Part V Legal and Conduct Risk in Interconnected Financial Markets, 19 ‘Brexit’
Roger Mccormick, Chris Stears
Roger McCormick, Chris Stears
- Banks and cross-border issues
19.01 On 23 June 2016, a referendum was held in the UK on the question of whether the country should remain in, or leave, the European Union. The majority voted to leave. Nine months later, on 29 March 2017, the UK formally served notice of its intention to leave the EU pursuant to Article 50(2) of the Treaty of Lisbon. The expression ‘Brexit’ has become the accepted shorthand for the UK’s departure from the EU. The serving of the Article 50 notice triggered a two-year period during which the UK and other members of the EU have the opportunity to negotiate the terms on which the UK departs. At the time of writing, that negotiation (the ‘Brexit negotiation’) is ongoing and there is virtually no clarity as to what the outcome will be. Whether reference is made to Theresa May’s Lancaster House speech on 17 January 20171 or the UK Government white paper2 that shortly followed, there is little to assist a detailed analysis of the legal and conduct risk implications of Brexit on the financial markets. We are told that the UK will not be seeking to remain in either the Customs Union or the Single Market,3 although a free trade agreement may ‘take in elements of current Single Market arrangements’.4 There has been speculation as to the possibility of some kind of ‘transition’ or ‘implementation’ period being agreed once the two year period expires. This may be for a period of several years but, again, no one knows for certain whether there will be such a period or how long it might last.
19.02 It is, of course, evident that the circumstances described above have resulted in potential change of law risk for the financial markets and especially for institutions (p. 342) that wish to do cross-border business in the EU as it currently stands (including the UK). The risk may not only manifest itself as a direct result of Brexit, but also as an ongoing concern where certain legal rights and obligations, post-Brexit, remain subject to, or at least affected or materially influenced by, European law. For example, while the UK remains in the EU, financial institutions carrying on certain ‘regulated activities’ are afforded so-called ‘passporting’ rights pursuant to which, broadly, they can take advantage of the fact that they are established and appropriately authorized in one Member State to do business in other Member States, without the need for separate permissions or authorizations in those other states.5 If the UK leaves the EU, such passporting rights may be terminated unless the Brexit negotiation results in them being preserved in some way. If they are terminated, this would, of course, have a potentially adverse effect on banks established in the UK wishing to do business in the ‘EU27’6 states and also on banks in the EU27 states to the extent they wish to do business in the UK. Opinions differ as to how important the loss of passporting rights would be in practice. However, a number of banks based in the UK are, at the time of writing, considering moving some business lines to an EU27 state in order to minimize the risk of post-Brexit disruption. For example, on 4 August 2017, RBS announced that it was thinking of using its (existing) Amsterdam office as its ‘post-Brexit EU hub’ and transferring its NatWest Markets arm there. The operation was said to involve 150 people. A number of cities in EU27 states are said to be ‘wooing’ London-based banks to move operations across. This may require firms to apply for authorization and be subject to prudential and conduct regulation by a regulator with which they may not have had a prior relationship. Legal and regulatory risk, as a result of Brexit, may also cause firms to consider forming a subsidiary rather than providing services cross-border or establishing a branch. This will, almost certainly, require the firm to apply for authorization of that legal entity in the jurisdiction, and face the legal and conduct risks resulting from such.
19.03 Aside from moving operations, alternative scenarios for the preservation of passporting rights (or a bespoke arrangement that has—possibly only a vaguely—equivalent effect) have included a so-called ‘equivalence’ determination (or third party passporting), as well as structuring transactions in order to avoid cross-border and/or regulated activity. The legal risk consequences vary. The equivalence option, for example, relies on a determination by the EU Commission (possibly following a vote by EU Member States) having received technical advice from the European Supervisory Authorities.7 The process is lengthy; a favourable (p. 343) determination, while expected, is not assured; and it is not without a degree of political risk. A determination may also be conditional or temporary (and/or the EU Commission may withdraw its approval). These factors conspire to raise the legal risk inherent in such an approach. It should also be borne in mind that the mechanism for an equivalence determination is contained within specific Single Market directives and not all activities are covered. Still, a bespoke model of ‘equivalence’ for the UK, post-Brexit, may be the solution ultimately negotiated.
19.04 On the transactional side, Brexit-related legal risk has caused firms to review their contractual rights and obligations, specifically in regard to cross-border business. The need to mitigate, by way of express contractual terms, the risk that events beyond the parties’ control may adversely affect their ability to perform contractual obligations or the costs of doing so, is not new. Having recourse to a contractual right to terminate or renegotiate terms in certain such circumstances is an almost ubiquitous option for parties to commercial contracts. However, Brexit-related events may fall outside the scope of such clauses. In the case of force majeure clauses, for example, one might ask: If the party looking to rely on such a clause had the opportunity to make provision for a Brexit ‘trigger event’ at the time the contract was settled and failed to so provide, can the event be said to have been outside the control of the party—that party having taken all reasonable steps to avoid its effect? Can a Brexit event be considered ‘temporary’, permitting the cessation of rights/obligations during this time (or termination and/or renegotiation), when force majeure clauses generally assume a transient impact on performance? Further, a change in economic conditions or the market due to a Brexit event would arguably not fall within the parameters of a force majeure clause. Material adverse change (MAC) clauses may provide some assistance, but these tend to provide for more specific events—such as a change in the credit risk profile of a counterparty. But, like force majeure clauses, MAC terms may fail to respond in circumstances where the party was aware of the risk prior to the contract coming into force. This could conceivably include Brexit events. Other contractual provisions such as ‘compliance with the law’ (such as a loss of regulatory permission—or a ‘passport’—to carry on the activities contractually required), change of control and specific termination wording, will also have to be reviewed in light of Brexit risk. Of course, the above is highly speculative. Whether contractual terms give rise to Brexit-related legal risk (and how they will respond) will depend on the wording. Relying on implied terms, a favourable interpretation, or the common law of frustration may be considered too risky.
19.05 ‘Passporting’ issues are not the only potential change in law risks raised by Brexit. A number of others are, for example, covered in papers on the FMLC website. For the purposes of this book, we have not thought it appropriate to provide a detailed account of ‘Brexit risk’ issues. The area is fraught with politics and objective analysis of these risks is almost impossible to undertake with any confidence, given that every issue is heavily dependent on the outcome of the Brexit (p. 344) negotiation. However, it is equally impossible to ignore Brexit altogether. It provides an excellent example of the need for extensive contingency planning, both by market participants and by the lawmakers and regulatory authorities.8 There is every possibility of an important issue affecting the orderly operation of the markets being overlooked as the Brexit negotiation comes to a conclusion with consequent effect on the text of legislation and the desirability of being able to ‘fix’ problem areas swiftly and efficiently. There is, of course, a danger that one or more parties to the Brexit negotiation will seek to gain short-term political advantage at the expense of what markets would regard as a ‘common sense outcome’. But the need for good faith and a common understanding of the importance of enabling the financial markets to function as intended will, it is hoped, be seen as paramount. As of the end of 2017, there are indeed interesting times ahead.