European Funds Comment: Preparing For a Hard Brexit (Again) … and Autumn’s To-Do List

26 July 2019
Issue 89

The UK’s incoming Prime Minister, Boris Johnson, clearly faces some formidable challenges in the months ahead.  The central question facing him – the same crucial question faced by many European and international businesses – is whether he can secure a negotiated withdrawal arrangement that allows the UK to leave the European Union in something approaching an orderly way. 

Mr Johnson himself has quite recently said that the chances of a no-deal Brexit are a “million to one against”.  Even allowing for some rhetorical flourish, those odds seem hard to square with other public statements he and other key figures have made in recent weeks.  Prime Minister Johnson continues to say that the UK will leave the EU on 31 October, with or without a negotiated deal, and that the current draft deal is not acceptable and must be re-negotiated.  The EU side, on the other hand, has repeatedly said that re-negotiation is not possible.  If the UK is to avoid crashing out of the EU on Halloween, one or both sides will clearly have to find a way to step back from their previous position – and Mr Johnson’s strongly pro-Brexit Cabinet will make it harder for him to do that – or the UK Parliament will have to intervene to force the British Prime Minster to change course, probably triggering a general election. 

Many commentators continue to believe that one of these routes to a negotiated settlement (or, at least, a further delay to Brexit) is likely but – as the depreciation of sterling in recent months illustrates – most think that the risk of a disorderly Brexit in October has risen.  So, just as in the run-up to the 29 March deadline, European businesses have to be ready for WTO-style tariffs and trade barriers.  And for British firms – since the UK has not yet been able to roll-over the terms of many of the EU’s free trade deals, so that it can continue to benefit from them after Brexit – those new tariffs and trade barriers may extend to some other important trading partners.  In the financial services sector, the loss of passporting rights has been anticipated for some time, but many private equity and venture capital firms cannot fully mitigate the impact, at least not in the short term. 

For UK- and Irish- focused investment funds, the regulatory challenge of accessing EU-based investors may not be the most significant hurdle in reaching a successful closing: investor sentiment is likely to be a bigger concern.  But any firm currently marketing with an EU passport, or with a significant fund distribution team located in the UK, needs a workable solution, and such solutions involve significant cost and upheaval.  The transitional period that would be baked into any negotiated settlement will not solve that problem, but will buy significantly more time to manage the transition to a new European structure.  Costs will increase substantially if politicians are unable to secure a transitional period.

Brexit aside, the start of the summer break may be a good time to reflect on other recent and impending developments that will keep the legal and compliance teams of European firms busy in the second half of the year, and beyond.   (These and other developments are explored more fully in our sister publication, The Private Equity Report, published this week.)

For UK firms, the most significant (non-Brexit related) project in the autumn will be implementation of the Senior Managers and Certification Regime (SM&CR).  The UK’s regulator, the FCA, hopes that the SM&CR will herald a step-change in the compliance culture at some firms, especially because it will require senior business people to sign up to specified responsibilities, but the FCA does not expect major upheaval or reorganisation within firms – although the regime has already caused some firms to make board changes.  Implementation projects are underway and there will need to be an investment in new procedures, especially on recruitment and annual reviews, and training.  But the project is certainly manageable and the regulator has given helpful guidance and reasonable time to prepare.

EU-wide projects are also looming, following a rush of legislative activity immediately before the European Parliament was dissolved for the May elections.  Among the key issues are increased capital requirements for firms regulated by the Markets in Financial Instruments Directive (including UK firms that give advice or arrange deals for other fund managers) – still some years away, but likely to require a very significant increase in resources for affected firms – and an ever-increasing focus on the sustainability agenda.  This latter policy initiative will require firms to demonstrate to regulators and investors that certain material environmental, social and governance (ESG) issues are properly assessed and considered in due diligence and decision-making procedures.  Private equity and venture capital firms are well-placed to respond positively to these initiatives and will continue to promote their credentials as responsible stewards of investors’ capital.

Finally, many portfolio companies in the UK will need to start reporting on their corporate governance arrangements – and, in particular, their engagement with employees and other stakeholders – in 2020.  The autumn would be a good time to review underlying portfolio company governance arrangements, both to anticipate this reporting requirement and to prepare for the inevitable increased scrutiny that an industry-wide focus on sustainability will bring.


European Funds Comment will take a summer break and will return in September.