TSL TRENDING STORY
By Richard Hawkins
I am often asked, “So what is going on in the UK?” or “What about Brexit?”
Sadly, as an Englishman living and working in America, I am not able to fend this off with my usual hail-fellow-well-met response or dive into deep reserves of repartee with a short quip and do the usual English thing of leaving my North American friends with a good feeling and little else.
My first reply is brief: “Well, it’s complicated [sucks teeth to emphasize the point].” If this does not elicit the appropriate reaction, i.e. they change the subject to something more mundane and maybe even joyous, I venture, “You don’t want to get into this?”
And so it begins.
This subject is continuously evolving; more questions are born than answers to them. At this stage I think it worth taking a little look at the history on the basis that if you don’t know from where you have come, it is more difficult to work out where you are going.
It all started in 1951 when the French and the Germans got together with Luxembourg, The Netherlands, Belgium and Italy to form the European Coal and Steel Community (ECSC). The idea was that a cross-border trade association would be a good way to help make sure that those commodities would be used for peaceful purposes and avoid war.
The Euro-Skeptic view sees its real intent has been to subsidize inefficient French food production whilst allowing Germany to dominate the rest of Europe industrially. The Common Agricultural Policy achieved the former and it can be argued that the single currency has reinforced the latter.
One could argue that this has been completely successful if you ignore the impact of NATO and the Cold War that gave rise to the common adversary then under the auspices of the Warsaw Pact, or the USSR.
The ECSC later became The European Community (EC), although my parents were being asked to vote for something called The Common Market in 1973. The idea of a European Union with all the trappings of a Super State was not on the ballot paper; there was no hint of a European Union, European Flag, European Parliament, or a European Central Bank, let alone a European Currency.
Since the UK joined the EU, membership has swelled from seven countries to 27. Several major treaties have been implemented to provide a closer Union which attempt to level the playing field across all member states in respect of human rights, criminal justice, immigration, employment law and trading standards.
Forty-three years later, on the 24th June 2016, the UK voted 52% to 48% to leave the European Union and the country has gone through much soul searching ever since.
The vote, in my view, demonstrated a number of things, but chiefly: a huge disconnect between the mainstream political parties, the London-centric media and the people that live in the provinces. The country is more divided now on the basis of age, race, culture education, class, geography and wealth, than at any point in my lifetime.
Nearly everything that could go wrong has gone wrong following the vote. The sitting Prime Minister, David Cameron, resigned immediately despite reassurances to the contrary before the vote, whatever the outcome. A new leader, who then decided to call a general election to increase her majority – for a stronger hand in negotiations – faltered in execution and we now have a minority government. Additionally, this delayed the beginning of separation talks.
The Brexit negotiations appear to have gone badly, as somehow the UK has signed up for an Agenda that requires it to solve three problems listed below before the EU will discuss a trade deal:
1. The Divorce Bill.
2. The Irish Problem
3. The rights of EU citizens during and post Brexit.
Last week was a tumultuous one, even by Brexit Standards. It looked as if there was no deal and then the EU relented and has agreed that negotiations can move on to discussing a trade deal. Does this mean that the three problems have been resolved?
Of course not. It seems that, for the first time, the EU has realized that a No Deal at this time, the potential to cause the UK Government to fail and the economic impact across the continent is just too big a risk.
The Irish Problem
Considering the sensitivity that still exists between the Unionist and Republican movements in the North, loosely supported by the Good Friday Agreement that was signed nearly 20 years ago, peace on the island remains fragile.
The North is part of the UK, the South part of the EU and would remain so. There is no hard border between the two and everyone agrees that there is not going to be one.
It has also been agreed that the North will leave the EU on the same terms as the rest of the UK; these two positions are incompatible.
What is the UK Leaving?
As mentioned above, the UK is party to and is attempting to extricate itself from many treaties that have crested the framework of EU governance.
There are four main institutions that are uppermost in the mind when talking about exiting.
- European Court of Justice
- European Court of Human Rights
- European Economic Area (EEA)
- European Customs Union (ECU)
For the purpose of this discussion and how it relates to the activity of asset-based lending, we will focus on the EEA and ECU.
European Economic Area
- The EEA enshrines the Four Freedoms concept
- The movement of Person, Goods, Services and Capital within the European Single Market
- This is without doubt the most important aspect of Brexit from the perspective of financial institutions based in the UK and doing business across the EU as this enables passporting, i.e. financial institutions that are regulated in one EEA Country to operate in any EEA Country.
Because the UK has provided a very safe legal environment with lender-friendly laws, we see that many cross-border ABL transactions use the UK as a platform to anchor security interests. The Concept of Centre of Main Interest (COMI) which regulates competing insolvency regimes in a bankruptcy process has further encouraged the concept of the UK performing the air craft carrier role in respect of these transactions and especially those that have deep capital structures.
European Customs Union
- Single Market Concept: goods and services can be provided across all EU countries without tariffs or duties
- Determines the import tariff rules and regulations to be applied to all goods and services into the EU area regardless of the exporting country
- Acts as the single negotiator on all trade deals on behalf of its members
- Restricts individual ECU countries from negotiating its own trade deals
Brexit Options: “Soft” to “Hard”
1. Delayed Brexit
UK negotiates some continuation of its EU membership on a time-limited basis.
- It’s the equivalent of kicking the ball into the long grass.
— More time to negotiate a better post-Brexit landscape and implement new, required systems
- It would be politically difficult as the suspicion would be that the government is not carrying out “the will of the people,” a slogan which is readily thrown about by the staunchest leavers.
— Not a Brexit solution in itself
— UK would continue to be bound by regulations and budgetary requirements
The UK could join the European Free Trade Association, there are many advantages to the Norwegian model and many on the leave side of the argument advocated that this would be a sensible first step or transitional arrangement.
- Restores full sovereignty to the UK in respect of criminal justice and other law making.
- Provides continued access to the EEA and ECU and thus fully participate in the EU’s single market
- EFTA members must submit to EU regulations and contribute to the bloc’s budget
- EU ideologically committed to the four freedoms, which would mean that the UK would not control immigration, which was a significant reason for the leave voters, see “will of the people” above.
Switzerland is another EFTA member and operates on similar terms to Norway
- Limited access to the single market
- Greater sovereignty – EU policy decisions are put to national referendum
- Likely have to adopt the EU “Four Freedoms”
- Policy decision put to referendum on an ongoing basis could have undesirable results
Turkey is effectively a member of the Customs Union.
Customs Union members do not charge import taxes on each other’s goods and agree to a common tariff on goods from states outside the Union. The goods that Turkey can export to the EU within the its Trade Agreement are restricted
- Less bureaucracy when shipping goods to and from the EU
- There would be no hard boarder between Northern Ireland and the Republic
- Does not cover services
- Customs Union members are unable to negotiate independent trade deals
A more comprehensive agreement than free trade, offering a certain degree of access to the single market and some harmonization of regulation between the two partners
- Some single market access
- Freedom to seek other trade deals
- Room for negotiation on which EU rules to adopt
- Tremendously complex to work out
- Very little influence on EU policy
- Likely toll on the UK financial sector, unless financial services can be included.
Based on the latest information, it would appear that a Canada-plus is what the UK is aiming for, the plus being a deal on financial services.
With no EU deal, the UK would trade based on World Trade Organisation rules only because all trade deals that the UK currently enjoys are those negotiated by the EU with the rest of the world.
- Freedom to negotiate independent trade deals, but obviously this cannot be achieved over night.
- Period of international financial limbo with no international trading status
- Unprecedented legal situation
- Tremendously complex
- Likely wholesale adoption of EU trade schedules as a basis for future trade
This is not a deal, but rather where the UK attempts to become a free trade zone off the coast of Europe. With no EU deal in place, the UK reverts to WTO rules, then drops tariff on imports completely
- Extremely simple.
- UK becomes a free trader
- Other countries may not drop their import tariffs against UK goods\
- Likely decimation of UK manufacturing sector
What does this all mean for asset-based lenders?
There are two risks in light of the potential outcomes from the UK’s Brexit negotiations.
The first is the impact on the financial services sector and the potential that the ability to passport from the UK to EU entities will be cancelled. This may cause conflict between the UK and EU courts, whereas in the past there has been recognition of local actions taken in a UK court by other European countries’ courts and also the EU courts. The advantages that the UK provides under C.O.M.I are likely to fall away, which could make work out or bankruptcy procedures in multi-jurisdictional cases more difficult. Please note that cross-border bankruptcy can hardly be described as a walk in the park as EU countries are a very long way from harmonization of bankruptcy lending and contract law.
The most significant risk is economic, leading to higher credit risk in respect of UK companies and particularly those that export within Europe or to the UK.
I do not think that any one doubts that there will be an economic impact. It is more a question of how deep and for how long. The path that the UK goes in the Brexit negotiations will obviously be a major factor here.
Look to Germany
Based on all of the reports, negotiations are not going well. My guess is that because the adult, in the shape of Angela Merkel, is not in the room.
She has been focused on the German election, which has left her unable so far to form a government. My view has been that since the UK General Election, the UK will get the deal that Germany wants her to get on the basis that Merkel will form a government under her Chancellery. If this is not the case, then all bets are off and the wounds of Brexit could run very deep.
The good news is that the UK and EU negotiators are moving to Phase 2 and are about to discuss a trade deal. The bad news is that the big Issues have been fudged and there remains a lack of consensus within the government, across the political spectrum or the country.
The March 2019 date is likely to get pushed back, maybe a long way to allow for the “transitionary “period.
From a lender’s perspective there is likely to be no change as far as the EU/UK legal environment is concerned, but the continuing uncertainty will likely have an adverse impact on the economic and credit risk conditions.
Richard Hawkins is founder and CEO of Atlantic Risk Management Services. www.atlanticrms.com