See below for a roundup of yesterday’s Brexit news and updates based on our conversations with clients. This includes both political and economic updates and legal and market developments. Please let us know if you'd like to speak about any of this in further detail.
- Leadership of European Commission, Germany, France, and Italy reject prospect of negotiations with United Kingdom before it gives formal notice that it is leaving EU.
- Uncertainty continues over future leadership of UK Conservative and Labour parties.
- Questions persist about whether referendum is sufficient to authorize UK’s departure from EU and Scotland’s leadership vows to preserve relationship with Europe.
- Deal makers and capital markets adopt wait and see attitude.
- Regulators say business as usual, for now, while passporting continues.
Political and economic developments
In Continental Europe
- German Chancellor Merkel, French President Hollande and Italian Prime Minister Renzi have agreed not to push for an immediate British exit from the EU, but they have urged the UK to act “as fast as possible”. All three, along with European Commission President Juncker, have publically rejected the idea of informal negotiations with the UK before Article 50 is invoked.
- Former UK cabinet secretary, Andrew Turnbull, told the Treasury Select Committee today that “if central authorities in Brussels say they won’t talk to us we should find other confidential channels of communication with Europe” and that it would be strategically sensible to delay triggering Article 50. Off the record, British officials in Brussels confirmed that they would probably be pursuing this strategy.
- Merkel has said that a precondition of UK membership in the EU single market would be the acceptance of the four fundamental freedoms of movement (goods, services, labor and capital) and all the rules connected to them. Meanwhile, Boris Johnson has suggested that the UK could remain part of the EU single market without free movement of labor. We have summarized the different possible models for the terms of a Brexit here.
In United Kingdom
- Some constitutional experts have argued that, as a matter of UK law, the Prime Minister is unable to issue a declaration under Article 50 without having been first authorized to do so by an Act of the UK Parliament. That is relevant because it is thought that a majority in the UK Parliament oppose leaving the EU. Experts also said that if the Prime Minister were to attempt to issue an Article 50 declaration before such a statute was passed, the declaration would be legally ineffective as a matter of domestic law and would therefore also fail to comply with the requirements of Article 50 itself. The online petition for a second EU referendum in the UK surpassed 4 million signatures overnight.
- Scotland’s First Minister Nicola Sturgeon has set up a “standing council” of experts to provide her with advice following the Brexit vote. Sturgeon, who is in Brussels today for talks, said she was “utterly determined” to protect Scotland’s relationship with Europe.
- Chancellor George Osborne has quashed rumors that he will run for the leadership of the Conservative Party. Osborne said he would not run as he was “not the person to provide the unity my party needs”. Polling numbers showed that Home Secretary Theresa May (who backed Remain but was not active in the campaign) was narrowly ahead of Boris Johnson in the race to be the next Conservative leader and Prime Minister.
- George Osborne has said that tax rises and spending cuts will be needed to deal with the “shock” to the UK economy caused by leaving the EU. He said such decisions would be taken by the next Prime Minister, adding that his pre-referendum warnings “have started to be borne out by events”.
- A motion of no confidence in Labour leader Jeremy Corbyn has been passed by the party's MPs. The 172-40 vote, which is not binding, follows substantial resignations from the shadow cabinet and calls on Corbyn to quit. Corbyn said the ballot had “no constitutional legitimacy” and said he would not “betray” the members who voted for him by resigning. This leaves Labour MPs and the party leadership in a position of standoff with a possible General Election later in the year.
- Fitch lowered its rating for the UK from AA+ to AA, forecasting an “abrupt slowdown” in growth in the short-term. Moodys cut the UK’s outlook to negative on Friday and S&P downgraded the UK on Monday.
Legal and market developments
Corporate / M&A
- Some sale processes involving UK targets are being temporarily put on hold or are proceeding with caution pending greater certainty in the political and economic climate, as well as clarity from lending banks regarding the availability of sterling-denominated debt.
- The transaction documents of “live” transactions are likely to be scrutinized to assess parties’ respective closing and funding obligations, including the scope of any MAE provisions and, in the case of private equity deals, any fund-level commitments provided in equity commitment letters to support debt drawdown.
- Investors from outside the UK and EU, in particular US corporates with material amounts of trapped cash outside the US as well as USD-denominated PE funds and investors, are expected over time to seek to take advantage of lower company valuations and adjustments in exchange rates to acquire UK and European price-quoted businesses at lower prices. However, there is likely to be a slow-down in deal activity in the short term as investors take stock.
- We also believe that once current market shocks abate, well-placed, strong balance sheet UK and European corporates will both look for M&A and investment opportunities outside of the region to diversify their portfolios, which transactions could take the form of outbound investment or other business combinations with US and Asian companies.
- Existing financing contracts (loans or bonds) are unlikely to default or otherwise be materially adversely affected by the Brexit vote, although there may be some technical adjustments required or advisable. More material adjustments (e.g., around permitted acquisition regimes) will be required upon the UK’s actual exit from the EU (but this is unlikely to be for another 2 years at least).
- There may be opportunities for non-bank credit funds and other debt investors as direct lenders to larger LBO transactions, if banks have reduced appetite to underwrite those transactions (as well as potential opportunities for those funds / investors on the distressed side).
- Investors continue to look for yield in a very low interest rate environment, giving some strength to the investment grade and high yield markets in opportunistic funding situations.
- Given the current volatility in currency, borrowers should review any particular currency-related loan covenants and monitor on an ongoing basis. There is also a potential over the medium to long-term for a negative impact on consolidated income for reporting purposes which will affect both historical results and guidance for 2016 and 2017.
Equity capital markets
- There are not many, if any, live capital markets transactions in the UK as issuers and their advisers were waiting for the outcome of the Brexit vote.
- There were a lot of transactions in preparation but those that were planning to launch shortly after the vote have now been put on hold and we expect to them to remain so until the picture becomes clearer as capital market transactions do not enjoy volatility and uncertainty.
- Issuers and their shareholders that were planning to list in London are now considering other European jurisdictions as listing locations. Those considerations are more relevant for issuers with multi-jurisdictional businesses.
- There will be no immediate change to financial services regulation in the UK in terms of existing regulation and rights under the EU single market directives (such as the passporting right). Nor is there likely to be any immediate change to EU regulations that are coming into effect over the next couple of years (e.g., the Market Abuse Regulation and MiFID 2). This means that on-going regulatory compliance projects will continue, and the same requirements for change in control approvals on transactions will apply at least until the UK formally leaves the EU.
- Regulated financial companies such as banks and insurers will continue to need to meet their regulatory capital requirements. Sustained falls in the markets could affect the regulatory capital ratios of those companies and, if the falls are sufficiently sustained and severe, risk breaching regulatory capital requirements. Also, to the extent those companies have derivative positions (e.g., FX swaps), margin calls could put pressure on the companies’ liquidity.
- Consequences of pressure on companies’ capital could include the need for funding support from parent companies, funds or the markets, as relevant, or restrictions on the payment of dividends in order to shore up regulatory capital positions.
- In the longer term, regulated financial companies that rely on “passports” to access the EU single market will need to consider what business structure will support continued access after the UK leaves the EU if passporting rights cease to be available. For example, this could mean establishing new entities in the EU and the transfer of business and people from the UK to those entities (or transfers to existing EU entities).
- Until the outcome of the Brexit negotiations is implemented, UK competition law will remain unchanged. Both UK and EU competition and merger control law, as well as State aid law, will continue to apply in the UK.
- As regards merger control, in the event that the UK does not reach an agreement with the EU that sees continued application of the EU Merger Regulation, then many deals will become subject to parallel review by the Competition and Markets Authority (CMA) in the UK. Previously they would have benefited from the “one stop shop” principle applicable to EU filings made in Brussels. The CMA’s approach is typically very thorough, and deals that are subject to such an approach may therefore face materially greater regulatory burdens.