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Analysis: Brexit’s Potential Impact On MRO

Restrictions that limit the ability EU citizens to work in the U.K. could hurt aerospace companies after withdrawal from the EU.

 

Prior to Britain’s referendum on European Union membership, almost every big financial institution outlined the dire economic consequences of a vote to leave. Brexit would cause inflation to rise while living standards fell, said the International Monetary Fund; UK output would be 3% lower by 2020 forecast the Organization for Economic Cooperation and Development (OECD); and the average British family would be £4,300 ($5,600) worse off by 2030, predicted the country’s treasury.

None of the warnings mattered, or if they did, perhaps they only galvanized voters outraged at what they saw as cynical doom-mongering. On a big turnout, 52% opted to leave the EU, a result that prompted the immediate resignation of Prime Minister David Cameron, a 10% fall in the value of the pound and billions wiped off stock markets around the world.

Some of the damage was short-lived. By mid-August, British and European stock markets exceeded their pre-referendum levels, and the UK has a stable government under new leader Theresa May, although the pound continues to struggle at a 30-year low of $1.30. This is bad for UK airlines, as foreign holidays become more expensive for Britons, but potentially beneficial for exporters of aerospace goods and services, such as OEMs and maintenance providers.

One of the biggest, GKN, supplies composite and other components to Boeing and Airbus. Most of the company’s business is outside the UK, so a falling pound should increase profits. “The material impacts on GKN from a weak pound, however, are small,” notes a GKN spokesperson.

This is partly because multinationals like GKN hedge against currency volatility, plus any currency gains can be offset by the higher cost of imported inputs. Most important, aerospace order streams are fixed too far in advance to react quickly to foreign exchange movements.

“There are not going to be any more wings, engines or planes ordered globally because there’s a weak pound,” says Jeegar Kakkad, chief economist for ADS, the trade body for the UK aerospace sector.

But what about maintenance, a sector that could pick up some opportunistic orders as labor rates suddenly become more competitive in the UK? Greg Macleod, managing director of Stansted-based GT Engine Services, says, “the majority of our business is dollar-based, so current market conditions favor us.”

Like most other UK-based maintenance companies, GT does the bulk of its work for British customers, who cannot benefit from a cheaper pound. On top of this, imported spare parts and replacements will become more expensive for UK MRO providers. 

British Manufacturing

Although Brexit has hit the share prices of airlines in continental Europe, and could theoretically damage companies beyond Britain’s borders if it caused a European downturn, it is the UK that will feel the brunt of any knock-on effects.

Excluding airlines and airports, the aerospace sector is worth about £10 billion per year to Britain, according to Oxford Economics. About two-thirds of its sales are in commercial aerospace, and the vast majority of these are earned from exports of goods such as Rolls-Royce engines, wings from Airbus UK and components from GKN. Britain is a signatory to the 1980 Plurilateral Agreement on Trade in Civil Aircraft, which eliminates duties on all civil aircraft and their components. The U.S., EU, Canada and Japan are among other signatories, while China has observer status. Thus, tariff barriers to major markets are not likely to change after Britain leaves the EU.

We’re not as exposed as other parts of UK industry might be,” comments Kakkad.

However, there is a risk that materials not covered by the 1980 agreement—sheet aluminium, for instance—will be hit by tariffs, depending on both the exit terms Britain strikes with Europe on whatever new trade deals it draws up with the rest of the world. These were previously handled by EU negotiators.

“The single market means GKN’s UK operations benefit from the ability to import and export free from tariff and non-tariff barriers, as well as allowing free movement of labor and access to collaborative research funding. We are working with the UK government to ensure that the UK’s new relationship with the EU will protect the interests of British industry and its workers,” says a GKN spokesperson. 

Non-Tariff Barriers

New export and import duties are not the only risk from Brexit. In the June referendum, many voted to restore British sovereignty, but immigration concerns were considered decisive. Specifically, Brexiteers objected to one of the EU’s core principles, the free movement of labor between member states. New Prime Minister May has said that restrictions on freedom of movement must be imposed to respect the spirit of the result.

ADS believes such restrictions would have “significant consequences” for British aerospace. “For high-end innovation, design and engineering, we draw on the best talent from across Europe, and we get them into the UK much easier than from the rest of the world because of free movement of labor,” Kakkad says.

GKN reports that about 10% of its UK workforce is composed of non-British EU nationals and that it “benefits” from free movement of labor. Such positives come not only from full-time employees but also from consultants and problem-solvers who can be flown in at a moment’s notice to resolve emergencies such as a manufacturing stoppage.

At GT Engine Services, however, Macleod is unconcerned. “We do not see this as an issue. Currently, we do not have any non-UK EU nationals working with us, but we employ people from further afield, and by the very nature of the business people are very transient. The personnel with the skill levels we require will always find it easier to travel and work,” he says.

A more serious issue, potentially, is the certification of UK-made parts. This is currently handled by the European Aviation Safety Agency (EASA), an agency of the EU. If the UK were to assume safety and certification responsibilities—as it did before the creation of EASA in 2002—it would take 10 years to create the necessary infrastructure, asserts Kakkad. EASA’s ties to the FAA also speed up certification of parts in the U.S., and it is working on similar bilateral deals with aviation authorities in Japan and China.

“Maintaining access to the certification regime in Europe is absolutely critical, as there is no UK replacement that can get up to speed quickly enough,” Kakkad says.

Thankfully, the chances of Britain leaving EASA are low. The agency’s 32 member states already include four from outside the EU—Iceland, Switzerland, Liechtenstein and Norway—and third-party countries can still apply for certification. 

While Brexit may not end Britain’s EASA membership, there is a serious question about its ongoing participation in European research

Research Funding

Under the European Commission’s Horizon 2020 and other schemes, the UK receives about £1 billion per year in research and innovation funding. Of this, about £700 million goes to universities and the rest to industry. ADS estimates aerospace companies receive about £30 million a year from the latter pot, which may seem small in absolute terms, but it still represents the sector punching above its weight.

Although the aerospace funding that comes from the EU could easily be replaced by grants from the national government, Kakkad is concerned about more than the money involved.

“We must retain access to EU funding pots. It’s partly to shape direction of research to make sure it’s aligned with our industrial priorities,” he says. Collaborative research is also more efficient, he points out. For example, capital investments by Germany in expensive testing equipment such as wind tunnels can free the UK to divert its funds elsewhere.

Human factors must also be considered. A big contingent of aerospace research and lecturing staff at British universities are non-UK EU nationals. If their funding from Europe dries up or if they start needing visas to participate in UK research programs, the chance that they will relocate increases. Losing this knowledge base could in the long term undermine the technological prowess of British aerospace manufacturing. 

Not All Doom and Gloom

Despite some alarming risks, many businesses are confident that Britain will leave the EU in a competent fashion.

“There has been some initial chest-beating from the European leaders, but we are sure post-Brexit negotiations will be mutually beneficial, and common sense will prevail,” says Macleod.

And although few would bet on the country securing a better economic deal than it had as a member, departure is unlikely to be disastrous. That said, expect plenty of politicians and companies to cite “Brexit uncertainty” as a catch-all excuse for any poor performance in the coming years.

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