Commercial and legal implications of Brexit: a 360⁰ analysis
By Dr. Hanns Christoph Siebold and Dr. Mark C. Hilgard

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On March 22, 2016, AmCham’s Financial Services Committee and the Corporate and Business Law Committee held a joint meeting in Frankfurt am Main at the offices of Squire Patton Boggs (US) LLP. Dr. Jens Rinze, Partner at Squire Patton Boggs, and Sam Hill, CFA and Senior UK Economist at RBC Capital Markets, offered their insights on Brexit in a presentation titled “Commercial and legal implications of a Brexit: a 360° analysis.”

Now that the referendum on June 23, 2016, has actually resulted into a pro-Brexit majority, the aspects presented during the joint committee meeting have become even more relevant. In the article that follows, Rinze begins the analysis by demonstrating that the legal implications of Brexit are myriad and need to be considered for each industry and market participant from all relevant legal perspectives. Hill follows this examination with an economic analysis that addresses a number of commercial aspects of Brexit, starting with the issue of whether Brexit also means Smexit.

Legal implications of Brexit: an introduction

Brexit will affect all industries and have consequences for all companies and professionals situated in the UK and the remaining Member States (MS) of the EU (EU 27). It will also affect market participants situated in other countries around the world that hold interests in the EU or in EU-based entities. And Brexit will have consequences for all products and services produced within or distributed through the UK and EU 27.

In addition, Brexit will have consequences for the international treaties entered into by the EU, including, for example, the more than 100 association agreements, free trade agreements, partnership and cooperation agreements and other international agreements (the most prominent international agreement being the Open Skies Agreement) because the UK is usually involved in such international agreements only in its capacity as a Member State of the EU; accordingly, such international agreements cease to apply to the UK once Brexit becomes effective and the UK ceases to be a Member State of the EU.

Article 50 of the Treaty on the EU

Article 50 (1) provides that each Member State of the EU can, in accordance with its own constitutional rules, decide to cease to be a Member State of the EU.

Article 50 (2) provides that the European Council needs to be notified of such a decision to terminate membership in the EU.

Upon receipt of such notification, the EU will negotiate with such a Member State, addressing “the arrangements for its withdrawal” while “taking account the framework for its future relationship.” The withdrawal agreement between the EU and the UK would be adopted with a qualified majority within the Council. The agreement on the details of the future relationship would need to be adopted separately in accordance with the relevant procedures and majorities – for example, unanimity pursuant to Article 218 (8) of the Treaty on the Functioning of the EU in the case of a future Association Agreement.

Article 50 (3) stipulates that should no such withdrawal agreement between the UK and the EU be concluded, the Treaty on the EU and the Treaty on the Functioning of the EU will no longer apply to the UK two years after receipt of the termination declaration from the UK by the European Council; accordingly, the UK will no longer be a Member State of the EU, and persons and companies domiciled in the UK and products and services originating from or distributed through the UK will no longer enjoy the status of being domiciled in or originating from or distributed through the EU.

This automatic termination rule following the lapse of two years after receipt of the termination declaration (unless unanimously extended) stipulates a well-defined cut for the legal consequences should no other rules be adopted.

Freedom of movement terminated

In principle, membership in the EU means that persons, entities, companies, products and services from Member States of the EU benefit from the principles of the free movement of goods, services, capital, establishment and persons within the entire EU.

Such rights of free movement within the EU not only mean that there are no customs borders, procedures and duties, but also that, in principle, mutual recognition prevails and that Member States are prohibited from directly or indirectly restricting the sale or distribution of goods and services and the movement of capital or persons or the establishment of subsidiaries, branches and other businesses by persons and companies domiciled in another Member State within their territory unless this is justified by important reasons that apply without discrimination to everyone and unless the relevant area is not harmonized through EU law.

As long as Brexit is not in effect, a banking institution or an insurance company established and licensed in the UK in accordance with the harmonized rules adopted on the basis of EU legislation cannot, for example, be barred from providing its services in all other Member States of the EU and cannot be barred from establishing branches or other businesses or subsidiaries in the other Member States of the EU. This will change once Brexit takes effec.

Rules of general application not directly relating to products and producers

In addition, an abundance of EU rules do not directly relate to the mutual recognition of products and producers, but are nevertheless highly relevant to the legal sector. Such rules include, for example, the EU Jurisdiction and Enforcement Regulation 1215/2012. This regulation would cease to be applicable in the UK as EU law should the UK cease to be a Member State of the EU; a consequence of this would be that judgements rendered by English courts would no longer be enforceable in the remaining Member States of the EU in accordance with the rules set out by the regulation. The beneficiaries of court judgements rendered by English courts would have to go through the various domestic recognition proceedings stipulated by the domestic laws of the EU 27.

Furthermore, Council Regulation (EC) No. 1346/2000 of May 29, 2000, on insolvency proceedings and Regulation (EU) 2015/848 of May 20, 2015, on insolvency proceedings (which applies starting on June 26, 2017) would no longer apply in and with respect to the UK. This would mean that the mutual recognition of insolvency proceedings, the barring of a wide jurisdiction for secondary proceedings and the mutual recognition of acquired in rem rights would no longer be applicable with respect to the UK.

Contractual reference to EU persons, companies and products

As a final point, existing and future commercial agreements and other contractual arrangements that contain references to certain persons, counterparties, assets, products or services domiciled or licensed in or originated from a Member State of the EU need to be reviewed and adapted from the Brexit perspective. Apart from specific EU references in contracts, parties need to take into consideration the perspective of each applicable law chosen by the parties or the otherwise applicable general issues of customs duties, licenses, termination rights, increased cost provisions, margin calls, rights to demand placement of collateral, representatives and warranties, events of default and other rights and consequences that might be triggered by Brexit.

The Brexit files: the economics of the UK’s referendum on EU membership

There’s Brexit and then there’s Smexit: That’s Br(itish)-exit from the EU and then the Single Market (S-M)-exit. As portmanteaus go, admittedly, the latter is not a linguistically aesthetic construction, but the Smexit question is one of the big ones when it pertains to the economic and market implications of the UK’s EU referendum on June 23, 2016.

When it comes to the economics of Brexit, Single Market access is seen to be the key factor. However, it appears difficult to avoid reaching the conclusion that it could take a long time, possibly up to two years, before the UK’s EU withdrawal agreement would emerge. The fear for markets is not just the uncertainty about future access to the Single Market in a Brexit scenario, but also the possible extended period of uncertainty about it.

During the time before any deal is reached, it is likely that markets will, temporarily at least, move to discount the scenario of an outcome a long way from full Single Market access, even if that doesn’t ultimately come to fruition. The consequences of this outlook for the economy and for financial markets are summarized below.

Given the circumstances described above, the speakers said they would adopt a scenario that sees the cost of the uncertainty about the post-Brexit UK-EU relationship resulting in the UK economy contracting by 2% to 4% over a two-to-three-year horizon, similar to some previous cyclical downturns.

Postponed investment decisions in light of the uncertain outlook and the subsequent consequences for employment and confidence are some of the channels through which economic costs would be expected to develop. The argument is strong against endorsing estimates at either extreme of the Brexit debate.

Sterling depreciation would be expected to cause a short-term spike in inflation, but in the longer term would more likely run the risk of undershooting the target as spare capacity opens up. A cut in the bank rate “toward zero” would be the first policy-easing option for the Bank of England, followed by a new round of Quantitative Easing (QE) gilt purchases to the extent further stimulus may be required.

For the rest of the EU, Brexit poses questions both about scope for more integration among euro-area members as their share of EU voting weight increases further, but also about the risk of other countries seeking new accommodations. On a country-specific level, Ireland is arguably most exposed with 15% of its exports going to the UK.

In an exit scenario with the economic shock outlined above, one primarily driven through the monetary-policy expectations channel, it could be appropriate for market participants to consider planning to anticipate the effects of a broad 10% to 15% move lower in the sterling exchange rate. The adjustment would be seen happening in weeks rather than months.

For the gilt market, lower risk-free real rates over a longer timeframe would be one factor pulling yields down, particularly with shorter maturities. But with another round of QE gilt purchases, the same reaction could be seen farther along the curve, too. Lower medium-term inflation expectations would also contribute to lower yields, with these effects seen to dominate upward pressure from credit considerations associated with cyclical deterioration in public finances.

hanns.christoph.siebold@morganstanley.com

mhilgard@mayerbrown.com

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