December 4 by Cory Haynes
The royal nuptials are all over the news these days. Prince Harry, third in line to throne, is engaged to Meghan Markle an American model/actress, making this a fairytale worthy of Disney. Ironically, as the wedding of the year is being planned, Brexit, the divorce of the year is occurring with the UK and the European Union. Funny enough Brexit, barely makes the front page of the news these days. Brexit hasn’t gone away. In fact, its accelerating. Teresa May, Prime Minister for the United Kingdom, announced that the financial services sector should be treated as a special case within Brexit negotiations. After the June 23, 2017 referendum vote by the United Kingdom citizen, the UK Parliament voted on March 29, 2017 to evoke the European Union’s constitutional Article 50 clause, setting the clock for a two-year exit. According, to Article 50, which states :
“Any member state may decide to withdraw from the union in accordance with its own constitutional requirements.”
Simply, this brief clause specifies that a leaver (of the union) should notify the European council of its intention, negotiate a deal on its withdrawal and establish legal grounds for a future relationship with the EU. On the European side, the agreement needs a qualified majority of member states and consent of the European parliament. The proverbial clock is ticking.
Two years from now the sector could be operating ‘business as usual’ or the UK could have lost its EU passporting rights and become an outcast from the global economy. If I had a magical crystal ball, I could predict the outcome, but I don’t, so I won’t. Therefore, most financial services firms have been testing the potential impact of Brexit on current business operations – and that means looking at both best and worst-case scenarios. Firms may have to examine every contract and repaper them to be complaint with the new laws.
Below are a five areas of concern that may require more than repapering:
• Laws from EU and UK: Firms are still recovering from repapering and reporting for derivatives documentation required by the CFTC (Commodities Futures and Traders Commission) in the US and the EU’s EMIR (European Markets Infrastructure Regulation). Yet as the UK and EU laws are disentangled over the next two years (or more), and with the new UK, EMIR may no longer be applicable, therefore requiring all of those previously amended contracts to be amended to remove references to EMIR—smells like another repapering exercise. Uncertainty may also lead to credit rating downgrades.
• Rating Downgrades: There are many contracts with credit rating triggers. If the rate goes down the contracts may go into default which could trigger a domino effect, especially since most triggers are embedded deep into boiler-plate contracts and have automatic parameters in place. The dominoes may fall and require payments in Euros or Sterling. However, what happens if the currency values drop?
• Currency Hedging: If Sterling or Euro takes a hit it could be destabilizing to contracts based on either currency. The safe bet may be to change contracts to hedge on the U.S. Dollar (USD), which may lead to rise in purchasing US treasuries—driving the US dollar higher and foreign dollars down thus counteracting the US desire to lower the trade deficit, as foreign goods become cheaper. The desire to find cheaper imports and better investments overall may stall with changes in passport laws, esp. in the Euro-zone.
• Passporting: With potential implications on the selling of notes and financial instruments if that passport no longer applies, firms will need to amend platform architecture and need to consider renegotiating thousands of contracts between counterparties. The ability to travel or ship may also be impacted, leading to issues with delivery.
• Delivery: Contracts with underlying commodity delivery could be affected by Brexit, as cost and timing for the delivery of goods may be negatively impacted with higher tariffs or border crossing delays. Firms need to understand the specifics of each contract. For example, if commodities are being delivered either from the EU into the UK or vice versa.
Clearly, contracts of all sorts will be affected by Brexit. Having digital documents with flexible platforms like Apttus’ contract lifecycle management could help Asset and Wealth Managers and Insurance/reinsurance firms prepare, regardless of how Brexit comes about. Whether two years will be long enough to repaper and stress test contracts – or even determine what needs to be addressed – remains moot. However, the onus is on firms to undertake a robust impact assessment exercise that looks at the worst-case scenario, as soon as possible. What happens if the EU decides on 1 April that a firm can no longer passport from the UK into the EU? How will a firm service its clients? And from where with the least legal and contractual impact?
Brexit is more than just one event. Brexit may be just the beginning. Frexit (France) or Dexit (Deutschland exit) may not too far off, based on the last French and Germany close elections. The ‘America first’ focus and regulation retreat of the US’ Trump Administration poses new uncertainties. The ascension of autocrats in China and Russia –surely create more turbulence and global power shifts. Not to mention the North Korea and Syrian conflicts. Technology cannot cure the world’s ills, but it is a way to get to ahead of the ever-changing regulations and global uncertainty. Automation, artificial intelligence, crypto-currencies, blockchain are just a few technologies that maybe panaceas for being less reliant on unstable geopolitics. In the interim, every business should do an assessment of their current contracts. Legal contract management is fast becoming a core component of scenario and disaster planning – without automation and digitization, firms will struggle to be prepared. The nationalistic and isolationistic fever is not contained in the UK. It has spread globally to near outbreak proportions, the smart money is on companies that have flexible digital Client Lifecyle Management for seamless onboarding, deal structuring, proposal generation and contracting systems to quickly adapt and maintain compliance. Speaking to Apttus is a great place to start. A little Markle-magic and fairytale pixie dust, not required.