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.