Introduction

Sometimes, I sit and wonder if the Clash saw this one coming back in 1981. In recent months, Brexit, that is the possible exit of the United Kingdom ("UK") from the European Union ("EU"), has been making headlines worldwide. On June 23, 2016, the UK will hold a historic referendum, the outcome of which will undeniably have an impact on business globally. The question: "Should the UK remain a member of the EU or leave the EU?"

A large majority of participants in the financial services industry have been particularly outspoken about their opposition to a withdrawal. Mark Carney, the esteemed governor of the Bank of England, has equally issued a warning that the forthcoming vote poses a genuine risk to the UK economy. Yet, the opinion polls suggest that the "stay" lead is narrowing. The Brexit poll of the Financial Times has the "stay" campaign ahead of the "leave" campaign by 47% to 41%[1]. While the referendum question is itself quite simple, gauging the potential knock-on effects following a "leave" vote is not entirely straightforward. One of the obstacles is that there is no useful template on how to withdraw from the EU[2]. While a basic withdrawal mechanism is set out in the Treaty on European Union[3] ("TEU"), it remains untested. As such, the UK and the EU would be forced to navigate in unchartered territory for an indeterminate period of time while an orderly and mutually agreeable exit is negotiated. Given the symbiotic legal framework in place, this could take up to ten years. Another complication is that, until we know the model of the post-Brexit relationship between the UK and the EU, the full extent of the repercussions on business are challenging to forecast. There is, however, a consensus among the likes of the International Monetary Fund and the Organisation for Economic Co-operation and Development (OECD) that a Brexit would trigger a period of uncertainty and instability which, in turn, would cause market volatility.

There is no shortage of literature on this topic in the European and English press. Because the world today is so interconnected, it would be short-sighted to think that a Brexit would not have ramifications outside of Europe. Given the long standing economic ties between Canada and the UK, the impact on Canadian business and trade would be unquestionable, albeit challenging to qualify at the moment. Though we are by no stretch of the imagination experts on European law, we thought that it may be useful to share our preliminary thoughts on these potential impacts with a Canadian audience. Hopefully, this will encourage informed discussion on this side of the pond. This article focuses on two key considerations that Canadian businesses should be mindful of, the first relates broadly to trade and the second to the ability of Canadian financial institutions to carry out operations in the UK and the EU going forward.

Bilateral Trade in Numbers

To focus the mind, we thought that it may be useful at the outset to provide some telling data in respect of bilateral trade between Canada and the UK and the EU, respectively. The aim is to highlight the magnitude of what may be at stake. The UK is by far Canada’s most important trade partner in Europe and ranks third after the United States and China. The EU, taken as a whole (including the UK), is Canada’s second largest trading partner, after the United States. In 2013, bilateral trade between Canada and the UK reached over $22 billion and bilateral trade between Canada and the EU reached over $86 billion. The EU, with its 28 member states, a population of 500 million people and annual economic activity of almost $18 trillion, is the world’s largest economy by some measure.

CETA: The Sleeping Giant

For the better part of seven years, Canada and the EU have been involved in protracted negotiations over a monumental free trade agreement, the Canada-European Union Comprehensive Economic and Trade Agreement ("CETA"). CETA is being hyped (certainly here in Canada) as a game-changer for our fragile economy. To put things in perspective, CETA would dwarf the North American Free Trade Agreement. CETA covers almost all trade sectors, namely tariffs, product standards, investment and professional certification. It is expected that bilateral trade in goods and services will increase by up to twenty percent as a result of CETA. On February 29, 2016, the Canadian Minister of International Trade announced that the legal review of CETA was finally complete. The hope now is that CETA will come into force at some point in 2017, once the translation process is completed and all necessary ratifications are obtained.

Canada may need to keep its umbrella and wellingtons handy because there could be rain on its parade. If the UK ceases to be a party to CETA post-Brexit, Canada would need to do some damage control in a very fiddly situation. Canada could be daring, for a change. It could attempt to renegotiate improved CETA terms with the EU. It could rightly argue that the existing deal is significantly less attractive without the UK, its largest European trading partner. Canada’s bargaining power would be questionable, but it may be worth a go. For example, Canada could attempt to persuade the EU that CETA is not only the best deal on the table, it is the only one. The Transatlantic Trade and Investment Partnership ("TTIP") currently being negotiated between the US and the EU may not be such a foregone conclusion after all. Post-Brexit, the US may well prioritize sealing a bilateral agreement with its old mate, the UK. The value of these arguments partially depends on how much credence the EU gives to recent comments made by the US in connection with the Brexit debate (discussed below).

In such a scenario, as a matter of urgency (and in parallel with any renegotiation attempts with the EU), Canada would need to initiate negotiations with the UK for a bilateral trade agreement. This could take some time and resource to finalize. Equally, there is no assurance that Canada would be able to negotiate comparable or better terms bilaterally with the UK than those negotiated with the EU under CETA. Canada also needs to be mindful that the UK may have other fish to fry (no pun intended). In addition to negotiating its orderly exit from, and future relationship with, the EU; the UK may prioritize striking a deal with the likes of the US, India, China, Japan or Australia (the US being the most likely target). Strategically, Canada’s goal should be to beat the US to the punch. This would require finesse to avoid irritating our neighbor to the South. Canada’s luck, in the same way as the UK’s priorities, may just have changed.

In order to reassure voters on the economic viability of a Brexit, the "leave" camp have basically guaranteed a bilateral trade agreement between the UK and the US post-Brexit. Naively, they may have taken for granted the UK's supposedly privileged status with the US. In quite a provocative speech, that has thrown the referendum campaign up in the air, US President, Barack Obama, issued a warning to the UK about the upcoming referendum:

""The UK is going to be in the back of the queue," Obama said, pointing out that the United States was already working on concluding a free trade agreement with the European Union itself, noting that in the current political environment negotiating such deals was a heavy lift. "I think it is fair to say that maybe some point down the line, there might be a UK-US trade agreement but it is not going to happen any time soon," Obama said."[4]

One could speculate interminably about the sincerity of these comments and what stance a subsequent US administration, whether Democrat or Republican, would take. Canada would be well advised to curb any impulse that it may have to take sides in this debate. Too much is at stake for the Canadian economy. As the outcome of the referendum remains uncertain, Canada cannot afford to get it wrong and end up on the wrong side of the fence.

Passporting: the Attraction of the Single Market

Passporting is the system of mutual regulatory recognition allowing financial services firms authorized in one EU member state to operate and carry on business in another EU member state without being obligated to obtain an authorization in each host state. This system applies to numerous areas of financial services, including, without limitation, banking, securities underwriting, derivatives and insurance. Certain Canadian financial institutions likely take advantage of this passporting system. They can use the UK, more particularly London, as a gateway to access the European continent along with its 500 million prospective customers. Given that the passporting system is potentially at risk if the UK withdraws from the EU, Canadian financial institutions will need to be nimble. They should closely monitor the campaign and give careful consideration to contingency planning. If the passporting system were to evaporate, it would be necessary to revisit how their European business will continue to operate going forward. For example, there may be a need to migrate the business (or a portion thereof) and/or employees to another EU financial hub where they could resume enjoying the passporting system and tapping into the single market. Frankfurt, Paris, Dublin or Amsterdam would be logical candidates. Many high profile financial institutions, including HSBC and Goldman Sachs, have already publicly announced that, in the event of a Brexit, they would likely move offices and/or employees elsewhere in the EU.

Maintaining the existing passporting rights in the UK post-Brexit would largely be dependent on the framework chosen by the UK for a future relationship with the EU. Preserving these passporting rights will be no easy task. The EU will likely want to make the process as painful as possible for the UK in order to disincentivize others from following suit. Adopting a Norwegian model as a framework for its post-Brexit future would be one of the more viable options available to the UK. Like Norway, the UK would become a member of the European Economic Area ("EEA") and the European Free Trade Association ("EFTA"). The UK is currently a member of EEA as a result of its membership to the EU. Upon a Brexit, the UK would be able to re-join EEA by joining EFTA. This would allow the UK to retain access to the internal market, but it remains unclear if the existing passporting system would be preserved or susceptible of being negotiated.

Unfortunately for Canadian entities, CETA (as currently drafted) does not address the passporting issue. Although CETA is very broad in scope and covers numerous areas of financial services, it does not contemplate the passporting rights described above. As such, the potential need for Canadian financial institutions to establish a presence elsewhere in the EU would not be circumvented. This is an excellent point for Canada to raise in any renegotiation with the EU. The other issue, is that there could be a gap as CETA may not be in force at the time the UK withdraws from the EU.

EU Withdrawal Procedure and Transition Period

In the event of a "leave" vote, the UK government has already indicated that it would trigger the process under Article 50 of the TEU. Article 50(1) of the TEU provides that any member state may decide to withdraw from the EU in accordance with its own constitutional requirements. Article 50(2) of TEU provides that a member state must notify the European Council of its intention to exit the EU and a withdrawal agreement must be negotiated between the EU and that state. Article 50(3) of the TEU provides that the EU treaties would cease to be applicable to that state from the date of the withdrawal agreement or, failing that, within two years of this notification, unless the state and the European Council both agree to extend the two year period.

As and when a withdrawal agreement comes into force, the EU treaties would cease to apply to the UK. This could theoretically occur before (unlikely) or after the two year period has lapsed. Until such time as the EU treaties cease to apply to the UK, it would remain in the EU and, as such, the existing EU legislation regulating the single market would remain in place (including passporting rights).

Conclusion

It will be fascinating to see where things go from here. Will Mr. Obama’s comments ultimately influence the vote? Will there be a major run on both the pound and the euro leading up to the referendum or post-Brexit? Will London, as a financial hub, implode or flourish? Will CETA and TTIP ever see the light of day? One thing is certain, if in fact there is a Brexit, there will be ramifications that extend well beyond the UK and Europe. Canadian companies, in particular financial services firms, will need to remain vigilant and closely monitor the situation. While the full impact will only be known once the withdrawal framework has been agreed, contingency planning and risk mitigating should be at the forefront of the mind for any Canadian firm having any exposure in the UK or the EU.