Posted in Brexit
This article was written by King &
Wood Mallesons
A decision to exit the European Union would
fundamentally and irrevocably affect how our clients do business. That impact
would vary tremendously across different sectors. The ramifications of a vote
to leave extend far beyond just the legal considerations; there is a vast array
of issues at play.
Over the past six months, the King & Wood
Mallesons Banking & Finance Team in Europe have been working with clients,
industry leaders, academics and media influencers to offer a 360° view of the
implications of Brexit for businesses. The following guide provides a
background to Brexit and, more importantly, outlines the implications of Brexit
for banking & financial services.
A referendum is being held in the UK on 23 June
to decide whether the UK should leave or remain in the European Union (the EU).
A referendum is a vote where everyone (or nearly everyone) of voting age can
take part, usually giving a “yes” or “no” answer to a question. This particular
referendum is being held because the British Prime Minister, David
Cameron, promised to hold a vote on EU membership if he won the 2015 general
election. The promise was given in response to calls from politicians
that people in the UK had not had a chance to vote on EU membership since
1975.
A lot has changed within the EU since then and it was felt that it
was time to re-evaluate membership. The referendum has triggered frantic
campaigning both by those wanting to leave the EU and those who are determined
that the UK should remain a EU member. “Brexit” (a combination of the
words “Britain” and “exit”) is the shorthand way of referring to Britain
leaving the EU.
What is the EU?
The EU is a group of 28 countries operating a
single market allowing the free movement of goods, capital, services and people
between member states. Twenty two of the EU states have also abolished
border controls along their common borders.
Who wants the UK to leave the EU?
The British public are fairly evenly split according
to the latest opinion polls. The UK Independence Party, which received nearly
13% of votes cast at the last general election, campaigns for Brexit.
About half the politicians within David Cameron’s own Conservative Party are
also in favour of leaving the EU. They believe that the UK is held back
by the EU which, in their view, imposes too many regulations on business and
charges billions of pounds a year in membership fees without giving sufficient
benefits in return. Those in favour of Brexit are also anxious for the UK
to retain control of its own borders and to reduce the number of people from
outside the UK seeking to live permanently within the UK.
One of the main
principles of EU membership is the “free movement” of people within the
EU, meaning that a EU citizen of one country does not need a visa to live
or work in another EU country. People in favour of Brexit are also
nervous about the EU’s objective of “ever closer union”, fearing that this
means a loss of sovereignty for individual states and a move towards the
creation of a single, federal state, rather like the USA.
Who wants the UK to stay within the EU?
Prime Minister David Cameron wants the UK to
remain as a EU state. He points out that he has negotiated a special
status for the UK within the EU, for example by getting a commitment from other
EU states that they will not discriminate against the UK because it has
retained its own currency (the pound) rather than using the euro. He has
also obtained a commitment that the UK will not be expected to be part of the
drive towards the EU’s aim of “ever closer union”. Many members of Mr
Cameron’s cabinet of senior ministers support the “remain” campaign and the
opposition party, Labour, is also supportive. President Obama of the USA
has indicated that he wants to see the UK remain within the EU. The
governments of other EU states (many of which are challenged by “pro-EU exit”
movements within their own jurisdictions) are opposed to Brexit.
Would the UK be better off in or out of the EU?
It is difficult to predict what would happen
following Brexit – there are risks associated both with remaining within and with
leaving the EU. EU membership affects many different aspects of life
within the UK and there is intense debate about the impact of Brexit on each of
those aspects. A very brief description of just some of the arguments is
given below:
Cost of EU membership: Those in favour of Brexit argue that the cost
of EU membership is around £280 million a week – the “remain” campaigners argue
that the economic benefits of membership outweigh the costs.
Global role: Those in favour of Brexit argue that the UK’s
membership of NATO and the UN Security Council are more important, in terms of
defence, than EU membership but “remain” campaigners feel that the UK’s role on
the global stage will be diminished by Brexit.
Trade and economy: “Brexiteers” want UK businesses to be freed
from the expensive burden of EU legislation. They argue that Brexit would
allow the UK to form its own trade alliances without waiting for the EU to
negotiate trade deals on its behalf – trade would continue with other EU
countries notwithstanding any exit. “Remain” campaigners argue that
Brexit would trigger an economic shock and that it could take years to
negotiate independent trade deals.
The Governor of the Bank of England
has warned that Brexit will lead to capital flight and higher interest
rates. Sterling has certainly slid in value in the run up to the
referendum (hence the fear that higher interest rates will be needed in order
to protect the pound). Brexiteers point to the benefits of a low pound
for exporters and highlight the fact that UK Government debt continues to be a
popular investment – “remainers” focus on the risks of inflation and recession.
What would the impact of Brexit be on banking and
financial services?
A lot of cross-border banking within the EU is
made possible by EU legislation. One of the most important pieces of
EU-derived legislation in this area is the Markets in Financial Instruments
Directive (MIFID). Amongst other things, MIFID allows banks in an EU member
state to carry on business and sell services throughout the entire EU without
having to obtain a banking licence in each individual state.
This concept
is called “passporting” and is crucial to the European financial services
industry. Non-EU banks (“third party” banks), including those based in
the PRC, cannot make use of the passporting system unless they access it via a
subsidiary set up within an EU state. If Brexit occurs, third-party banks
may choose to conduct their business via a subsidiary based not in London
(which has, to date, been the preferred location for many banking businesses)
but in a state which is a EU member.
UK banks and financial institutions
would themselves become third-party banks and lose their passporting
rights. Many banks and asset managers based within the UK see passporting
as of vital importance – they want London to remain as a bridge to continental
Europe and for the UK to retain its ability to influence EU policy. The
UK Chancellor has predicted the loss of tens of thousands of jobs within the UK
financial services sector as a result of Brexit. Meanwhile, hedge-fund
managers often favour Brexit – they object to the heavy cost of complying with
EU legislation.
The on-going nervousness about Brexit has had an
impact on banking documentation. Certain real estate financing deals due
to close prior to the referendum may now include a “Brexit clause” –
essentially a material adverse change provision which allows termination of the
contract if Brexit occurs. Some banks have also discussed the inclusion
of a “flexit” clause in loan documentation, allowing them to increase the
interest rate by up to 0.5% if the UK pulls out of the EU. The relevant
borrowers involved in “flexit” discussions have, apparently, been
non-investment grade and involved in industries at particular risk of brexit
(i.e. with a business dependent on EU exports).
More generally, banks using
English law loan agreements have been considering whether clauses in their
documentation will need to change, or may be interpreted differently,
post-Brexit – for example, current EU legislation means that judgments of a
court in one EU Country will generally be recognised in another EU country, so
how will English judgments and jurisdiction clauses be treated if the UK votes
“leave”?
It is, of course, impossible to cover all the
ramifications of Brexit in one short article – it is only possible to give the
briefest overview of some of the issues and arguments. The campaign for
and against Brexit will no doubt continue until the day of the referendum
itself. Further information is available here
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