Blog: The consequences of Brexit

Bruce Stephen is a partner and head of banking and financial services at Brodies LLP.

BANKING & FINANCE: BREXIT

We have been considering with clients the impact of a Brexit vote in the forthcoming EU referendum on 23 June. The outcome will have a direct impact on businesses in the financial services sector in the UK and Scotland, as well as those in the wider economy who obtain finance or debt either through lenders (banks and other funders) or capital markets. We have set out below some of our combined experience and understanding in this area, drawing on our strengths in financial services, our knowledge of the Scottish market and economy, and the expertise of our cutting edge public law team. More updates to follow.

Flagging key EU law in your sector

There is a raft of EU legislation that impacts upon regulated industries such as the financial services sector, including banking, insurance, investment services and financial products or funds. Leaving the EU would change the basis on which these entities operate across Europe. In the event of Brexit, UK firms that have been ‘passported’ into other EU member states and operate in these additional jurisdictions (on the basis of much lighter regulation provided that they comply with main UK regulator requirements) would likely be faced with additional local regulation. They would, potentially, have to set up independently-regulated branches or subsidiaries in each country in which they operate in the rEU. The removal of the current ‘passporting’ arrangements would affect licences and authorisations for banks as well as ongoing regulatory compliance requirements, such as capital requirements currently subject to EU regulation. Detailed rules applicable to products such as consumer finance contracts and mortgages are heavily influenced by EU law. At the very least a divergence of rules may affect access to rEU customers.

The extent of the impact would be heavily influenced by the form of trade and regulatory rules established between UK and rEU following Brexit.

Options include:

• trading under the WTO rules;

• a customs union (like Turkey);

• entering into a number of bilateral agreements with individual trade partners (like Switzerland); or

• entering into an agreement to conform with certain key aspects of EU law while being outside the EU (such as Norway).

While compensation schemes in respect of funds held on deposit operate on a national basis, they are subject to a EU framework.

Currently, the UK is on track for further integration across Europe, including in the area of capital markets and their regulation. In September last year, the European Commission adopted an action plan to implement the Capital Markets Union (CMU). The CMU affects a vast range of capital-raising activity, including securitisations involving Scottish assets through the new STS principles (Simple, Transparent and Standardised).

It is designed to improve access to capital while at the same time protecting investors. The shape of the regulations as applied in the UK after a Brexit remains to be seen, however we would assume that the UK would look to follow best practice in order to maintain its status as one of the leaders in Europe in this area.

Identifying where access to/coverage by EU institutions or agreements is, or may be, particularly relevant to clients.

For regulated businesses, changes to the regulation of rEU businesses within the group is likely to be one of the most significant factors affecting their business in the longer-term in the event of a ‘leave’ vote.

For the wider economy and trading businesses, the access to EU markets through current EU membership will be affected and much will depend upon the trade negotiations and deals struck between the UK and rEU. Fluctuations in exchange rates may assist exports, provided demand and confidence is maintained.

Estimating what key changes might be likely in the event of Brexit

• Regulated businesses must consider their regulatory requirements in each member state in which they operate to the extent that the passport regime is restricted or removed.

• Product regulation – this is less likely to have an immediate impact, however divergent regulation across the UK and rEU will impact on compliance costs for those operating beyond the UK.

• The impact on the wider economy and meeting the financing needs of corporate Scotland and businesses more generally.

• As well as considering the potential impact on market conditions for businesses in the UK and changes to the current free movement of goods - people and services rules which are the pillars of EU membership - consideration should also be given to the availability and cost of finance.

• Asset values are likely to be affected, at least in the short-term by uncertainty following a Brexit decision. This may impact on the availability of new finance. To the extent that funders rely upon wholesale markets for liquidity, this may impact on availability funds, so it is important to consider this now. Terms of funding packages should be reviewed for the potential impact of increased costs.

• Management of exchange rate risk and related product prices.

• It is impossible to predict the impact on inward investment to the UK, although investors generally seek investment in relatively stable markets so one factor for the politicians in their discussions will be to achieve a stable environment for business and investment in the UK. Perception of the UK as a bridge into Europe would be affected.

Identifying key threats and opportunities of Brexit for affected sectors

The financial services sector employs over 2.1 million people and accounts for over 11% of economic output, so there can be no doubt of its importance to the UK economy, with Europe being our single biggest export market. Scotland owes 7% of its GDP to the sector. Is there the potential opportunity for Scotland and the rest of the UK to become a more attractive regulatory environment while at the same time maintaining a robust system of market governance and prudent approach, ensuring the market can cope with unforeseen shocks?

There may be investment opportunities and the need to consider the correct locations for businesses’ operations.

Certainly financial services firms should be considering investment mandates and product terms in light of the changing regulatory framework and potential impact on customer base.

Consideration should also need to be given to product marketing arrangements.

Conclusion

The implications of the EU referendum for business are significant, and should be considered now. Plans should be in the process of being formulated with a view to putting your business in the best position going forward (whatever the outcome).

Bruce Stephen can be contacted on 0131 656 0260 or at bruce.stephen@brodies.com