On June 23, Britain voted to leave the European Union. The repercussions of this unprecedented decision could be felt beyond the UK and Europe, as businesses and investors the world over determine how they will be impacted by Brexit.
The result of the UK referendum on the country's membership in the European Union has quashed hopes of an end to a period of uncertainty for business. Companies based in the UK, the rest of Europe and beyond are still digesting the implications of the result and questioning how any eventual Brexit will impact their existing structures, strategies and operations, as well as future plans for investment.
At this stage, Article 50 of the Lisbon Treaty, which codified the withdrawal rights of EU member states, has yet to be invoked, and there are uncertainties around this process. "Article 50 is a relatively new provision. It was only incorporated into the European Treaties in 2009. It was the first time that any European Treaty had included an express provision about a withdrawal. No one has used it before, so this is unexplored territory," says Sir Nicholas Forwood QC, White & Case counsel in Brussels.
Article 50 specifies that any state withdrawing from the EU should do so in accordance with its own constitutional requirements. As the UK does not have a written constitution, the exit rules are difficult to specify. One immediate issue is the question of whether parliamentary approval must be obtained before the Article 50 notice can be served. With the referendum only being advisory and not legally binding, prior parliamentary approval may be necessary.
The UK government's position is that the Article 50 notice will not be served immediately, despite pressure from certain EU governments to do so.
The key points for withdrawal negotiations include the UK's access to the single market, the grandfathering of the acquired rights of UK citizens and businesses in the rest of the EU, and the rights of citizens and businesses from other member states in the UK.
Banking on Brexit
Of particular concern is the impact that Brexit could have on banking and financial services in the UK. "If financial services companies in the UK lose passporting rights into Europe, that would make it much harder to do business. No one in financial services is going to wait for two years or more to see what the impact of negotiations is, and we could see some organizations migrate at least part of their operations out of London. The downside risks are significant," adds Anthony Hilton, financial editor of the British daily newspapers the Evening Standard and The Independent.
Banking regulations in the UK and Europe are likely to diverge, according to Henning Berger, a White & Case partner in Berlin. "Even if the UK continues to operate within international frameworks, as we expect, there will still be different standards in place and that will be demanding for institutions. Institutions will be looking at restructuring and relocating parts of their businesses, which would involve setting up new entities and applying for new licenses, a process that typically takes up to at least nine months," Berger says.
Uncertainty is the main risk of Brexit to business. "Uncertainty impacts economic growth and business confidence. What is going to happen in the rest of the EU? Let's hope that the EU takes the lead of Germany's chancellor Angela Merkel, who has taken a patient approach and is waiting to see what happens rather than taking sudden actions that can run out of control," says Hilton.
Immediately after the referendum result, the sterling dropped to its lowest point against the dollar in more than three decades. Initial market volatility had a lot to do with the result running against the expectations of investors, who had taken positions in anticipation of the vote being to remain, according to Dr. Martin Lück, BlackRock's chief investment strategist for Germany, Austria and Eastern Europe. He said that there is "too much uncertainty to make predictions in the medium to long term" on what the impacts of Brexit would be on the UK and Europe but that sterling is likely to remain weaker in the medium term at least.
"The UK trade account deficit is sitting at around 7 percent of GDP and the budget deficit is at around 4 percent. So that 11 percent deficit will need to be financed and over the last five years the ownership of UK gilts from abroad has increased substantially. The UK depends on foreign investment to fund deficits, and Brexit won't make that any easier," Lück says. Given that the current climate of uncertainty looks likely to persist for the foreseeable future, capital markets—especially in the UK/ EU—will have to get used to the situation and, until the future becomes clearer, uncertainty will have to be priced into any deals and investments.
"The European capital markets are all dependent on uniform rules that have been established over a number of years. For now, all the rules remain in place, and will do so until the UK has negotiated its exit, but it does mean that financial organizations have to start thinking strategically about what the situation will be in a couple of years and be ready to take appropriate measures in advance as the situation of what that might be becomes clearer over time. One scenario is that there will be some kind of equivalence regime between the UK and the EU, but that will have to be sold to the EU states," says Cenzi Gargaro, a White & Case partner in Paris.
Brexit will create issues for parties with existing long-term contracts. A number of contracts refer to EU territories and EU laws, for example, which could lead to interpretation issues. Transaction and loan agreements could also be affected, although according to Charles Balmain, a partner at White & Case London, it looks unlikely that the referendum result, of itself, will be enough to satisfy a material adverse change or material adverse effect test. "Market standard material adverse change clauses have a high threshold," he says. "At this point it is likely to be far too early to tell if the result of the referendum will have a material adverse effect on a particular borrower or target. There has to be a degree of permanence to the impact on the finances and prospects of the entity in question. It is a highly subjective assessment." Going forward, parties negotiating new contracts will have to consider how Brexit-related risks should be allocated—for the time being at least, against a background of uncertainty over what the new legal landscape will look like and when any changes will occur.
It would be easy to see the uncertainty surrounding Brexit as unique to Britain and the EU, and it is clear that this secession will prove challenging in the near term as both sides negotiate the exit. But in today's interconnected, cross-border business landscape, the ripple effect will undoubtedly be global. The Organisation for Economic Co-operation and Development (OECD), for example, has projected that the UK economy will be nearly 1.5 percentage points smaller in 2018 owing to its decision to leave; more broadly, growth for the OECD—a group of 34 developed nations—will be cut by more than half a point. Businesses around the world must take note as to how Brexit will impact them as the UK forges ahead alone.