This report looks at the legal process to be followed if the UK were to decide to leave the European Union (EU). It is one of a series based on our recent webinar/seminar series ‘Helping financial institutions deal with the risks from a changing EU and Brexit’. You can access a recording of one of these events here. If the UK votes to leave the EU in the referendum on 23rd June, we will  hold a further seminar on 29th June (at Cannon Place, London) and a CMS-wide webinar on 5th July.

No Member State has left the EU, so the process of withdrawal is untested and inherently uncertain. Achieving “Brexit” would involve disentangling the UK from complex politico-legal, financial and other relationships and obligations. According to the UK government: “a vote to leave the EU would be the start, not the end, of a process. It could lead up to a decade or more of uncertainty”[1].

Key issues and risks

Withdrawal from the EU requires the UK to secure many new international agreements and arrangements in a variety of different areas. These include –

  • a Withdrawal Agreement with the EU
  • an agreement on a new  relationship with the EU
  • new trade agreements with a large number of non-EU states (because the current EU agreements with third countries will cease to apply to the UK).

There are potential risks and benefits for business in replacing EU membership. There are additional risks and uncertainties posed by the transition process during the period whilst negotiations continue until the new agreements are in operation -

  • There will be a period of years after a referendum vote to leave, when the UK remains a member of the EU and subject to EU law, whilst it negotiates its exit. The referendum itself has no legal effect, and even the giving of notice under Article 50 does not change the UK’s legal position within the EU. UK MEPs and Commissioners will remain in place and the UK will continue to be bound by EU law and the decisions of the ECJ (see below). This period of ‘purgatory’ - between a vote to leave and the date when Brexit takes effect legally (the Brexit date) - will be a difficult time[2] – the parties will be committed to a separation but still bound together. There may be frustration domestically that the ‘vote to leave’ is not implemented more quickly.
  • There will be uncertainty about the outcome of all the different negotiations. Each of these will involve complex issues. At the outset it may well be unclear what terms each party is proposing, let alone what would eventually be agreed.
  • There are risks that the UK may not be able to agree all of these new agreements before the UK exit takes effect (e.g. under the Article 50 procedure). There could then be periods where companies have to operate without either the benefit of current arrangements deriving from the UK’s membership of the EU or the replacement arrangements above. This might result for example in UK trading with the EU and other countries reverting to WTO (on UK exit) until the negotiations had resulted in a new trade agreement.
  • There are concerns that the terms of Article 50 pose a further risk to the UK. If the UK found that more time was needed to complete negotiations, it could not delay the exit taking effect unless it obtained agreement of each and every of the 27 remaining EU states. This places the UK at a considerable disadvantage in that each/any state might well extract a considerable price for agreeing to an extension.

Exiting the EU: the legal process and implications at EU and international levels

The rules for exiting the EU are set out in Article 50 of the Treaty on European Union (“TEU”). The UK Government has made clear that this is the only lawful route available to the UK to withdraw from the EU and is the one which the UK Government would follow[3]. The Prime Minister has also indicated that he would start the process immediately if the UK votes to leave the EU in the June referendum[4]. (Sir Jon Cunliffe (Deputy Governor, Financial Stability, Bank of England) was questioned by the Treasury Select Committee about the merits of the UK delaying the giving of formal notice under Article 50[5]).

The TEU affords the Member State a two year notice period to negotiate and conclude an agreement with the 27 EU Member States. Article 50 provides that within that two year period, that exiting Member State shall conclude an agreement on the arrangements on the withdrawal from the EU. This would need to cover a range of issues and detail arrangements required to sort out the break-up. This includes budget contributions/financial matters and other loose ends.

One particular area of complexity will be the treatment of EU derived rights exercised by individuals and companies – both UK and from other member states (e.g. where a UK bank is exercising passporting rights via an existing branch in an EU country or in relation to EU citizens, without UK nationality, living in the UK). The principle of Article 50 appears to recognise that these rights are not permanent and would cease upon exit, so the question of transitional arrangements and/or grandfathering might be addressed under the withdrawal agreement.

Article 50 makes reference to ‘taking into account the framework’ for the future relationship [of the UK] with the EU[6] but agreement on that issue is not a pre-condition for exit. Indeed, Article 50 suffers from all the problems of an ‘agreement to agree’.

If at the end of the two years, no agreement has been reached as to special withdrawal terms and/or a new relationship, Brexit still takes effect. If that happened, the UK/EU relationship[7] would then, presumably, be no more than the basic terms of pre-existing international arrangements such as WTO and Basel.

In terms of process, before negotiations commence, the European Commission would need to seek a mandate from the European Council (without the UK present). The withdrawal agreement would also require the consent of the European Parliament. The final agreement would have to be agreed by the UK and the enhanced qualified majority among the remaining Member States.

Any extension to the two year notice period would require the agreement of all 27 remaining EU Member States. The UK Government is of the view that it is probable that it would take anextended period (beyond the two year period) to negotiate its exit arrangements from the EU, and also future relationship with the EU. The fact that any extension of the two year notice period would require all 27 remaining EU Member States to agree would mean that any one Member State can veto any request for extension.

The threshold for agreeing a new UK/EU relationship is even higher than for the withdrawal agreement – all 27 EU states must agree and the approval of the European Parliament and some national parliaments of EU states including, in Belgium, no less than 7 Parliamentary Chambers.

The UK currently operates under EU free trade agreements with 53 non-EU states (or third countries) which would cease to be applicable on Brexit. The UK would need to negotiate replacement agreements with each country and potentially to negotiate updated terms for its WTO membership (which involves 161 countries in total).

Exiting the EU: the legal process and implications at the UK level

The UK government has not published any detailed plans[8] as to how it would implement Brexit domestically (the domestic transition). Indeed there are concerns that the UK law-making institutions and the broader legal system are not well prepared to implement a complete break with EU law.

The amount of law and regulation applicable in the UK and derived from EU law has built up over 40 years and is now very large – perhaps 15% or 40% of all UK legislation. The scale of the legal project to bring about this domestic transition is very considerable and has been described as one of the largest legal projects ever undertaken.

Ultimately Brexit would give the UK the freedom to adjust, change or replace completely the rules and requirements which had derived from EU law, but in the short term, at least, it is assumed that the priority will be to move EU derived law/regulation onto a purely domestic basis.

The legislative changes to effect the domestic transition would be passed during the purgatory period but would presumably only take effect on the Brexit date (when the UK ceases to be subject to EU law). The UK government may, however, be under pressure to give some more immediate recognition to the referendum result. This might perhaps involve the European Communities Act 1972 (the ECA) which is the cornerstone domestic legislation for EU law implementation and which introduced the principle of the supremacy of EU law over domestic legislation.

UK legislation to deal with the domestic transition at the Brexit date would need to address many complex legal issues including –

  • Replacing EU law which is currently directly applicable in the UK (for example regulations such as EMIR and level 2 material such as technical standards in the form of Commission Regulations).
  • Putting UK law which implements EU requirements (for example statutory instruments under the ECA and PRA/FCA rules implementing directives such as MiFID and Solvency II) onto a domestic footing.
  • Amending current legislation which reflects EU arrangements that will no longer be applicable at Brexit – such as passporting, mutual recognition or EU wide schemes such as European patents.
  • Giving new powers and responsibilities to UK bodies where these are currently exercised by EU institutions such as EBA, EIOPA, ESMA and the European Commission’s role under Competition and state aid rules.
  • Dealing with the post Brexit interpretation of EU derived legislation. This relates to the principles of interpretation and specifically to judgements of the ECJ – covering judgments pre-dating the referendum, those during the period of purgatory and those after the Brexit date.

The domestic transition project will be challenging partly because of the sheer quantity of UK and EU legislation, delegated instruments, rules and guidance which would need to be reviewed and ‘transitioned’.