Brexit Exploring the Threats Opportunities

Dr. Priscilla Mifsud Parker co-authored with Sarah Vassallo | 23 Apr 2018

Brexit Exploring the Threats Opportunities

On the 29th March, 2017, a long-standing status quo came to an end as UK Prime Minister Theresa May triggered Article 50 for the first time in the history of the European Union. The UK’s decision to end its relationship as a Member State of the EU has cast uncertainty and doubt not only on future EU-UK relations and what these shall entail for EU & UK nationals living on either side of the English Channel, but also for British businesses which to this day remain in the dark as to what the future holds in terms of trade with its EU Member State counterparts. Unfortunately, much of what one can predict remains in the realm of speculation, relying on future agreements which the UK and the EU may reach – or lack of thereof. Nonetheless, the only certainty we can derive from the wording of the European treaties is that unless an agreement is reached whereby the transition period is extended past the set date, the UK will officially cease to form part of the EU on the 29th March 2019

Brexit - The First Consequences and Developments

Although ‘divorce’ talks have been initiated, the actual process through which the UK will exit the EU is still shrouded in mystery and marred with the political agendas of those involved in the negotiations. Economists predict that a scenario where the UK and the EU do not manage to agree on a deal that is acceptable to both parties might have adverse effects on the economies of all the states concerned. Although this might have a highly undesirable outcome, it is not a scenario that can be ruled out completely, particularly since Prime Minister Theresa May reiterated that ‘no deal is better than a bad deal’.

There are a number of salient issues which will need to be dealt with, primarily the infamous “divorce bill” which the UK will need to honor before it leaves the EU, which numerous sources claimed that these could run into the hundreds of billions of pounds which some putting down a figure of £50bn. Standard & Poor have predicted that failure on the UK’s behalf to honor this financial obligation could have an adverse effect on the EU’s credit rating which currently stands at AA following the downgrade after Britain voted to exit the EU.  While this warning might push European negotiators to assert its stance on the bill, British negotiators have claimed that the bill is too high.

While the UK is pushing for a much-coveted trade deal, pressured by businesses whose livelihoods and prosperity is severely dependent on their ability to market their goods and services freely to the EU member states, Chief Brexit negotiator for the EU Michel Barnier has staunchly reiterated the EU’s position that a customs deal for the future cannot be initiated before the UK makes sufficient progress on issues of citizens’ rights, the cost of leaving and the Northern Ireland - Irish border operations. It is reported that Barnier will disclose to the EU leaders in October 2017 whether the UK has made sufficient progress in the areas to warrant trade talks to open. Political tensions are currently running high as the EU is using a future trade deal as a bargaining chip to secure EU citizens’ rights in the UK. Moreover, although the British government is calling for “a new customs arrangement that facilitates the freest and most frictionless trade possible in goods between the UK and the EU” in a proposal paper for its future partnership with the EU, this arrangement does not seem plausible to many who believe that the UK should not be afforded a deal whereby it enjoys more rights than it would as an EU member state.

From a legal practitioner’s point of view, Brexit will also pose a number of challenges. As soon as the transitory period is over, the law of the EU treaties will seize to apply on the UK, however, this is not as straightforward as it sounds. EU law is not only made up of treaties and regulations to be followed, but it is also created through an extensive network of directives which are transposed into the national legislation of each member state. Thus, unravelling over forty (40) years of complex directives which have embedded themselves in Britain’s national legislation shall neither be an easy feat, nor one which can be settled swiftly. Moreover, the European Court of Justice will lose its jurisdiction to adjudicate in cases where the UK is involved in disputes with other European states, thus an alternative will need to be found.

Brexit - Potential Trade Models – What can be expected? 

Talk of a ‘hard Brexit’ has sent several businesses, particularly financial services firms, in frenzy to find a European domicile in order to avoid losing their Passporting rights. Indeed, one cannot rule out the possibility that the UK would completely separate from the EU with no negotiated access to the EU market. In such an instance, trade between the UK and the EU would be negotiated under the World Trade Organisation (WTO)’s rules. The UK could initially opt to trade with EU as well as non-EU countries under the WTO rules, however, it would lose its special relationship with the EU and any preferential access to the single market. British businesses will be subject to trade tariffs which could potentially have adverse consequences on international trade patterns and domestic prices, thus such a model is generally regarded as the least plausible option that the UK will pursue.

An option which can be considered as a middle ground for both parties would be a bespoke arrangement between the EU and the UK, which might be very befitting considering that this is the first time any EU member state has triggered Article 50. This arrangement would see the UK enter into a bilateral trade agreement with the EU which is similar to the agreements negotiated with countries such as Switzerland and Canada. Switzerland has signed over one hundred and twenty (120) agreements with the EU and has fostered a very robust relationship with the EU based on bilateral agreements. In return, Switzerland is a contributor to the EU budget and programmes and also adheres to with most legislation governing the single market and adheres to free movement of people.  

Another interesting model is the one adopted under the Canadian free trade agreement which does away with trade tariffs but imposes a number of restrictions on Canadian manufactured goods. If the EU and the UK opt for a trade deal based on the Canadian model, this would not cater to the needs of UK asset managers, investment providers, insurance companies as well as banking and financial institutions, since it does not provide Passporting rights to Canadian financial entities wishing to operate within the EU. Nonetheless, it might still be considered since Canada retains control over immigration policies, an issue which was a driving factor behind the success of the Brexit vote.

To cater for the needs of the UK’s financial services industry, the UK and the EU may also agree on an equivalence regime which would effectively ensure that they retain their Passporting rights without holding a full passport. Under the equivalence regime which exists in the Alternative Investment Fund Managers Directive (AIFMD) and the Markets in Financial Instruments Directive (MiFID 2), the EU would need to formally designate that the UK’s regulatory regime is equivalent to the EU’s. This arrangement would allow asset managers to continue operating as they do today so long as the UK does not significantly deviate from the EU regulatory framework that would warrant the revocation of equivalence.

Another possible model could see the UK adopting a customs union that is similar to the Turkish model. Under this customs union, European and Turkish industrial goods can be exchanged freely.

Alternatively, and perhaps the most straightforward model which the UK could opt for, owing to its shared history with the EU, is the EEA model. This model allows countries such as Norway, Iceland and Liechtenstein to benefit from the most integrated access to the single market; however, it would not be part of the Customs Union. Therefore the UK would lose access to countries which have free trade agreements with the EU. As an EEA treaty signatory, the UK could opt for this model, however, it would still be required to contribute towards the EU budget. It would also have to adhere to legislation which governs the single market while relinquishing its right to vote or veto and allows the free movement of people.

The UK’s latest policy paper on trade with the EU makes it clear that the UK intends to continue its trade talks with other countries but acknowledges that any new arrangements would have to conform with the EU’s transition terms, thus, although there could be room for negotiation, the EEA model might pose more restrictions than the UK would be willing to stand for.

Although there might be several options which the UK may opt for, perhaps even a wholly new, inventive trade model, some are also suggesting that Brexit may not happen at all, including Maltese Prime Minister Joseph Muscat.

Brexit - The Business Implications 

Businesses hate uncertainty, and several British businesses were cast into a long period of scepticism as to what the future will hold for them since the infamous referendum of June 2016 marking the start of Brexit. To this day, sixteen (16) months following the referendum, the EU is yet to start considering initiating trade talks with the UK.  In light of this uncertainty, a small minority number of businesses, particularly in the field of financial services and asset management remain hopeful for a soft Brexit and have not yet executed a strategy in case the Brexit agreement turns sour, despite warnings from Bank of England Governor Mark Carney. However, most key players have decided to take the matter into their own hands and secure unfettered trade with the EU, irrespective of any agreements between the EU and the UK by relocating to a European Member State.

Chief executive Dr Jo Twist for Ukie, a British games industry organisation, made the following comment which perhaps captures the common feeling experienced by several UK based companies in the past months following the referendum: “The triggering of Article 50 signals the beginning of the end of the uncertainty we’ve all been facing since the Referendum last June.”

While there is no doubt that a hard Brexit will certainly impact the financial services and banking industries, the Boston Consulting Group conducted a report which was commissioned by the Association for Financial Markets in Europe which suggests that Small to Medium Enterprises in the UK and the EU are likely to experience the most severe backlash following the disruption caused to the banking sector. Should a hard Brexit leave banks struggling, this could lead to a higher cost of capital for SMEs and more restricted access to wholesale banking services. Indeed, while larger corporations might have the resources and experience to tackle the wholesale banking impacts of a hard Brexit, SMEs will struggle to do so and may find their access to such services restricted. Moreover, the report highlighted a very crucial and worrying fact – 55% of respondent SMEs had not yet made any plans so far for Brexit. 

A special focus on the effects of Brexit on the Financial Services Sector

The post-Brexit future of the European Financial Services industry will greatly depend on any future agreement, or lack of thereof, which shall be agreed upon by the EU and the UK. The UK has firmly established itself as the largest financial centre in Europe and the preferred gateway for numerous non-EU financial institutions using the UK as a hub to access their European clients and the EU market through the highly advantageous Passporting rights.

Brexit might change this, and indeed, a survey by Reuters shows that 10,000 finance-related jobs in the UK will be affected in Brexit’s first wave if the UK is no longer given access to the European single market. The outcome of an EU-UK trade agreement will particularly affect Management Companies whose livelihoods in the UK depend on the retention of their MiFID passports. If no agreement is reached whereby UK-based Management Companies retain their Passporting rights, they would need to set up an EU entity although the MiFID does seek to provide access for third country access for wholesale businesses. The same can be said to other areas of the industry such as insurance and banking.

In fact, the current EU banking regulatory framework, the Capital Requirements Directive, does not provide access to third countries. The regulatory structure of the funds market might need to be overhauled as well since it is highly doubtful whether EU UCITS funds will continue to enjoy access to the UK market. These are all changes which shall redesign the future of the Financial Services sector. 

The Current Brexit Situation- Securing a stable future for European Businesses

As things stand, although the clock is ticking and the date when the UK formally exits the European Union draws near, there is still no concrete way forward with respect to the future form of Brexit, and indeed British Chancellor Hammond has recently admitted that the British Cabinet is split on how Brexit should happen. In her symbolic speech in Florence, Prime Minister Theresa May announced that there should be a transition period of about two years after Brexit, however, the journey to a Brexit deal is still unclear.

In light of this surmounting uncertainty, individuals and businesses alike whose position in the EU or the UK might be compromised following Brexit are already reaching out to legal professionals and Banks to ascertain what their future might look like in a few months.

Unfortunately, there is little which can be forgone, but as an old saying rightly states, prevention is better than cure. A number of entities have opted to wait until there are concrete developments, others are hoping for a soft Brexit whereby their current position will not change. The Bank of England has forewarned against this approach and encouraged businesses to set up a plan for Brexit.

The current situation of uncertainty is highly undesirable for businesses, and the Bank of England warns that unless the negotiations have not reached any agreements on a Brexit transition deal by Christmas, there will be a risk that banks will trigger their contingency plans which would entail a potentially disorderly shift of operations overseas.

Such a disruption will see the banking industry suffer as supervising banks will be a much harder and complex exercise. Should the banks take this approach, other financial services entities may also follow suit.


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