Well first thoughts would be - didn't WW2 start on something like the 28th Sept 1939?
I know that depending on what base you play out of, you can sail before the war starts and therefore be ready to attack the british at the outbreak of war.
Also you must remember that even today, alot of the world's merchat fleets sail under the red ensign because of the prestege it gives in terms of maritime safety.
Back then I think something like 60%-70% of the world's merchant shipping sailed under the red ensign, so a ship from Brazil could sail under that ensign and be neutral.
Hope this helps a little.
Just a thought.
When did Canada join the war?
The Canadian flag at the time was almost identical to the british red ensign except that it had a coat of arms in the center.
In the game it is hard to spot this difference from any real range.
If I remember my history correctly it took a few days at least before Canada joined the war on the British side and I have come across Canadian ships in North Sea waters before.
They only gave the Canadians the small and coastal merchants, which is exactly what you found.
I've actually seen a couple of British warships flying the red ensign (not the Canadian flag or any other, I checked the flag with external view as they sank). They were DDs and they happened to be engaging me...it's not my fault that my finger slipped on the fire button...twice (sending them on a one way trip 20,000 leagues under the sea)...