To kick off the debate, Herbert Smith Freehills (HSF) M&A partner Stephen Wilkinson introduced guest speaker Tom White, head of Europe at Global Counsel – who has over a decade of experience working for the UK Government primarily on EU single market negotiations – to give an overview of where the UK is, both in its internal preparedness for Brexit and in its negotiations with the EU. To the surprise of some, he takes an optimistic view: ‘We could have been in a much worse position than we are now.’ However, he did point out that there were a number of major caveats to that optimism. The first being ‘we have an incredibly weak government in the UK that can actually be voted down on an issue any time and could lead to the Prime Minister having to resign and having a general election’.
The second, crucial aspect is that whereas in the past there has been the option of kicking the can down the road, with Brexit we have a ticking clock. ‘It is that ticking clock which makes it harder to fudge some of the issues that need to be fudged, to be honest, for the UK to have an orderly exit.’
White notes that the progress of the Withdrawal Bill in the House of Commons came to a clear conclusion earlier this year with a couple of minor defeats for the Government related to the need for there to be another vote in Parliament to implement the withdrawal agreement, as well as the need for a vote to set the precise final date of withdrawal. Compared to the hundreds of amendments that were posed from all sides, it emerged relatively unscathed from the process.
‘Of course, we have stored up some problems for the future. When we look at the inflection point of the Bill leaving the Committee stage in the House of Lords, we then have to look ahead to the other bills that the government needs to pass to have an orderly Brexit, most notably a bill on immigration to set up a new framework and a bill on trade and customs to essentially create an autonomous UK trade policy, both of which we know will face amendments from the Conservative Party that will potentially mean the Government being defeated on some very fundamental aspects of both those pieces of legislation.’
White’s main point centres on the Euro 27’s attitude towards negotiations and what that means for the change in the dynamics. ‘That is the key point for many of us watching Brexit. You can read an FT article from a year ago and it is almost the same as one from yesterday. There will be a need to involve sectoral ministries from across EU member states. We will have finance ministries talking about the interests of financial services. We will have economic ministries talking about the interest of industry. We will have agricultural ministries talking about the interest of agriculture. We will also see the committees in the European Parliament finally let off the leash, taking this from a constitutional question to an economic and positive question of what is wanted from the UK. This will not be comfortable for the UK. People in the EU know exactly where the UK’s pressure points are. The emphasis on financial services being outside the scope is partly to do with the special nature of financial services and why you do not have cross-border provision in such a regulated sector but it is mainly because they know it is a UK surplus sector and the UK will pay a very high price in other areas to secure that.’
And that is the crucial point for businesses now, the vulnerability of the Government becoming increasingly exposed as we move into the detail of Brexit. ‘On the EU side, we are also going to see a slightly more pragmatic and positive focus on what is wanted from the UK. That poses a number of opportunities for businesses to work out how they might advocate for change – drawing up your exposures, your problems and what your transition is going to be. Then there is a question of what you do commercially to adapt and what you do in your advocacy to adapt’.
The UK is not the reliable aircraft carrier international investors were relying on to move into Europe. They want to be better diversified in case the UK does something else crazy.
Stephen Wilkinson – HSF
On the question of transition, White is clear that what is going to happen is not great for businesses, particularly on questions such as the European Court of Justice and free movement of people, and on the EU side of consultation and the recognition of the UK’s potential rights in negotiation trade agreements. The uncertainty for business is caused by the principle that ‘nothing is agreed until everything is agreed. Clearly, until the whole withdrawal agreement is drawn up, you cannot bank transition… That is the bite of Brexit. The political statement is good for the politicians but I do not think it is going to be enough for [clients].’
A concern raised by one client is that the uncertainty from a business perspective means companies will not move ahead properly with all of the work needed to prepare for Brexit. There is a universal agreement that the only solution is getting ready for a worst-case scenario.
Prepare for the worst
As there is a clear planning assumption in financial services that there is not going to be a soft landing at the end of transition and all we are doing is deferring the cliff edge, the transition agreement is not the be-all and end-all. HSF partner Barnaby Hinnigan says that in financial services generally, everyone the firm is working with is planning for a hard Brexit.
‘For people who are moving significant balance sheets or people, that takes a long time and they have already started. If the final deal is favourable it is going to be far too late in the process to turn round and change your mind, anyway. You are already doing it. The legal structure of doing the transfers of banks and insurance companies is not really reversible. You have to go for it.’
One client confirms that it is already setting up a new EU subsidiary base in the UK and the transition agreement just affects how quickly it executes the setting up of this subsidiary, given the difficult position the UK government will find itself in, which is not beneficial to financial services. Says Hinnigan: ‘In banking and insurance, you can basically say it is a year-long process from start to finish. No-one really wants to be completing this in March next year; they want to be getting it done by the end of this calendar year. People will be filing their documents with the courts and sending communications out to their customers over the summer. Hard Brexit, soft Brexit; it does not really matter. It is happening.’
White observes that the vote in Parliament, probably in November, ‘is going to be the most important vote in the Commons since the decision to go to war in Iraq. It is really going to be one that splits the country and will divide people in parties as well. It will be a huge existential moment for the country in deciding whether to accept the deal that has been negotiated’.
The most we will see, he says, is whether there is a repositioning – through the Parliamentary debate, through an election or through a party election – to soften the kind of Brexit the UK will aim for. ‘The red line about leaving the customs union in order to negotiate free trade deals will become significantly weak and possibly just abandoned altogether if that is the price of keeping Northern Ireland in the UK… Ultimately, when you talk about the economic consequences of Brexit, if the UK were to stay in the customs union at least all the projections by the Treasury show that the economic consequences are not great but they are manageable. It is about going down to 0.5% growth a year for a few years, which is bad from an economist’s perspective, but if you are a man or woman on the street, it is not even a recession. You may start to see more detailed work around participation in the single market.’
IHL editor-in-chief Alex Novarese then asked the clients whether there are any particular lessons that people have learned in terms of what they can do now. The main message is to hedge your bets by having a foot in both camps because if you are a business that operates across Europe, you need to be present in both jurisdictions, as you do not know the extent to which being based in the UK is going to allow you access to Europe or vice versa. The other key issue is to do a detailed analysis of the impact on local markets beyond just setting up an EU subsidiary to benefit from passporting. Businesses can make those sorts of assessments by looking at local legislation.
Says one client: ‘Some regimes will allow you to effectively access London’s pool of funding and liquidity and others will not, but there is also the possibility that, as a reaction to all this, we end up with another wave of EU legislation that turns off all those taps. You would hope that by the time people look at that, they will realise that you cannot transfer a large, deep market from one place to another just like that. It is going to take years. If you do not allow that access through local regimes, you will add a layer of expense for the corporates that are trying to access that level of funding. They will need to be able to access a market with depth and strength, and you cannot create that in Europe just like that. Effectively, the immediate knock-on effect will be on small corporates in Europe, which are going to be trying to access a wider pool of funding than can be had in, say, domestic France.’
Wilkinson remarks that a lot of international investors have realised that the UK is ‘not the reliable aircraft carrier that they were relying on to move into Europe. Having seen what has happened, a lot of firms – American and Japanese ones in particular – have realised that they are overweight in the UK in their business strategy, so whatever happens in the longer term, they want to be better diversified in case the UK does something else a bit crazy’.
The final word goes to Paul Butcher, HSF’s Brexit director, who gives a foreboding prognosis. ‘We forget that the EU has done all these Brexit preparedness notices basically warning UK businesses what it will do. To an extent, it is using those as part of the negotiation to set a baseline. There is some blood-curdling stuff in them. Some of it is factually true, some of it we do not think is necessarily correct under EU law, and some of it may be in breach of World Trade Organization law, but at least it is setting out in quite a lot of detail what it thinks would happen in the event of a hard Brexit. The UK is not doing that, but of course there will be an impact for European businesses wanting to do business with the UK. It goes both ways.’
In a sense, he adds, the financial services sector has the advantage of having some clear, big issues that it knows about. For other businesses, it is going to be a question of finding out what those issues are, prioritising what businesses need to do and responding proportionately.