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Farewell Brussels?

13 July 15

With an in/out EU referendum now in prospect, how would a vote to leave affect legal practice in the UK? The authors suggest that EU law would continue to have a big impact in many key sectors

by Louisa Knox, Gordon Downie

The EU Referendum Bill paves the way for an in/out referendum on the UK’s continued membership of the European Union to be held before the end of 2017, following negotiations between the British Government and EU representatives on the terms of the UK’s future membership. This will be the first such referendum since 1975.

Businesses and individuals are already considering the potential impact of the UK leaving the EU, often referred to as “Brexit”. In this feature, we look at some of the implications for domestic law, and the likely continuing influence of the EU in important sectors.

What would happen if the UK voted to leave is not clear. Options could involve a combination of free trade agreements with individual EU member states, bilateral deals or a customs union with the EU, or membership of the European Economic Area (EEA) and the European Free Trade Association (EFTA). The impact for business and individuals would depend on the terms which the UK was able to negotiate in respect of each option; lengthy negotiations after the referendum would be inevitable. The UK would probably still have to comply with EU legislation in order to benefit from some of the advantageous terms and freedoms available under specific options.

Banking and financial services

A Brexit would have a significant impact on the banking and financial services sector, with far-reaching repercussions for the City of London. The majority of UK legislation in the sector is derived from EU law, and would need to be replaced or amended, though it is likely that it would be broadly similar to EU law.

Currently, a UK authorised investment firm under the Financial Services and Markets Act has the right to carry on business in another EEA state, provided it meets the requirements of the EU Single Market directive under which the activities will be carried out. This right would be at risk following a Brexit. Some existing contracts may contain obligations to comply with EU law, and a Brexit could render such contracts impracticable. As such, it is possible that many contracts between now and the referendum will be drafted to include provisions regarding a Brexit.

With financial institutions already examining their position, it is important for businesses to consider now how a Brexit could change the reputation of the UK as a location to base their banks and financial institutions, in order to minimise potential business disruption.

Competition

One might think that a Brexit would mean that UK businesses would no longer be subject to EU competition law. That view, however, is too simplistic. EU competition law applies to undertakings whose activities have an effect on trade between member states. Jurisdiction to enforce EU competition law does not depend on a business being based in a member state. Therefore, if a UK business was to participate in a cartel which had an effect on trade between member states, this could still be subject to enforcement action by the European Commission. Similarly, EU merger control rules would continue to apply where the jurisdictional tests were met.

There would, however, be two key differences. First, instead of the Commission having exclusive jurisdiction over mergers with an EU dimension, companies could have to obtain separate merger clearances from the UK and EU competition authorities. This would increase transactional costs and regulatory uncertainty. Secondly, the UK would lose its entitlement to “call in” a merger for UK consideration where the effects of an EU merger were expected to be experienced in the UK.

Finally, it is worth noting that if the current UK legal regime were to be maintained, some of the EU block exemptions which currently apply, such as for vertical agreements, would no longer apply to conduct or agreements which affect only UK markets. This could potentially lead to a significant alteration in the legal position in the UK if replacement provisions are not introduced.

Construction and infrastructure

Many of the key issues relating to a Brexit, such as changes in taxation and the effect on foreign investment into the UK (particularly in real estate), would inevitably impact on the construction sector. Restrictions on labour migration would potentially also affect the cost of projects. In terms of current legislation, there would be little short-term impact, as most EU measures are enshrined in UK law and there would need to be a specific move to change it.

UK-based contractors seeking to work on projects in the EU would continue to have to comply with EU legislation. Changes to the procurement regulations, covered below, could also impact on contractors both in the UK and elsewhere in the EU. Those supplying goods and materials to the sector would be affected by the terms of any new trade agreements.

Corporate finance

UK businesses will await the in/out referendum with three key questions in mind:

  1. Will the outcome make the UK more or less attractive to inward investors?
  2. Could withdrawal from the EU reduce red tape?
  3. How long will uncertainty linger about the impact of a Brexit?

A key point often overlooked is that any vote to leave the EU would trigger lengthy negotiations on the terms of withdrawal. Some are concerned that this window of uncertainty might discourage investment in the UK. Longer term, concerns focus on the potential impact on access to European markets, the financial dominance of the UK as a whole, and London in particular, and the loss of the UK’s voting rights in European matters.

Many UK businesses, particularly in funds and financial services, are governed by extensive EU directives and regulations which some consider to be burdensome “red tape”. However, the UK has historically driven much of this regulation and, at times, it has gone beyond the requirements of EU regulation in order to enhance investor confidence in the UK. The regime for market abuse is a good example of this. The impact may therefore be more neutral than might at first be thought.

Corporate taxation

Leaving the EU is likely to affect the UK tax system in a number of ways, most notably in relation to VAT. While VAT only applies to supplies made in the UK, the framework is laid down in an EU directive, and supplies made to and from other European countries are treated differently to those made outside the EU.

A Brexit is not likely to lead to a withdrawal of VAT – it currently raises almost a sixth of Government revenue. However, subject to the terms of the UK’s future relationship with the EU, the UK may no longer be constrained by the terms of EU VAT regulations and directives.

Various other rules ensure that taxpayers throughout the EU are treated equally by the UK tax system. On a Brexit, such protections might no longer be offered. For example, UK personal allowances might no longer be available to EU citizens, and other tax reliefs might no longer treat EU businesses in the same way as those based in the UK.

Electricity and downstream gas

For electricity and downstream gas companies, a Brexit would raise significant questions. A range of European companies have interests across much of the EU, underpinned by the freedom of movement of goods and capital. The continued ability to transfer key personnel to and from UK operations, and capital in and out of the UK, would be a key issue.

EU law also sets critical aspects of the UK regulatory framework for electricity and gas. It requires that regulators such as Ofgem be independent from political influence, a key protection for investors. Also, member states must not unlawfully discriminate between companies, national or foreign. For renewables, EU law provides a legally binding target for the UK, one that is much more difficult to change than UK targets and therefore underpins significant investments in renewables.

The EU energy market is becoming much more integrated, physically and economically. The UK has significant gas and electricity interconnection with Europe, and the trend is for greater integration. This relies on a common set of rules against which large capital investments can be made. It also helps promote security of supply at an economical price. Against this background a Brexit is a significant issue for the UK energy sector.

Employment

Free movement of workers between member states is a central pillar of the EU. If the UK were to leave, EU nationals could potentially face the same visa restrictions as those from outside the EU. However, if the UK were to join the EEA/EFTA, this would guarantee workers the right to free movement throughout the EU and other EEA nations, so would not curb immigration. If the UK were to follow the Swiss model of bilateral agreements with the EU, amendments to the immigration system would be needed.

The following EU directives underpin key aspects of UK employment law and apply to all members of the EEA: the Acquired Rights Directive, embodied in UK law by the TUPE Regulations, which protect employees during business transfers; the Working Time Directive, which regulates hours of work and notably holiday pay; Collective Redundancies Directive; Equal Treatment Directive; Part-time Workers Directive; Posted Workers Directive; Parental Leave Directive; European Works Councils Directive; and the Agency Workers Directive. As such, if there was a Brexit followed by an agreement to join the EEA, Britain would remain bound by many regulations and decisions that it was seeking to avoid by exiting the EU, but with less influence over the legislative process.

In addition, the EFTA Court, which would have jurisdiction in these matters for EEA nations, is bound to follow decisions of the CJEU. Switzerland, with more than 100 bilateral agreements with Europe, operates TUPE, collective redundancy and working time, and its courts treat CJEU decisions as persuasive. Currently, UK legislation is in place to implement EU law, so there would be no immediate change in the event of a vote to leave the EU. However, the impact over time on UK employment rights and working practices could be significant, dependent on the nature of any new relationships.

Food and drink

Food and drink exports are particularly significant for Scotland, amounting in 2012 to £5.3 billion, approximately 80% by value relating to whisky. In the event of a Brexit, exporting producers would be exposed, at least potentially, to higher charges at all points in the supply chain, both through tariffs on exports to EU member states and increased administration incurred on goods crossing the border of a customs union. (This is likely to be true for all manufacturing sectors.)

It is necessary to consider what a post-Brexit trading landscape would look like. If the UK sought new free trade agreements, following the model of Norway, or bilateral deals, as adopted by Switzerland, there would still need to be compliance with EU law in order to export into the EU. Current international free trade deals, most recently with South Korea, were also negotiated at EU level and the UK would have to negotiate such deals afresh. The high Indian tariffs on Scotch whisky continue to be the subject of debate in the context of an EU/India Free Trade Agreement.

In terms of food production, a Brexit would mean no further Common Agricultural Payments, in relation to which the UK is currently a net contributor. The costs, benefits and consequences of this change cannot be fully determined without further details on what an alternative UK-based structure would look like. It is likely that food and drink suppliers would face uncertainty and, in common with other sectors, a likely downturn in foreign direct investment in the short term, alongside a potential period of paralysis.

Insolvency

The European Insolvency Regulation (EUIR) established a regime for automatic mutual recognition within the EU of insolvency proceedings. It provides uniform protections for security rights, employment rights and various other interests. In the event of a Brexit, it is likely that the UK would seek similar arrangements, in order to preserve the stable environment currently available for business restructuring and to replicate the relatively predictable insolvency backdrop to lending and investment activity within the EU. Directives relating to credit institutions and insurers which are parallel to the EUIR have been extended beyond the EU to EEA institutions and insurers. It is possible that this could provide a model for a broader application of the EUIR.

Intellectual property and data protection

Data protection legislation (currently the Data Protection Act 1998) comes from the EU, and this is proposed to be covered by a regulation in the near future, to create certainty across the EU for businesses. A Brexit might mean that businesses would grapple with a regime that differed between the UK and the EU.

The UK is part of the one-stop-shop European trade mark application and grant process, and is supportive of the European unitary patent and Unified Patent Court. While wider international conventions are key to intellectual property law, many developments are driven by the EU and this allows UK companies to deal with broadly similar treatment of IP across the EU.

Pensions

Regulation of private pensions has traditionally been carried out at a UK level, but recent trends have moved greater influence towards the EU. The IORP Directive in 2003, for example, formed the basis for the Pensions Act 2004; the IORP regime is currently being substantially revised. Key employment principles, enshrined in the EU treaties, have also had an impact, with many schemes continuing to grapple with the impact of equalisation of benefits and age discrimination.

If the UK opted to join the EEA, it would require to adhere to EU rules, but EEA members are not traditionally involved in the rule-making process. The UK pension market is relatively unique compared to other European models, and there is therefore a risk that the UK may become subject to rules which are inappropriate for its pension market or which are overly onerous.

Planning and environment

Environmental legislation at EU level has increasingly shaped domestic UK legislation. In many cases, this has gone further than required by the directives. In the event of a Brexit, it is unlikely that domestic legislation originally deriving from EU law would significantly change.

Some recent EU legislation that the UK must now implement could have far-reaching consequences, for example, new monitoring obligations and timeframes relating to environmental impact assessment. Depending on timing and the outcome of the referendum, the UK may not be required to implement those changes. However, in the event of a Brexit, the UK may be required to retain equivalent levels of environmental protection if it wishes to maintain trade relationships.

Private client

The EU has generally taken only limited action in relation to trusts, succession and personal taxation, and the UK has often chosen not to adopt such measures as have been adopted. Nevertheless, a Brexit could mean a number of changes to the UK tax code, such as the removal of agricultural property relief in relation to farmland in EU countries, and the removal of tax relief to charities located in the EU. In addition, UK-based individuals holding assets in EU countries could find themselves subject to a more punitive taxation regime as compared to that which applies to EU nationals.

Property

The UK and the EU are major markets for each other, and the many UK businesses, including investors, retailers and developers, with property interests in Europe, will be concerned about the regulatory and fiscal implications of a Brexit. Any changes to freedom of movement could have repercussions for the industry. Funds which invest across different jurisdictions are likely to want to continue to invest across their desired locations regardless of the extent of the EU, but this is often governed by the fund’s internal constitution, which should be scrutinised to ensure that investment in the UK could continue following a Brexit.

Lower foreign direct investment in property would be likely, as global organisations and major corporates, especially in financial services, seek to cut back their UK operations and take them back to their traditional bases. A Brexit would also be likely to affect the ease with which supply chains work across Europe.

Farmers and estate owners will be anxious to understand how a vote to leave the EU would affect them. The payments system which emanates from the EU, but is administered locally within EU countries, could be replicated, but how it would be funded will be of concern.

UK legislation affecting property which emanates from the EU, such as energy efficiency and energy performance of buildings, is likely to be retained, in line with the UK’s commitment to carbon emissions reduction.

Public sector

A number of public sector issues would be affected in the event of a Brexit, many of which have already been mentioned. With regulated activities, such as public procurement, the UK would have a greater ability to vary or revoke legislation where it is no longer bound to comply with EU directives. This could mean greater flexibility in terms of restricting competitions to UK entities. However, it could also mean that UK entities which currently bid for contracts outside the UK lose the ability to do so. The UK would no longer be subject to EU rules on state aid. It is also possible that the public sector could be impacted by a change in accounting standards: it is currently subject to the internationally agreed European System of Accounts 2010.

How long would it take?

In order to exit the EU, the UK would be required to give two years’ notice, and it is likely that numerous interim and transitional measures would be put in place during this time in order to ensure that the legal and regulatory framework is not removed overnight. The UK leaving the EU, however, would be unprecedented, and the complexity of the negotiations as well the wider political background (e.g. Eurozone matters) might have an impact on the timeframe for a Brexit.

Louisa Knox and Gordon Downie are partners with Shepherd and Wedderburn 

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