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Brexit—What We Know

June 29, 2016

Background

On 23 June 2016, the electorate of the United Kingdom voted to secede from the European Union in an “in - out” referendum. Assuming that the UK government follows this direction, the UK would become the first major Member State to leave the EU (or one of its predecessor forms).[1] The situation can rightly, therefore, be categorised as without precedent and much that has been and will be said and written about the legal implications of “Brexit” in the near future will be mere speculation and conjecture. This note attempts to outline, in the memorable words of Donald Rumsfeld, the “known knowns” and the “known unknowns,” leaving the complete speculation of the “unknown unknowns” to others.

Executive Summary

  • It is the plan of the current government not to commence formal exit negotiations until at least October 2016.
  • The UK will then have two years to negotiate a settlement with the EU, at the end of which if no agreement is made the UK will lose access to the single market and EU laws will have no effect in the UK.
  • Until that point, as things stand, the UK will have access to the single market and the law will remain unchanged.
  • The fast-moving political and constitutional situation of the UK and EU make predictions extremely difficult, but some significant underlying factors are clear.

Known Knowns

Will There Actually Be a Brexit?

What we do know is that 51.89 percent of the UK electorate (or to be more precise, 51.89 percent of the 72 percent of eligible voters which turned out to vote) voted to leave the EU. However, it is important to note that this was only an advisory referendum and is therefore not binding on the UK government. Immediately after the outcome of the referendum became known, the general consensus was that secession was virtually inevitable. However, although secession is still, on balance, the more likely outcome, it is not a foregone conclusion. The UK Prime Minister David Cameron, one of the leading voices behind the “remain” campaign, resigned from office the day after the referendum. In an arguably politically shrewd move, he declined to serve the formal notice himself saying that this should be a task for his successor. In the intervening days, there has also been much press coverage of whether the majority of “leave” voters really thought that a “leave” vote was genuinely a decision to leave the EU or whether it was more a protest vote. Supporters of the view that the narrow margin of victory justifies ignoring the outcome of the referendum assert that (i) the dire economic consequences (sterling at its lowest level in 30 years, £120 billion wiped off the FTSE and the UK downgraded to AA by S&P and Fitch) were not fully understood before the referendum; (ii) there is a threat to the continued union within the United Kingdom arising from the divergence between voting patterns in England and Scotland; (iii) the lack of a clear majority would make such a fundamental, and potentially irreversible, decision inappropriate; and (iv) if the votes are weighted on a basis which gives preference to the younger voter (whose lives will be more affected by the decision), then the outcome would have been very different.

In addition, there is an “e-petition” regime in the UK, introduced in August 2011, which provides that any electronic petition which receives more than 100,000 signatures must be given time in the UK parliament for debate. An e-petition campaign (interestingly, launched by a “leave” supporter weeks ahead of the referendum and demanding that “if the remain or leave vote is less than 60% based on a turnout less than 75% there should be another referendum”) has currently attracted over four million signatories, the highest of any e-petition currently running.

Accordingly, although a Brexit is still the more likely result, there is likely to be some time still before it becomes reality, and there is some continued doubt as to whether it will, in fact, ever happen.

How Will Brexit Be Effected?

The next “fact” is that Article 50 of the Treaty of Lisbon (Treaty) provides the framework for withdrawing from the EU. This would be the first time Article 50 has been invoked (with both Algeria and Greenland leaving before the Treaty was signed). There is an academic argument that the UK could simply repeal the European Communities Act (1972) (the act of parliament providing for the incorporation of European Union law into the domestic law of the UK) as parliament is free to do. However, walking away from all of the UK’s rights and obligations under the Treaty would be interpreted as an inflammatory gesture and jeopardise future negotiations with the EU whilst ending its access to the free market. Additionally, it would mean the UK, a country renowned for its respect for the rule of law, would be walking away from an international treaty, a move that even Nigel Farage (prominent “leave” campaigner, leader of the UK Independence Party and bête noir of the EU) stated that he was not willing to endorse.

Article 50

Article 50 states that any Member State may withdraw if it so chooses.[2] To do this, the Member State has to notify the European Council.[3] The Union must then negotiate and conclude an agreement on behalf of the Union, acting as a qualified majority,[4] after obtaining the consent of the European Parliament. The Member State will have two years to conclude such an agreement, unless the Member State and the European Commission unanimously decide to extend the deadline. There is no provision in Article 50 that contemplates a Member State’s withdrawal or revocation of its notice, once submitted, nor is there a specification of how or when any such notice must be given. Re-entry to the Union requires a unanimous vote of the remaining Member States.

Known Unknowns

Brexit Mechanism

When, how and indeed if the UK will enter negotiations pursuant to Article 50 are still unknown. On the assumption that the UK does intend to leave the EU and abide by the Treaty, it does not look as if the current government intends to invoke Article 50 until perhaps October 2016. The reasoning behind this is both strategic and political. However, as the political and constitutional nature of the UK is more fluid than it has been in living memory, the intention of the government today may very well not be the intention of government tomorrow.

As things stand, the strategic reasoning for not invoking Article 50 immediately is that it would place a backstop date upon EU negotiations and strengthen the bargaining position of the EU. Therefore, the leaders of the successful “leave” campaign are suggesting “informal negotiations” will now commence, the object being to lay the foundations for Article 50 negotiations without a Damoclean deadline hanging over their heads.

The political rationale for not commencing Article 50 negotiations immediately is that the UK’s Prime Minister publically campaigned for the “remain” side. Thus, not only did he fail to convince the electorate of his position and no longer feels his position is tenable, but he is seen by some as unfit to be a part of any future negotiations. Mr. Cameron has announced that he hopes his successor as leader of the Conservative Party, and therefore (as things stand) Prime Minister, will be chosen by the next Conservative Party conference which is due to take place in October, although an important party committee has suggested that a new Prime Minister may be chosen as early as the first week of September. The new leader and Prime Minister will then set the timetable to commence negotiations. It is impossible to say not only who that future leader will be, but also when they will plan to invoke Article 50. Indeed, the shape of EU in October is unknowable, but if it is roughly the same shape as it is now there will no doubt be calls for the UK not to drag its feet when it comes to negotiations. Some representatives of other Member States have already demanded that the UK give notice and begin negotiating immediately, on the grounds that uncertainty is harmful to everyone, although the fact that this call was made in a joint statement by representatives of the six founding members of the EU has in itself caused dissent among the other 21 remaining states.

It is also possible for both the UK and EU to negotiate a deal outside of the Treaty; however, the EU is extremely unlikely to negotiate any deal that undermines one of its own constitutional documents in order to appease a secessionist state. To do so would be to encourage other (near-) secessionists and also undermine the separate arrangements that the EU has with Norway and Switzerland by tolerating free-riding. For example, the EU has not retreated from its position on the free movement of persons even though a Swiss referendum two years ago called for Switzerland to breach the existing agreement with the EU on that point.

In the interest of brevity, this note will not speculate on any of the possible trade deals the UK could strike with the EU besides noting that the trade deal struck by Canada with the EU (seen as particularly favourable, but considerably less complex) took seven years to negotiate. The relationships with Norway and Switzerland in effect subject those states to many of the EU’s rules without providing them a say in the way those rules change in the future; they also subject those states to the kinds of rules regarding the free movement of persons that seem to have been the cause of much of the emotional support in the UK for the vote to leave the EU.

EU Law in the UK

The UK joined the then European Economic Community in 1973 and in the last forty-three years European law has had a significant impact on the legislation and regulation of the UK as UK law and EU law became increasingly more entangled.

A hot topic of the referendum campaign was exactly how much of the UK’s legislation emanates from Westminster and how much is “imposed” from Brussels. Given the complexity of the manner in which the various types of EU law are incorporated into UK law, and the years of interpreting and drafting UK law to be in line with EU law, nobody was able to provide a satisfyingly simple answer. The task of uncoupling EU law from UK law, therefore, looks herculean—especially with a potential two-year time limit. It is also important to note that “UK law” is itself something of a misnomer since, while England and Wales share a single legal system, Scotland and Northern Ireland have their own, distinct legal systems particularly when it comes to issues involving real estate, trusts and insolvency.

EU law has been incorporated into the UK law by EU treaties, directives and primary and secondary UK legislation. To either repeal or replace so much legislation within two years under normal parliamentary conditions (and scrutiny) would be impossible. Additionally, the EU legislation given direct effect and therefore not sitting on the UK statute book will, once the UK leaves, have no effect, leaving large lacunae where there was once law. Then there is the complication of how the UK courts will treat any EU law that remains and has been interpreted by the European Court of Luxembourg (using European legal principles such as proportionality). Not to mention what happens to legislation that would be referred to the European Court for interpretation during the renegotiation period. So far, no convincing (or indeed unconvincing) solution has been offered.

In addition, the UK is a party to the treaty establishing the European Economic Area, which has the potential interpretive effect of maintaining certain aspects of EU law. Presumably, the meaning of this treaty in the current context will also need to be negotiated. Furthermore, the UK has separately submitted (along with numerous other non-Member States) to the jurisdiction of the European Court of Human Rights. Since the views of that court have also been among the things that have displeased certain opponents of the greater European project, the future of the UK’s relationship with the court may soon also become a topic of discussion.

Outside of the legal complexities, any changes will be driven by the treaty or deal the UK reaches with the EU (assuming one can be reached) and this in turn will be driven by political factors. There is a strong argument that much of the EU law will stay in place. It is difficult to envision there being much political will to repeal the vast majority of employment and health and safety regulation. Additionally, the UK will only be able to trade freely within the EU if it adopts the same standards and regulations as that of the rest of the single market.

For financial institutions, there is a cogent argument to suggest it will be plus ça change. Much of this regulation is either based to some degree on UK legislation or other regulations that the UK is unlikely to repeal, such as the Basel III accord. However, for the purpose of the EU regulations (unless the UK can negotiate otherwise), banks will no longer be regarded as “EU Credit Institutions” harming UK banks’ ability to trade and compete with the remaining EU Credit Institutions.

Further, many did not vote to leave the EU just to continue to be bound by those rules without an ability to shape them. For political reasons, it is likely there will be new legislation or repealed “EU legislation,” even if it is not substantive. It is almost impossible to know what laws the “Brexiter” pen will strike out, especially given the vague rhetoric often used by the leave side in relation to EU legislation. This aim of the UK to be seen as reasserting its “sovereignty” will be directly opposed to the EU’s aim of dissuading putative secessionists.

Political and Constitutional Situation in the UK

As the sands shift between the foundations of the UK after the referendum, they may settle beneath a smaller, and less united, kingdom. The vote showed huge disparities between Northern Ireland and Scotland (voting in favour of remain) and Wales and England (voting in favour of leave—especially outside of London). The pro EU vote by the Scots, in a country already politically dominated by a secessionist party (the SNP), led to the SNP leader Nicola Sturgeon immediately suggesting that a second Scottish independence referendum was inevitable and that she would now open channels of communication with Brussels with a view to Scotland remaining in the EU as an independent nation. This would be fraught with difficulty. For one, the EU is loath to promote secession within states. When Scotland held its referendum on the question of independence in 2014, much was made of the fact that Spain would almost certainly veto any such deal to dissuade nationalist sentiment in Catalonia. However, there has to be a difference in European perception between an application from a secessionist and newly independent country which has chosen to divorce itself from an EU member state, and an application from a country which has seceded itself from its Europhobic mother country in order to remain within the EU. If Scotland were to become independent from the UK while remaining a member of the EU (and they have a two-year transitional period in which they might achieve this), there is no question that it could continue to use sterling as its currency. It would make the border between England and Scotland a complicated one, but then we face that issue as between Ireland and Northern Ireland in any event. Currently, Scotland is also home to the UK’s two largest financial institutions, so the outcome of its place in the UK and EU is of particular note. It is also possible that if Edinburgh remains in the EU and London leaves, Edinburgh could regain some of its importance as a financial center.

Republicans in Northern Ireland have started advocating that with UK leaving the EU, Northern Ireland should not only secede from the UK, but unite with the Republic of Ireland: a long-held goal of Northern Irish Republicans. Due to demographic change, half of the counties in Northern Ireland are now majority Catholic. The counties next to the Republic of Ireland voted to remain, as did Belfast.

Further confusing the picture is the political upheaval caused by the vote. With the Prime Minister’s resignation, we do not know which individual will lead the UK through all this change. There have also been calls for a general election before the next scheduled election in 2020 so to avoid the UK being governed again by a Prime Minister who has not won a general election as leader (as was the case when Gordon Brown took over from Tony Blair in 2007). Who would lead the Labour Party if such an election were to take place has also been cast into doubt, with a motion of no confidence being tabled against its leader Jeremy Corbyn, already unpopular amongst his fellow members of parliament, shortly after Mr. Cameron resigned.

Future of the EU

Discontent by a Member State at the EU is not unique to Britain, and there has been much speculation about the “domino effect” caused by such an important member of the union leaving. Anti-immigration politicians in both France and the Netherlands have already called for their own referendum with the Netherlands currently seen as the more likely of the two to exit, although the Netherlands parliament voted down a referendum proposal on 28 June. There have also been calls by remaining Member States to reform the EU fundamentally, with the political leaders of France, Sweden, Czech Republic and Slovakia leading the calls for change.

However, without the UK’s protestations within the union it is also possible that the EU will forge ahead with its plans of ever closer union and become a more homogenous and integrated entity. This would likely require the resolution of issues relating to fiscal policy and democratic representation.

Market and Institutional Response

The markets were unambiguous in their response to the Brexit decision, with £120 billion wiped off the FTSE within its opening hour of trading the day the decision emerged, and sterling reaching a 30-year low. Other European, and indeed global, markets were also hit by the result. However, markets will rally (and already have to a certain extent). They do not give a long-term view of what Brexit truly means for the UK.

Institutionally, the only major responses to the news of the vote have been the memo sent by the JPMorgan CEO Jamie Dimon to his staff suggesting changes may be necessary in the months ahead to the “European legal entity structure and location of some roles,” and an announcement by HSBC that 1,000 jobs may be moved to Paris. The fear amongst financial institutions is that unless they can trade freely within the EU then they will be forced to move staff and even their headquarters to either Dublin, or more likely, Frankfurt. For now it is all dependent on the mood music emanating from the negotiations with the EU, but with that unlikely to start formally before October and possibly reach a conclusion in 2018 (if not longer) many may feel a restructuring is safer than living with the uncertainty of the UK’s position. Should the EU show any signs of additional disintegration though, this decision will be further complicated. Any decision is hampered not only by uncertainty regarding the terms and timing of any ultimate withdrawal by the UK (for example, financial services regulation is likely to be relatively uncontentious given that the EU laws were largely based on then existing English law, while other areas of the legal economy, such as competition, patent and data protection law are likely to be more difficult to uncouple completely from EU regulation), but also by uncertainty about how the EU might choose to restructure its own markets and the ultimate overall balancing of cost and benefit. There may be some temptation to make changes or acquisitions early. However, as negotiations progress considerations of timing and geography are likely to require very careful and detailed planning.

Conclusion

For now at least, there is little specific advice we can provide, save the fact that the legal landscape has not changed following the referendum and currently seems unlikely to change any time before October 2018 at the earliest. We can, however, advise regarding the potential need for changes in choice of law, venue and related provisions in existing and future agreements, including, perhaps, even giving greater consideration to the possibility of arbitration. Because the UK is not a member of the Euro Zone, currency provisions are less likely to need revision than when Greece faced a return to the drachma. We can also advise with respect to various kinds of concerns that may arise in different areas of business activity, with a view to focusing attention on areas that may affect current practices (e.g., how the withdrawal of the UK could affect the regulation and structure of the securitisation markets).[5] The main drivers of what the future of the UK outside of the European Union will look like are political, and which politicians will play the most significant role in that future is currently unknown. We can only speculate on what a future deal may look like based on what we now know. This situation will be monitored closely so that clients will be apprised of any significant developments, though there are likely to be many false dawns in the days ahead.

What we can say is that many of the main historical attractions of the UK for our clients, such as stability of government and certainty of law, are currently seriously at risk. Without question, unwinding this 43-year political and economic union will be extremely complicated, as will the UK’s confrontation with the unknown unknowns.

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[1] Algeria, as a legal part of the French Republic, left the European Economic Community upon achieving its independence in 1962 and Greenland left the EEC after a referendum in 1985.

[2] Note how this differs from the US Constitution as in effect when Fort Sumter was bombarded.

[3] An institution of the EU comprised of the heads of state or government of the Member States along with the President of the European Council and European Commission.

[4] 72 percent of the members of the Council representing Member States which themselves contain at least 65 percent of the population of the EU as a whole.

[5] Some clients may want to plan various responses to Brexit, while others may be in a position to lobby in one or more relevant jurisdictions.

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