Today, it was announced that the UK public has voted to leave the European Union. There will now be a negotiation of a new relationship between the UK and Europe. The fact of the vote itself has no legal effect on the laws of the UK or EU. The UK will remain a member of the EU until there is either an agreement to exit or expiry of a two-year period after issuance of a formal notice of exit by the UK government. That notice, when served, triggers a negotiation period of up to two years during which time the current EU laws continue to apply in the UK. The UK will lose some of its rights to participate in EU political processes during this period.
This note discusses potential legal models for any post-Brexit negotiated solution in the context of financial business in particular.
There are a number of possible models for a new UK deal with the rest of Europe. We discuss these below. It seems unlikely that any of the existing treaty infrastructures underpinning these models will be followed exactly in light of the size and importance of the UK as an economy within Europe and due to some of the policy issues behind the UK's vote. Instead, a unique new arrangement is likely to be negotiated, perhaps containing some elements of the arrangements that other non-EU countries such as Switzerland or Norway currently have in place (which are outlined below).
One key element of any deal from a financial services perspective will be the status of financial services "passports". These currently provide financial institutions incorporated within the EU (including the UK) with access to customers and markets across the EU based on a single home country regulatory authorization. Financial institutions can conduct financial business under the passport out of the UK with customers in European countries subject only to UK supervision under broadly EU-based rules, rather than being dually regulated. One possible post-Brexit scenario is for the UK to remain in the European Economic Area ("EEA"), giving it full EU passporting rights. However, this arrangement gives no vote to UK representatives on EU laws and comes with the "free movement of persons". As immigration from other EU countries has been one of the main issues in the referendum, such an arrangement is probably unacceptable to the UK people. The lack of ability to negotiate would most likely also prove to be a barrier. As a result, some level of tailored access solution is likely to be required even if this starting point were to be adopted. If the UK opts to stay out of any such arrangements with the EU entirely (at least temporarily), in order to get the relationship it wants, it could become what in European parlance is known as a "third country". There are two passports for third country entities that are being introduced in 2018 under the arrangements known as MiFID II, which give investment firms, and banks in their investment business activities, passports to access for professional and more sophisticated clients. MiFID II may provide the base level framework for a new arrangement for the City with the rest of Europe.
The Different Models
There are several legal models that the UK government could negotiate.1 These could include:
- Complete withdrawal from the EU, with new bespoke bilateral agreements that retain freedom of trade and/or establishment, without membership of an existing European bloc.
- Joining the European Free Trade Association ("EFTA") and re-joining the EEA (i.e. like Norway, Liechtenstein and Iceland).
- Joining EFTA and relinquishing membership of the EEA whilst gaining access to the European markets through bilateral agreements (i.e. like Switzerland).
- Entering into a customs union with the EU (i.e. like Turkey, although the Turkish-EU customs union is limited to trade in goods).
- Entering into a free trade agreement with the EU within the World Trade Organisation framework (i.e. like Canada).
The map below depicts the countries that are currently in the EEA as well as the candidate EU member states.
Brexit Negotiation Process
The process for exiting the EU is established under the Treaty on European Union.2 The provisions were inserted into the Treaty after Greenland exited the EU, as there was no mechanism at that time. An exit under the Treaty provisions has therefore not occurred before. The Treaty provides that a member state may withdraw from the EU following the negotiation and conclusion of an agreement with the EU, outlining the exiting member state's arrangements for withdrawal from the EU and its future relationship with the EU. EU Treaties would cease to apply to the UK upon an agreement taking effect or the expiry of two years from the date of the UK's notification to exit from the EU. The UK could apply to the European Council for an extension of the two-year period. Approval of any such extension requires unanimous consent of the other EU heads of state. Agreement to leave only needs a qualified majority vote at Council and majority ratification by Parliament, not unanimity.
In principle, the exit process could be triggered by the UK once a new arrangement has been negotiated; or it could be triggered before negotiations have been finalised. After notice is given, the UK would no longer have a presence in European Parliament and the exit negotiations would be led within the EU by representatives of the remaining EU member states in the relevant institutions. If no agreement is settled within the prescribed two-year period, and no extension of time is granted, the UK will be deemed to have effectively exited the EU and all associated constitutional, trade and other arrangements would largely cease to apply, unless other steps are taken.
Transitional arrangements necessary for the two-year period to be observed will add a layer of complexity concerning: (i) the validity of existing EU legislation; (ii) the nature of the legislation, in particular, whether it is directly effective or not; and (iii) the terms of the exit.
UK Legal Framework for EU Membership: Background
The UK legal framework for its EU membership and the manner in which it fulfils its current EU obligations is found in the European Communities Act 1972 ("ECA"). The ECA provides for all pre-existing EU texts to apply as UK law, although the method of transposition varies depending on the nature of the EU legislative instrument. All "directly effective" EU legislation (i.e. EU regulations and certain articles of the EU treaties) is automatically incorporated into national law without the need for further enactment through an Act of Parliament. In practice, some UK legislative changes are often needed to eliminate any inconsistencies with a particular EU regulation. In contrast, EU directives are binding on EU member states but require national implementation measures, often done in the UK by statutory instrument under authority of the ECA. In addition, in sectors which are subject to regulation, such as financial services, rules and guidance are often issued by the regulators to implement or further detail the requirements. It is unclear what will replace the ECA on a Brexit or whether existing EU legislation would be grandfathered.
EU law includes the principle of direct effect. EU law may be of vertical direct effect, which means that individuals can invoke an EU provision in relation to a country, or of horizontal direct effect which means that an individual can invoke an EU provision in relation to another individual. The EU treaties are of direct effect, both vertically and horizontally, provided that the obligations are precise, clear, unconditional, do not require additional measures at either national or European level and do not give member states any discretion. EU regulations are always of direct effect, both horizontally and vertically. EU directives are of vertical direct effect when the provisions are unconditional, clear, precise and have not been transposed by the relevant member state by the required deadline.
Another key EU principle is the precedence principle, which provides that European law is superior to the national laws of member states and that member states may not apply a national law that is contrary to European law. If a member state law is contradictory to EU law, then the member state law is invalid. The precedence principle applies to all EU laws of binding force—the treaties, regulations, directives, decisions and international agreements. The Court of Justice of the European Union ("CJEU") is responsible for ensuring compliance with both the precedence principle and the principle of direct effect.
These EU laws will remain in effect during the period after the termination notice has been served. After a post-Brexit agreement has been reached or the two-year notice period has expired, UK law would prevail in its entirety (as a matter of EU law) and EU courts would cease to have competence over UK issues. The ECA would have to be amended through a new Act of Parliament in the UK. Also, any EU measures which the UK wishes to retain will have to be enacted to form part of UK law, either specifically or through national grandfathering legislation. Interpretations could also change somewhat, since the CJEU will no longer be the ultimate arbiter of the meaning of previously EU provisions.
1 Note that the negotiation process would be in the hands of the UK government. The ability of individuals to influence the model that is adopted is restricted to lobbying.
2 Article 50, Treaty on European Union.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.