Brexit – why it’s not all bad for China

Just days after the UK has voted to leave the EU, regret is already surfacing and further dividing a split nation. Everything remains uncertain – from the timeline to the Brexit itself, as it is unclear whether the results of the referendum are legally binding. A long list of procedures must happen for the exit to be followed through, and for the implications to shift from mere anticipation to reality.

Both Europe and the UK have a lot to lose from a poorly executed separation agreement, from a trade perspective and in terms of political stability. The EIU expects all post-Brexit arrangements to be net negative in economic terms. Therefore, it’s in everyone’s interest to have an amicable separation.

As the implications of a full departure become fully realised, and as fears of economic hardship spread, individuals will push for their own economic self-interest. Public perception will be important for how pressure is applied to policymakers. Large corporations will push for single-market access and free labour movement to protect the economy. They are concentrated in the City of London, which is highly influential on UK policy.

Some degree of access to the EU market will continue to be a priority, and a win-win outcome might look more like Switzerland or Norway, which have direct market access without being full EU members.

While the implications of a Brexit are being discussed, markets everywhere are reacting. Though China clearly backed the Remain camp, the result now means that China has to make the most of the situation – and consider why it isn’t all bad.

China is expected to remain strong on the global stage

1. Brexit may allow the UK to operate independently to further strengthen favourable policies in its relationship with China, on a bilateral basis. The UK has openly prioritized China as a key partner. At the same time, China will be able to negotiate with Germany – the most important EU power – simultaneously. The competition may result in more favourable policies for China.
2. What should not be overlooked is that the largest effect on China's economic growth trajectory right now continues to be the recent mini-stimulus efforts to support further fixed asset investment in the economy. Trade between China and the UK is significant, but not to the degree that it is with South Korea, Australia, and other countries. External trade is also no longer a key driver of economic growth in China.
3. The first priority is to ensure that market volatility does not spill over into China. The main task at hand for officials and market leaders is to calm concerns and facilitate (as much as possible) a muted reaction within the domestic stock market. Brexit also means that another interest rate hike by the Fed in the US is very unlikely.
4. There silver lining is with the RMB. With the world’s attention now focused on and diverted to Europe, as well as a stronger US dollar, another window of opportunity has opened for controlled weakening of the RMB to siphon off pent-up pressure to weaken the currency. But after last year’s sudden depreciation of the yuan, we can expect to see concerted efforts to prevent major swings in the RMB/USD exchange rate.
5. The UK was a chief partner and advocate for China in the EU – for issues such as the China-EU free trade deal and pushing for the EU to grant market-economy status to China to avoid anti-dumping duties. However, we need to remember that China also has the ability to pivot its strategy and get closer to Germany. While both the EU and the UK work to limit the fallout from Brexit, both powers will have strong motivation to maintain good relations with China.
6. The results of the vote not only reveal a weakness and deficiency with “direct votes”, but are also being used to boost confidence in the robustness of China’s current policymaking approach.

Chinese firms will still draw interest from the UK and the EU

1. The UK’s relaxed stance on the entry of foreign firms has been important for Chinese companies, in terms of gaining a stepping stone to the EU market for unfettered cross-border access to the EU zone. China may experience some temporary disruption to these channels, but the EU is well-inclined to make sure that such hurdles are cleared up quickly.
2. As banks consider relocating staff to countries in western Europe, London’s position as a global financial centre is at stake. But while major financial institutions are looking at the continent, a wholesale move is constrained by EU regulations such as the Tobin Tax on financial transactions.
3. Companies may look at reducing costs in the UK to cushion against the future economic downturn, causing a slowdown in expansion.
4. Corporates may seek out other options within Europe. The advantages of other European cities as a base for operations will become clearer. Dublin, for example, is a popular location for US company headquarters in Europe. But this strategy must be balanced with the favourability of local regulations and the availability of talent.

Chinese investors in the UK housing market are more likely to gain once the dust settles

1. Many individual investors in China have invested substantial amounts of money into desirable areas of London. These are areas where international highly skilled talents tend to live and work given London’s immense services industry.
2. The UK government has two years to negotiate a policy for EU citizens working there. In the best case scenario, existing workers will be given favourable visa treatment to continue working in the UK. Most likely there would be a point-based system that would favour quality employees. This would limit the weakening of the rental market in London’s prime areas compared to the less expensive areas where more migrant labour is concentrated. However, new demand from skilled employee arrivals would be reduced. Therefore, the net result is still likely to give way to some degree of weakening for the rental market for investors who currently own property there, particularly over the short term as markets remain in a general state of uncertainty.
3. Immense pressure from the EU to speed up the exit would reduce bargaining power to settle on a reasonable immigration policy. The optimal outcome of post-Brexit negotiations would be more of an incremental change in the current set of immigration and trade policies, rather than a “rupture”.
4. One possible course of action is to wait for the London housing market to correct and then buy at a large discount, which would be making the most of an opportune moment. Many investors are sophisticated and will see this as a good buying opportunity. However, upside potential longer term may be reduced as the economic growth potential in the UK will be limited compared to before. Long term investors will still come out ahead, however. At the same time, there remain other key motives for continuing to hold assets in the UK housing market, such as having a place to live and providing a home for children who are educated at UK high schools and/or universities.

Institutional players from China will monitor the situation carefully

1. London is one of the most transparent and liquid real estate markets in the world and was seen to be an extremely low-risk play for Chinese institutional investors. Investing outside of China was motivated by hedging domestic economic risk in China. Though Brexit has challenged all assumptions about risk in the world’s lowest-risk countries, at this time, the UK is still considered to be a relatively safe place for long-term investment.
2. For institutional players who invested billions in London, the values of these assets are only likely to be significantly affected in the short-term by currency volatility. There is larger risk for the medium term, however; uncertainty around the transition timeframe will drag on economic growth and on valuations.
3. Similar to the impact on assets, ambiguity on transition timelines are also likely to have just a short-term impact. Deal flows into the UK over the next two years could be constrained as uncertainty persists and weakened sentiment requires time to recover.

Having looked for the potential bright spots on the current situation, we are acutely aware that the UK is facing pressure to leave promptly. However, the key downside risk to leaving too fast is that the quality of policies drawn up to deal with the transition will be diluted and thus, prolong uncertainty. The choices made in the coming weeks and months will have significant long-term implications that will need to be managed accordingly to offset further disruption to markets.

Steven McCord is Head of Retail Research, Asia, and Head of Research, North China for JLL.