Bracing SA for possible Brexit backlash

South Africa’s financial services sector has, in recent times, felt the harsh effect of a gradual depreciation in the value of the rand, which has been attributed to, among other things, a lethargic economy.

Many institutions have accordingly sought to diversify their investment portfolios by looking beyond the borders of South Africa in an attempt to prevent the negative effects of currency devaluation.

One of these jurisdictions has often been the United Kingdom. However, following the UK’s June 2016 decision to leave the European Union (EU), a cloud of uncertainty has been looming over whether the UK will leave with a deal for Brexit, or have to be put through the challenges that may arise out of a no-deal scenario – and what effects this may have on South Africa’s financial services sector.

During a recent meeting of the European Council in Brussels, the UK was granted a further extension until “not longer than 31 October 2019” in order to ratify the withdrawal agreement. This was contingent on the UK’s participation in the European Parliament elections between May 23 and 26, otherwise Brexit would have taken place as soon as June 1. The UK remains open to leave before October 31 if parliament ratifies the withdrawal agreement. It should be noted that a no-deal Brexit remains the default outcome if the UK parliament does not approve the deal, or a renegotiated version.

No-deal and the UK financial sector

When the UK leaves the EU, a knock-on effect may be felt in other jurisdictions, including South Africa, which has funds held in the UK. In a no-deal Brexit outcome, access to the EU by UK-based banks and other financial service firms would be determined by the relevant member state rules and any EU rules applicable to third countries. For example, some EU directives such as the Markets in Financial Instruments Directive (MiFID 2) and European Market Infrastructure Regulation (EMIR) potentially allow a degree of access to third country firms that are considered to have equivalent rules and are subject to effective supervision and enforcement.

Notably, UK financial institutions will no longer be able to ‘passport’ their UK authorisations across Europe, and their European counterparts will not be able to ‘passport’ into the UK.

The UK’s Financial Conduct Authority (FCA) has drawn attention to potential risks around contractual continuity – or how contracts underpinning financial products would work in the absence of passporting – and, in particular, has warned of potential volatility and disruption in the event of a no-deal exit, with risks related to operational challenges associated with relocating businesses or repapering clients in a short period of time.

Shifting destinations

To counter some of the effects of being a third country firm, UK banks and financial institutions have applied to obtain requisite EU licences as well as shifting personnel and balance sheet assets to destinations such as Frankfurt, Paris and Dublin.

The Bank of England has suggested that around 4 000 banking and insurance jobs will have moved from London to EU hubs by the Brexit deadline. UK-based firms accessing the EU post-Brexit may also consider ‘workarounds’, such as booking business to certain jurisdictions and using back-to-back transactions, however, these are subject to regulatory limitations.

The UK government will introduce a temporary permissions regime (TPR) to lessen disruption to European Economic Area (EEA) firms carrying on business in the UK. If no deal is reached with the EU, these firms will be allowed to continue to operate in the UK for three years after the UK leaves the EU, provided they notify the relevant UK regulator of their intention to participate prior to Brexit.

The ‘backstop’

Complementing this approach, the UK government recently passed the Financial Services Contracts (Transitional and Saving Provision) (EU Exit) Regulations 2019 (FSCR) into law. The FSCR establishes a financial services contracts regime or ‘backstop’ that ensures that those EEA firms that do not enter the TPR are able to wind down their UK regulated activities in an orderly fashion. The expectation is that both these regimes will serve to mitigate contract continuity risks.

The European Commission has also announced temporary measures to avoid market disruption on a non-deal Brexit by, for example, preserving EEA firms’ access to UK clearing services. For matters within the competence of member states rather than the EU itself, the contingency measures varies in nature from state to state and are not as comprehensive as the UK’s. By way of example, on March 25, the Italian government published Law Decree No 22, which confirms both urgent measures and a transitional period in order to manage the effects of a no-deal Brexit on UK banks and financial institutions operating in Italy. Similarly, on March 29, Germany stepped up its Brexit preparations by enacting a law entitled ‘Tax Act relating to Brexit’, which in addition to governing tax aspects, seeks to avoid market disruption and ensure financial stability in a no-deal scenario.

Enough to shield the blow?

Although some initial contingency plans have now been actioned by the EU and individual member states, it remains to be seen what further arrangements will be implemented over the coming months to ensure that a potentially heavy blow to the financial services sector is softened.

The South African concern

A hallmark of the South African banking and financial sector has always been its ability to withstand global financial tremors. The threat of a no-deal Brexit to those South African banks and financial institutions with EU headquarters in the UK is the possible change in access to the EU market. Depending on the way in which the scale ultimately tips, these businesses may be forced to re-establish their bases in alternative EU jurisdictions in order to ensure commercial continuity.

The concern from those South African companies who have placed eggs into the UK investment basket remains primarily focused on the way in which the pound will react to Brexit. Those carrying vested interests will be hopeful of a rally.

Takeaway

In the meantime, South African financial institutions should continue to keep abreast of negotiations and new developments, coming out of London and the rest of the EU, including promulgated regulations, and prepare contingency plans for any likely adverse risks that may arise from a no-deal outcome. In this regard, the formulation of a Brexit steering committee with a defined strategy will not go amiss. Any changes or developments should also be communicated to affected customers.

Even with careful preparation and negotiation, it is hard to predict the scale of the effect of Brexit and where the impact will be most felt. Investors, including those from South Africa, will be hoping that they will be treated rather than tricked this Halloween.

By Wildu du Plessis (partner and head of banking and finance), Rui Lopes (associate, dispute resolution) and Matthew Tout (candidate attorney, tax) at Baker McKenzie Johannesburg.

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