement.

As Paul summarizes the current state of events, while there is now a draft Withdrawal Agreement for the UK’s departure from the EU, it has been roundly criticised in Westminster. But although MPs of different stripes have united in their opposition to the Withdrawal Agreement, there is no consensus on what should replace it. Here, the Goldman analyst writes that relative to his base case, the shape of the Brexit deal looks likely to be in line, and its denouement "looks likely to be later."

According to Paul, if at first pass the deal does not garner a majority in the House of Commons - which now looks increasingly likely -  there are three viable destinations:

  1. a subsequent, successful attempt to pass an amended Withdrawal Agreement;
  2. a second referendum; or
  3. a “no deal” cliff-edge departure.

Goldman then sketches out the possible paths to each destination, warning that some of those paths raise the prospect of a general election. That said, "we are still some way from the Brexit endgame."

Goldman concludes on an optimistic note: "The UK is scheduled to leave the EU at the end of March 2019. Although the risks have intensified, we retain our base case that the House of Commons will ratify a Withdrawal Agreement by then. It is characteristic of European negotiations to come down to the wire."

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Below we lay out the key points from Goldman's note:

1. What are the most contentious aspects of the draft Withdrawal Agreement?

The ‘Irish backstop.’ In some scenarios, this backstop would keep the whole of the UK in a customs union with the EU after Brexit.

The draft Withdrawal Agreement struck between the UK and the EU paves the way to a ‘status quo’ post-Brexit transition period, lasting from March 2019 until at least December 2020. The crucial ingredient – and the bone of contention that has delayed agreement thus far – relates to the ‘Irish backstop.’ The Irish backstop comes into effect if the EU and the UK are unable to agree a comprehensive free trade agreement that would obviate the need for a physical border between Northern Ireland (which is part of the UK) and the Irish Republic (which is part of the EU). Neither the EU nor the UK sees the activation of the Irish backstop as the most likely scenario. But a legally binding Irish backstop is required in the UK’s EU Withdrawal Agreement nonetheless.

The backstop looks likely to have four key characteristics: (i) a UK-wide customs union with the EU, with no supplementary customs union applying only to Northern Ireland; (ii) rules to ensure that the UK and the EU operate on a ‘level playing field’ in
terms of regulatory requirements on goods and services; (iii) no specified expiry date; and (iv) an independent arbitration mechanism to determine when the requisite conditions have been met to allow the UK to exit the mechanism.

Even if the contents of the draft Withdrawal Agreement do not constitute a major surprise, the response with which it has been met in Westminster has raised the risk of a disorderly Brexit.

2. What happens after Cabinet approval?

The denouement comes later, in our view. Probably in December, MPs in the House of Commons will vote on the Withdrawal Agreement. There, the Prime Minister carries a very slim majority.

In concrete terms, there are two domestic hur dles to safe passage of the Withdrawal Agreement. Once the deal is approved by members of the Prime Minister’s Cabinet, it must then be put to the House of Commons for ratification. In our view, neither of  these hurdles is low, but the latter is significantly higher than the former. Yesterday’s vocal opposition to the agreement has, to our mind, significantly raised the hurdle to Commons ratification.

This criticism has come from all quarters of Westminster. It began even before the draft agreement was widely disseminated. A prominent Eurosceptic Conservative MP argued that the draft agreement would bind the UK to rules which it had played no part in designing. A prominent Labour MP argued that, even if the draft agreement did not precipitate a general election, “all options” should remain on the table — including a second EU referendum, perhaps with “Remain” on the ballot. A prominent member of the Democratic Unionist Party (the DUP) argued that the draft agreement could “lead to the break-up of the UK…and is not something we can support”.

The breadth of this dissent matters. When it comes to ratification in the House of Commons, any one of a handful of factions in Parliament — be it the Eurosceptic Conservative MPs, the pro-EU Conservative MPs, the bulk of Labour MPs, or the DUP’s ten MPs — is influential enough to vote down the Withdrawal Agreement. To the extent that the critics of the Prime Minister’s negotiating stance have adopted a united front in recent days, this has raised the risk of a more protracted endgame.

3. How do the numbers look in the House of Commons?

The parliamentary arithmetic has looked tight for some time. It now looks tighter, given signs of greater unity among those who object to the draft Agreement.

The parliamentary arithmetic has looked tight for some time. For a working government majority, PM May relies on 10 MPs from the DUP. Assuming the Speaker and two Deputy Speakers do not vote, assuming Sinn Fein MPs do not take their seats at Westminster, and assuming only a few Labour MPs cross party lines, a handful of Conservative MPs is all that is required to vote down the Withdrawal Agreement.

Added to this, in recent days, one prominent Conservative MP resigned from his ministerial post. The former Minister for Transport published a critique of the government’s negotiating position, and called for a second referendum.

4. How meaningful is the “meaningful vote”?

This remains unclear. The government has sought to discourage counter-proposals. Opposition MPs have sought the legislative power to propose alternative Brexit paths.

The leaders of four opposition parties — Labour, Plaid Cymru, the Scottish National Party and the Liberal Democrats (which together occupy around 47% of seats in the House of Commons) — wrote to the Prime Minister yesterday, urging her to offer Parliament a “truly meaningful vote” on any Withdrawal Agreement.

The letter comes against the backdrop of written communication between the Brexit Secretary and all sitting MPs back in October. In that letter, the Brexit Secretary asserted that Parliament’s “meaningful vote” on the exit treaty negotiated between the EU and the UK must be “unequivocal”, and thereby “clear to the British public”.

By contrast, yesterday’s letter from opposition leaders asserts that, at a minimum, MPs must be allowed to table “multiple amendments” to the main motion by which the Withdrawal Agreement would be passed. In particular, the group of four signatories argued that “it would be reckless to present this vote as a take-it-or-leave-it without Parliament being able to suggest an alternative”.

The scope of the “meaningful vote” remains unresolved. But it accentuates the risk of a disorderly Brexit. The amendments tabled by MPs may advocate for a second referendum, or a different version of withdrawal, even if the EU does not signal a willingness to re-open negotiations. The more meaningful the “meaningful vote”, the wider the spectrum of scenarios that could follow once the Withdrawal Agreement is presented to Parliament.

5. What happens if Parliament votes down the deal?

We see three viable destinations : (i) a subsequent, successful attempt to pass an amended Withdrawal Agreement; (ii) a second referendum; or (iii) a “no deal” cliff-edge departure. The path to one or more of these destinations could involve a general election.

We see three viable destinations. Each destination could be reached via multiple paths.

Destination 1: A successful, second attempt in Parliament. Presumably, this would require some amendments to the current Withdrawal Agreement. The response of companies, households and financial markets to a fraught political environment may also affect the stance taken by those MPs who vote down the initial deal.

Amendments to the Agreement could arise via three routes:

Either: (1a) Theresa May continues as PM. She negotiates a different exit treaty with the EU, which then garners a majority in the House of Commons, under its current composition;

Or: (1b) Theresa May is replaced as PM, but there is no general election. A new Conservative PM negotiates a different exit treaty with the EU, which then garners a majority in the House of Commons, under its current composition;

Or: (1c) Theresa May either resigns as PM, or is replaced as PM, and there is a general election. A new Prime Minister — from whichever party — negotiates a different exit treaty with the EU, which garners a majority in the House of Commons, under a different composition.

The UK leaves the EU on 29 March 2019 with a Withdrawal Agreement.

Destination 2: A second referendum. This would require a more fundamental change in policy stance, on the part of both major parties. Senior ministers in the Conservative Party have, thus far, ruled out the possibility of a second referendum, ostensibly as a matter of principle. Senior ministers in the Labour Party have prioritised a general election over a second referendum, arguing that a new government should come to power if PM May cannot deliver a workable deal.

A second referendum could arise via three routes:

Either: (2a) The current government tables a motion to legislate for a second referendum. This motion garners a majority in the House of Commons, under its current composition;

Or: (2b) A coalition of opposition MPs joins with a minority of Conservative MPs. This coalition garners a majority in the House of Commons, under its current composition. The political momentum behind a second referendum intensifies. Theresa May calls a second referendum;

Or: (2c) A new general election returns a government that has either campaigned for a second referendum, or decides to call a second referendum after taking office.

Assuming the EU grants the UK an extension to the Article 50 deadline, the UK does not leave the EU on 29 March. A second referendum takes place in 2019. Other complications arise. It would not be straigthforward for Parliament to determine how the options in a second referendum shoud be specified, precisely. And there would be disagreement about whether the option to “Remain” could appear on the ballot paper.

Destination 3: A “no deal” cliff-edge departure. Suppose that, irrespective of the government of the day, Article 50 is not extended. The UK would move directly to WTO tariffs in its trade with the EU. Non-tariff barriers would come into force.

A “no deal” cliff-edge departure could arise via two routes:

Either: (3a) No new exit treaty can be reached between the UK and the EU;

Or: (3b) An amended exit treaty again fails to garner a majority in the House of Commons, irrespective of its composition.

The UK leaves the EU on 29 March 2019 with a “bare bones” agreement. This is a far cry from the ‘status quo’ transition embodied in the current draft Withdrawal Agreement.

6. Where are the risks to our base case?

Relative to our base case, the shape of the Withdrawal Agreement looks broadly in line. Its discontents look likely to be more united. And its denouement looks likely to be later.  This raises the risks appreciably. But we are some way from the endgame.

All in all, we maintain our base case that the Withdrawal Agreement struck between the EU and the UK will be ratified by the House of Commons by the end of the year, and ratified by the European Parliament before the end of March 2019.

The risks to that view have clearly intensified.

Within our base case, an ‘Irish backstop’ in which the entire UK remains within a customs union with the EU — even if that backstop were never to be triggered — raises the prospect of a Brexit end-state involving permanent customs union membership.

Off our base case, we see a successful, second attempt to pass a Withdrawal Agreement through Parliament as more likely than a second referendum. In turn, we see a second referendum as more likely than a “no deal” cliff-edge departure.

To be sure, several of the paths to the destinations we sketch out above raise the prospect of a general election in the next six months. Indeed, it has been precisely that prospect of a general election that PM May’s government has used in crucial votes in the past to assuage potential backbench dissent.

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Got all that? No? Then here is a "simple" schematic summarizing most of the above in just one chart.

And now armed with all the latest hot takes, go out there and try make money trading the pound. Good luck.