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Guest post from Herbert Smith Freehills – Brexit: After the vote

The ‘in-out’ referendum on the question of the UK’s membership of the European Union (EU) which has dominated the political and business agenda in the UK for the last six months, has resulted in a majority of voters (on a turnout of approximately 72%) preferring the UK to leave the EU.

The vote was 51.9% in favour of leaving, with 48.1% voting to remain.

Businesses need to consider how to deal with the immediate effects, what analysis and planning they should undertake as a result and what communication they may need or wish to make to investors, staff, customers, suppliers and other stakeholders.

In this briefing, we consider what happens next, as well as outlining some practical steps.

1. Immediate effects on businesses exposed to the UK

This section deals with the possible immediate effects of the leave vote on businesses with heavy exposure to the UK. These factors, which organisations will likely have already anticipated, may now take on redoubled significance following the UK’s vote to leave the EU.

Market volatility

International financial organisations, the Bank of England, the major investment banks and expert commentators expect sharp movements in financial markets in response to the leave vote.

A variety of contracts and regulations may give rise to immediate exposures upon significant volatility or falls in foreign exchange rates or the value of traded securities; this in turn, may impact the financial or trading position of a business and its disclosures.

In the short-term, a sharp drop in the value of sterling immediately following the vote to leave may impact the ability of parties to comply with financial covenants under their financings and other financial contracts, particularly where covenant test dates fall on 30 June. The knock-on consequence for their counterparties would be the practical challenge of dealing with a potentially large number of technical defaults and requests for waivers, on the assumption that these counterparties would have limited desire to immediately accelerate or terminate the relevant financings or contracts.

In the longer-term the impact on profitability and cashflow of businesses, and how that feeds into the ability to comply with financial ratios, is both difficult to predict and would be varied.

Companies and institutions with significant sterling cashflows but with non-sterling debt will see the costs of servicing that debt and any related hedging rise with a fall, or substantial volatility, in the value of sterling.

Commercial contracts with unhedged obligations in foreign currency may become uneconomical to perform on a sustained basis and parties to contracts may seek to invoke material adverse change or other termination rights.

Counterparties to derivative contracts involving sterling may become significantly out of the money and be subject to substantial margin calls or have large mark to market payment obligations in the event of a close out following significant shifts in currency markets. A fall in share prices impacting the valuation of listed shares would affect margin financings, repos, equity derivatives and other such market contracts and may lead to margin calls. There may also be practical challenges of trading capacity in the equity markets for traders.

Whether the vote to leave would impact liquidity in the debt markets will be dependent on numerous factors. The decision to lend to a particular borrower will be influenced both by a lender’s view about the impact of an exit on the business of that borrower and also their view as to the broader macro-economic impact of the vote to leave and the appetite of lenders to provide liquidity into such markets. The position of UK banks and, if the view is taken that the vote to leave has a general unsettling impact on the EU more generally, of European banks may be perceived to have weakened as a consequence of the vote to leave. Any such weakening has the potential to impact the financial markets and the willingness of institutions to lend.

Finally, potential exists for the Brexit vote to bring about a downgrade or negative watch for companies with major sterling exposure and for a downgrading of publicly traded debt issued by such companies. To the extent the vote to leave is regarded as negatively impacting financial institutions with large sterling holdings, rating agencies may also consider downgrading such institutions; this could impact a whole range of financing transactions across various markets. In practice however, short term volatility in the markets may be unlikely to influence rating agencies to downgrade companies, debt and financial institutions in this way.

Consideration should therefore be given to material commercial contracts, financing and trading contracts and security agreements, and also to any regulatory capital obligations, and the risks under these assessed against the expected market shifts.

Financial and trading position

A review of contractual and regulatory obligations or the effects of external factors may result in the conclusion that the financial or trading position of a business is significantly adversely affected.

External factors such as a drop in market confidence may have an immediate negative effect on financial or trading positions.

Falls in consumer demand, a tightening of credit, and investors exiting UK-focused funds and equities are examples of possible early manifestations of such sentiment.

Boards should monitor closely any effects on financial or trading positions and observe their duties with regard to solvency and the interests of shareholders, the company and its creditors.

Directors should be particularly mindful of their duties when considering distributions or other discretionary payments or commitments.


Regulatory and contractual obligations as well as commercial factors may prompt communications with stakeholders in response to the leave vote.

Investors, lenders, auditors, regulators, customers and suppliers may all have contractual or legal rights to be informed of a significant shift in financial or trading position resulting from the vote to leave.

Irrespective of any strict obligation, organisations may wish to communicate voluntarily with such stakeholders, and in particular be prepared for queries from concerned staff and pension scheme members.

Although major market fluctuations in and of themselves will not amount to inside information requiring announcement by issuers, they may do so when taken together with other information which is not already in the public domain.

Issuers should monitor the prices of their publicly-traded securities and assess in the usual way whether they have inside information and their obligation to make it public, in consultation with their legal advisers and brokers.

Looking ahead: practical steps for business

-Inform the board by preparing briefings on the risks and opportunities raised by the vote to leave the EU.

-Analyse exposure by conducting due diligence of business lines and cost centres, eg identifying areas which depend on UK membership of the EU for market access or which would be affected by a change to tariffs.

-Build resilience by devising and applying risk mitigation strategies to address identified risks, eg new EU physical locations, modified legal structures, and amendments to policies and procedures.

-Review strategy by engaging with strategic planning exercises to include Brexit factors, eg consider revising longer-term plans to involve member states not planning to leave the EU.

-Revise projections by reviewing business projections, eg considering the impact of tariffs or other trade barriers, changes affecting the provision of services or the free movement of workers.

-Engage with stakeholders by communicating with investors, staff, suppliers and customers eg outlining analysis undertaken, assessment of impact, the (gradual) nature of the transitional process and an intention to monitor developments closely.

-Review employment plans including for recruitment and secondment of employees. Audit the immigration status of EU migrant workforce and the workforces of the businesses in supply chains. Communicate with employees, particularly those who might be affected by changes in immigration law, provide reassurance that they will be kept informed as the position becomes clearer and consider if any current employees can apply for British (or other EU) citizenship or permanent residence now.

2. What is the legal effect of the referendum vote?

The vote for the UK to leave the EU will not have any direct legal effect on its own.

Under the terms of Article 50 of the Treaty on European Union, which governs the process, the UK will first inform the European Council of its intention to leave the EU. This notification triggers the two-year period specified by the Treaty for the negotiation of the terms of a member state’s withdrawal. The British prime minister David Cameron (pictured) has previously indicated that he intends to inform the European Council immediately in the event of a leave vote but some delay may affect the procedure, particularly if there is political turmoil in the UK as a result of the leave vote.

3. The two-year transition period leading up to a UK exit from the EU

The two-year transition period can only be extended with the unanimous agreement of the UK and all of the remaining 27 member states. If the period is not extended and an agreement on the terms of the UK’s withdrawal has not been reached beforehand, the UK will cease to be a member state of the EU at the end of that two-year period, quite possibly before any agreement has been reached either on the terms of the withdrawal or the terms of the future EU-UK relationship.

In parallel with the negotiations with the EU of the UK’s terms of withdrawal, UK lawmakers will (during the same two-year notice period) need to review the elements of UK law which are derived from EU law and take decisions as to whether to retain, reform or repeal them. The enormity of this exercise makes it likely that, at least initially, most rules will be retained (or ‘grandfathered’) albeit not without significant issues to be addressed, including in relation to their future interpretation and the influence of decisions of the Court of Justice of the European Union (CJEU) on the interpretation of EU laws retained by the UK.

4. What will the key constitutional changes be once the UK leaves the EU?

When the UK eventually leaves the EU, the UK’s constitutional relations with the EU will be fundamentally altered. The EU Treaties will cease to have the same effect and new arrangements may be put in place. There is no requirement (or right) to have new arrangements in place with the EU before or after we leave.

The key constitutional changes on leaving the EU (in the absence of agreement to the contrary, such as the UK becoming a member of the European Economic Area (EEA)) are:

-there will be no obligation to apply or adopt new EU legislation;

-there will probably be no obligation to follow the CJEU interpretation of EU law or to apply that interpretation in UK law based on EU law; and

-there will be no financial contributions between the EU and the UK (unless the UK were to join the EEA or enter into a Swiss-style agreement with the EU).

-It is likely that the UK and the EU will seek to agree substitute arrangements as regards trade in particular but this may be a prolonged process extending beyond the two-year withdrawal negotiations, and possibly taking as long as ten years.

The UK will cease to benefit from existing EU trade agreements with third countries (whether or not it joins the EEA) and would be excluded from those under negotiation (including those with many Commonwealth countries).

It will benefit from the European Free Trade Association (EFTA) Free Trade Convention in trading with other EEA States if it re-joins EFTA (a precursor to joining the EEA) but otherwise could be expected to have no (or very few) trade agreements with third countries, other than as a member of the World Trade Organisation (WTO).

The EU has around 50 international trade agreements with third countries from which the UK benefits, and many more are under negotiation. The UK will therefore have to make a major effort to improve its position vis-à-vis third countries, including establishing its independent terms as a member of WTO and building up its capacity to negotiate trade agreements, which has largely been outsourced to the EU in recent years.

Rights enjoyed by UK businesses and citizens in the EU would be lost, including free movement, recognition of qualifications and protection from ‘soft’ trade barriers, except in so far as they are saved by new trade agreements with the EU or accepted by the CJEU as protected by the doctrine of ‘acquired rights’, which could cut both ways.

5. The future UK/EU relationship

The implications of the vote to leave depend very much on what EU membership will be replaced with. For example, will the UK have no formal link with the EU, or will it join the EFTA and (like most EFTA countries) the EEA agreement with the EU, or will it enter into some other form of free trade agreement with the EU? Given the uncertainty, business planning has to take into account the risks of the least favourable outcomes.

There would be a number of possible structural outcomes, apart from any bilateral arrangements arising from the secession negotiations. The main options, which have precedents in the EU’s relation with other countries, are:

-EEA (European Economic Area)

-EFTA (European Free Trade Association)

-EU/UK FTA (Free Trade Agreement)

-Customs Union

-EU/UK CETA (Comprehensive Economic and Trade Agreement)

-WTO (World Trade Organisation)

A key point to bear in mind is that apart from the EEA, none of these models would give the UK’s important financial services sector the same rights to do business across the EU which it currently enjoys. Most of these models, apart from a WTO relationship on its own, would eliminate customs duty for manufacturing businesses trading between the UK and the EU.

Read Herbert Smith Freehill’s full briefing here.

For more commentary see: ‘LB’s Brexit take: City law’s globalisation playbook has just been shredded’