The Brexit Challenge for Financial Services Firms
On 29th March 2017, the UK formally triggered Article 50 of the Treaty on European Union which officially signaled the UK’s intent to leave the European Union and consequently started the two-year countdown to negotiate a deal covering the UK’s withdrawal. The UK is due to leave the EU at 11 p.m. UK time on Friday, 29th March 2019, with the agreed transitional period giving businesses until December 2020 to execute plans that will enable them to comply with the new cross-border paradigm.
UK and EU-domiciled financial services institutions are assessing the impact that Brexit could have on their operations and existing relationships, in particular those relationships with clients who are in the EU.
One of the key areas of legal risk encompasses the cross-border legal relationship between institutions, including legal relationships with clients and suppliers alike. However, there are issues not just for UK-domiciled institutions but also for EU-domiciled entities. For example, securities contracts written under English governing law by EU banks may be considered third-country contracts thus affecting the bank’s Minimum Requirement for own funds and Eligible Liabilities buffers. Furthermore, whilst some institutions may consider Brexit a force majeure legal event, it is not clear that courts would take the same view, and therefore, specific Brexit clauses may need to be introduced where possible. As a result, a significant amount of effort is being expended to firstly assess the scope of the legal impact. This will naturally lead to the identification of legal gaps exposing institutions to potential risks – particularly contractual legal risks. Whilst there will be other areas of legal risk to be considered, for example holding the correct permissions, contract-based legal risks are at the forefront of major concerns for financial services institutions.
It should be noted that whilst a transitional deal has been struck, those financial institutions which are currently planning or have already started to assess the legal impacts, analyse the legal gaps and, in some cases, remediate these risks would be wise to continue their efforts at the same pace. The transitional period will end in 2020, and there is no guarantee that an extension would be agreed to if negotiations have not concluded nor that the final deal will represent a “best-case” scenario.
The challenge for financial services firms can be split into three main areas:
Whilst technology can certainly help institutions in terms of impact assessment and gap analysis, some of the legal risks and impacts they deal with will require a human review. This could be particularly true in the contract space where complexity can be high and the volume of contracts large. Leveraging a hybrid machine-learning/artificial intelligence approach will allow institutions to rapidly identify legal impacts and clauses that may generate risk exposure. However, quality assurance will likely require a human overlay, and certain segments of overall contract populations will not lend themselves to purely utilising technology. Therefore, the challenge will be to either use skilled internal resources or find a trusted third party that has both the technological and substantive capability to cover all three areas of challenge quickly and, just as importantly, cost-effectively.
We have seen a somewhat bifurcated approach to the challenges and risks that Brexit poses. Whilst all of our clients are going through or have gone through the same type of legal impact assessment and gap analysis, we have observed some clients use this legal risk remediation exercise to change key parts of their existing legal framework, e.g., termination events. However, it is by no means certain that counterparties will agree to proposed amendments, and this can lead to delays. Therefore, some institutions are taking a targeted approach solely focused on novating the agreement from a UK entity to an EU-27 entity.
This approach allows for progress even if, for example, the contract/document is governed by English law. Even in the case of a hard Brexit, Rome I and II regulations continue to apply if proceedings are brought before an EU court, and the UK’s withdrawal bill, if passed, will largely preserve existing EU directive-initiated UK domestic legislation. Whilst there are some caveats whereby the UK may amend some laws, Rome I and II regulation-driven legislation is not considered in scope.
This choice of which path to take will ultimately be driven by factors such as the volume and complexity of the legal risks. However, one aspect that has become abundantly clear is that the process of gathering all the data to even get to the point of impact assessment can be time-consuming. Therefore, whilst the end of the transitional period may seem far off in the distance, the time it takes to gather the data, assess the legal impact, identify and analyse gaps and then remediate will, in a lot of cases, be longer than most institutions expect.
If you are considering how to deal with a Brexit-related repapering challenge or are concerned about the costs of your current Brexit programme, we stand ready to help and would encourage you to contact us so that we can explain our approach in more detail.
Stay in the Know
Subscribe to our newsletter for the latest news about legal, risk, and compliance issues.