Joanna Perkins, CEO, Financial Markets Law Committee (FMLC), discusses the potentially complicated issues arising from the UK leaving the European Union, and how this may impact the finance industry.
Two alternative visions for a post-Brexit future were set out during the referendum campaigns.
On the one hand, there is the idea of Brexit-as-regeneration. This is an enticing prospect for some service providers who are focused on the domestic, Asian or U.S. markets. On the other hand, there is the idea of Brexit-as-degeneration, an idea born perhaps of the markets’ conventional antipathy to uncertainty and protectionism. While these are two equally unknowable visions of the future, it is the question of Brexit as uncertainty on which the FMLC has focused.
The core issue for any financial business currently doing cross-border business in Europe has mixed operational, legal and regulatory elements. It’s the question of whether a firm can continue to do business across European borders after Brexit. Each affected firm - whether UK, EU or Third Country - is currently wondering whether it will need new authorisations to continue providing services in both the UK and EU, moreover, whether it will require restructuring and/or if establishing a larger presence in a new jurisdiction is needed.
Many financial firms, chiefly based in the UK, worry about the loss of ‘passporting’. If there is no political agreement over transitional arrangements in wholesale investment services, securities issuance, and capital-raising, then affected domestic and foreign firms are relying on a series of complicated regulatory Third Country access regimes embedded in EU law. In these circumstances, the UK’s equivalence may be part of the story, but so too, the discretion of EU agencies and the often-lengthy timetable for decision-making by those agencies. EU based firms also worry about the loss of ‘passporting’ rights into UK markets, however, the expectation is that the UK will provide for regulatory continuity.
Other firms worry about the potential for market fragmentation, loss of liquidity and consequential costs, and volatility which could be associated with market restructuring in the wake of Brexit.
Ancillary to these important operational questions are several others about the legal and regulatory framework. For example, on the British side, it is common to express concern about the following:
• The risk that courts in EU Member States will no longer recognise the jurisdiction and judgments of English courts.
• The loss of those provisions of EU legislation which refer to the authority and discretion of EU institutions.
• The continuity of legacy contracts in a post-Brexit world.
The first of these ideas certainly has some legal merit. It will not be possible for the UK government to unilaterally guarantee the recognition of English jurisdiction and judgments in the rest of the EU once Brexit has removed us from the protective umbrella of EU civil justice measures. In practice, however, some provision for mutual recognition may be possible if the political will is present: this is a possibility the British government has indicated it might pursue. For the time being, it’s a case of wait-and-see.
The second concern has two aspects: interpretive (how will we understand EU-derived law without EU institutions?) and political (what structures will exist in place of the European ones we are familiar with?). In respect of the latter, we should have greater clarity in the Autumn when secondary legislation is scheduled to be laid before Parliament. The third concern could be the most challenging but the least susceptible to a political resolution.
It’s these aspects of Brexit which may trigger contractual terms and doctrines that bring an abrupt - and, in some cases, disorderly - end to financial contracts.
Broadly, the issue is whether Brexit makes the performance of a contract illegal, impracticable or impossible in some way. It’s sometimes said that performance of an obligation, which one has no regulatory permission to perform in a foreign jurisdiction, is either impracticable or illegal and, in those circumstances, the parties must unwind, terminate or walk away from their contract. This is certainly true in principle, but the size of the problem depends on the number of obligations in legacy contracts subject to regulatory permission. Thankfully the number is not huge because it’s the activity of entering into contracts which requires permission, not the performing of them. For example, a market participant normally needs regulatory permission to deal in swaps, but not to perform a payment obligation under a swap contract.
There are, however, exceptions and this is where it’s right to be cautious. Some contracts, such as insurance policies, involve core activities (e.g. claims adjusting) and require regulatory permission, while other contracts require ad-hoc or ancillary servicing. Performance of these servicing obligations, in circumstances where regulatory permission is unavailable, may trigger one of the terms or doctrines in question, but the problem for legacy contracts is not as significant as some have feared.