As we approach 29 March 2019 the race is on for banks and financial investors to prepare for a fundamental change in the way they have been doing business in Europe in the last 25 years.
The European Union (EU) gave London more than a base for expansion in the European common markets, it also gave London the conditions to establish itself as a leader in modern global financial markets. The EU unified set of rules gave London the platform to dominate Europe’s unified financial markets, cementing its position among the World’s top financial centres.
It is true that London has been, along with New York, one of the main financial centres in the World since the XIX century. However, XXI century global capital markets are very different from financial markets in the XIX and XX centuries.
Globalization of the financial markets requires size and Europe gave London the grandeur it had lost after the World War I. As the hub for European financial markets operations, London became an unique place in the World, a bridge between East and West.
Will all of this be lost on 29 March 2019? The answer is inevitably “no”. But since Brexit was announced we have seen an erosion of London’s position in the global markets. Global players are planning for Brexit. In any context, a hard or soft Brexit, financial institutions and investors are no longer considering London as the centre of European finance. Other locations emerge wanting to take that role: Paris, Frankfurt, Amsterdam and Dublin. All have an eye for a lucrative market until now dominated by London.
The tendency seems to be for banks and other financial investors to keep a significant presence in London and open other important operation centre or centres in mainland Europe and sometimes in Ireland. Internet-based systems allow for a virtual presence anywhere in Europe, so the choice will be driven by convenience, cost, tax and the incentives local governments will give to attract these investors.
The end of London’s dominance seems to anticipate the loss of English law and English courts’ pre-eminence in financial law matters. Unsurprisingly, it is more difficult to change from English law and English courts to French, German or Portuguese law than moving offices from London to Paris, Frankfurt or Lisbon.
The arguments for choosing English law and English courts are clear: a sound, business friendly, reliable and trusted system of law applied by courts that are commercially aware, fast and predictable. All of these arguments lauded by London based law firms play in favour of English law and English courts.
However, banks are concerned that when they move to Europe there will be no reason to choose English law, which will be a foreign legal system after Brexit and that will not be related to them or their clients. Also the laws of EU countries will continue aligned by EU directives and regulations while English will start to deviate from EU law. This means that while contractual terms can be governed by English law, the regulatory aspects of financial instruments will be governed by EU law and local laws harmonized by EU legislation. English law will add unnecessary complexity that will only be justifiable if the advantages of the English legal system, law and courts, significantly outweigh the advantages of keeping the entire transaction under the umbrella of a single legal system.
Another point to consider is the origin of clients and investors. While the UK was part of the EU, there was no issue for a client or investor to question the choice of English law and English courts because of the advantages of the English legal system which we highlighted above and the fact that as part of a unified and integrated market, the UK offered the best of the two worlds. After Brexit, investors will question the choice of English law and English courts in favour of their own legal system. Why should a French, Spanish, German or Portuguese client or investor prefer English law, which many times will be totally foreign to the transaction, in relation to the laws of an EU country?
In the US financial markets, NY law and NY courts is the obvious choice. US investors and those gravitating around the US, such as Asian, Latin American and Middle East investors, trust the choice of NY law and NY courts. In Europe, English law and English courts will cease to preform that role in a post-Brexit world. In the last 25 years, English law imposed itself due to the business minded approach of city of London and the weight of the European markets to which investors from other latitudes adhered.
After Brexit, English law and English courts will not be as attractive to investors, who will mistrust the added complexity and the risk of local courts having to confirm English courts judgements. English law and English courts will retain an important role in international, maybe larger than the role of City of London banks and financiers, but not the same dominant role they had until today.
Paris courts and French law are emerging as the strongest challenger, but the importance of Paris in Europe’s next financial hub will depend on the ability of the country to present to the finance world a well-established, predictable, creditor and business friendly set of rules, faster court decisions and no political or ideological bias. In essence, continental European countries have a system of rules that is predictable and fair, but court decisions are less predictable, less business friendly, sometimes contaminated by ideological considerations and many times slow. Recent events in France show that it will be difficult for Paris to give the same assurances as London.
If the flaws of Europe’s legal and court systems remain unchanged, English law and English courts will keep a pre-eminent role in Europe’s financial markets once the short-term effects of Brexit fade away and people get used to border controls and other idiosyncrasies of a divided Europe. As a Portuguese wishing financial investors choose Lisbon to set up their European headquarters, I propose:
- First: create a business friendly and creditor friendly legal environment, with no bias against banks and financial investors;
- Second: put together a clear set of rules, predictable, less open to variations in interpretation and not dependent on general well-intended considerations that impair the application of the law in its full force; and
- Third: set up specialised finance courts that are quick in deciding, commercially aware and practical in their decision making process.
We doubt that Portugal or any other EU country will be able to do all three things, but Europe could lead the way and issue directives and regulations to create a Pan-European unified body of rules concerning commercial borrowing and lending and other financial matters and propose that countries create specialised courts dealing with finance matters to solve matters more quickly and by way of a specialised court system gain the experience needed to better decide these issues.
The Portuguese Parliament discussions on the draft 2017 budget presented by the Government are on the way.
The draft forecasts a budget deficit of 1.6% of the GDP which, if achieved, would be the lowest Portuguese budget deficit in 40 years. A 0.8% deficit cut should make EU Commission happy and the Government expects to reach it despite of the €10 increase in all lower pensions imposed by the far-left parties to approve the budget, the entire removal of all cuts in public officers' salaries and pension made from 2010 to 2015 and the phase-out of the 3.5% personal income tax surcharge.
Considering the increase in public spending and the reduction in income tax revenues, it does not come as a surprise that, despite the “treats” offered by the Government, fiscal policy will have to do its “tricks” and taxes overall will have to increase further.
The Government had already announced in November 2015 that it would stop the corporate income tax reform, which contemplated a reduction of the general rate from 21% to 20% in 2016 and from 20% to 19% in 2017. The draft 2017 budget confirms that the general rate will remain unchanged.
The removal in 2017 of the personal income tax 3.5% surcharge, approved by the Government in December 2015, will now only apply in full to those earning less than €20,261 euros a year. Taxpayers earning up to €80,640 will only benefit from a gradual phase-out in 2017 and those earning more than €80,640 will have to wait until December.
In addition, the Government decided to resort to an increase of indirect taxation. Not only to the recurrent increase of taxes over vehicles, alcohol, oil products and tobacco, but also to a new tax on sugary and low alcoholic drinks (“fat tax”), an extra 0.3% tax on real estate above €600,000 (which will be levied on top of the current real estate tax) and even a special tax on gun shells.
Notwithstanding the 2016 figures on the budget implementation disclosed last week showing that indirect tax revenues, including VAT, are expected to fall below the forecasts made in the 2016 budget, the Government seems convinced that there is still room to increase indirect taxation. And the fact is it may well be right.
As an example, the new fat tax on sugary and low alcoholic drinks should raise a mere €80 million in 2017. But what prevents the Government from increasing it in the next years, as it was done in respect of all other excite taxes in the last years? And why leaving other sugary products out of this tax? After all, aren't these products associated with weight and obesity problems?
The room to increase indirect taxes seems endless and new taxes are very likely to appear in the next years, such as the inheritance tax over high-net-worth estates - which was included in the Government’s programme and is waiting for the right moment - and the financial transactions tax - which is waiting for EU approval.
The 2017 budget shows a clear trend to give preference to indirect taxes, which already represent more than 50% of the whole tax revenues. One of the arguments used by the Government is that this is the only way to reduce personal income tax.
A more pragmatic perspective would argue that indirect taxes are efficient, raise less controversy and could even be more popular, if you have the right arguments - in reality, many times the end consumer will not even notice them, especially if they have a marginal impact on prices.
The downsides are known: unlike direct taxes, indirect taxes are regressive and will treat taxpayers equally irrespectively of their income, which may increase inequality and affect those with low income; on the other hand, some indirect taxes may harm competitiveness of the economy as a whole and/or of some products produced locally, especially if they entail an increase of production costs (e.g. taxes on oil products/power).
For now, the Government seems to have accomplished what some considered the impossible mission of squaring the circle: increase taxes and keep everyone happy! However, if inflation, interest rates or oil prices increase in the near future, the Government and taxpayers may be faced with a new dilemma: trick-or-trick?
The end of 2015 was difficult for the battered Portuguese banking sector. The Bank of Portugal and the European Central Bank wanted to clean up the house before the entry into force, on 1 January 2016, of the unified European bank resolution mechanism.
On 20 December, the Portuguese Government was forced to intervene in BANIF which was about to lose access to the ECB’s emergency liquidity funding. Although BANIF was a small bank it may end up costing Portuguese taxpayers over €3,000 million.
On 29 December, the Bank of Portugal adopted a second resolution in respect of BES ordering the "re-transfer" of certain Novo Banco senior notes worth approximately €2,000 million to BES, the bad bank that resulted from the collapse of the Espírito Santo Group.
As announced by the Bank of Portugal, this measure increased Novo Banco’s capital ratio to 13% making it more attractive to potential buyers.
In anticipation of the litigation that will certainly follow, the Bank of Portugal stated in its press release that its decision was due to the additional “losses arising from facts with their origin at Banco Espírito Santo, S.A. and prior to the date of the resolution [3 august 2014]"; in other words, the Bank of Portugal is arguing that the measure aims to solve a problem created before the incorporation of Novo Banco. The Bank of Portugal also states that the resolution was "necessary to ensure that, as set out in the resolution legal framework, the losses of Banco Espírito Santo, S.A. are absorbed, firstly, by the shareholders and creditors of this institution and not by the banking system or the taxpayers", which would justify the less favourable treatment given to the holders of the notes “re-transferred” to BES. Lastly, the Bank of Portugal concludes that this last decision "is the final and definitive change in the perimeter of assets, liabilities, off-balance sheet and assets under management transferred to Novo Banco" that was left open in the original resolution measure isnow “definitively closed" by this decision.
In contrast with the Bank of Portugal’s original resolution measure of 3 August 2014, which, we have always believed, would be hard to challenge in court, in this particular case investors have strong reasons to question the timing and the proportionality of the measure adopted.
As regards the timing, this last measure was taken one year and four months after the Bank of Portugal’s first intervention in BES, which took place on 3 August 2014. It is difficult to understand which facts occurred before August 2014 could justify such a serious measure. As is publicly known, since the adoption of the original resolution, Novo Banco approved its 2014 financial statements, which have been audited by its statutory auditors and reviewed by the Bank of Portugal in the exercise of their supervisory functions. Novo Banco also approved quarterly and semi-annual financial statements concerning the year 2015 and was subject to stress tests by the European Central Bank, which were announced by the Bank of Portugal on 14 November 2014.
The Bank of Portugal’s decision also breaches the principle of equal treatment of creditors within their respective rankings, as Novo Banco has repaid other notes with the same ranking in 2015 and assumed responsibility for other senior bonds issued by BES and/or vehicles of BES. Therefore, the decision favours other unsecured creditors of Novo Banco whose rights are not affected by the resolution now adopted in relation to the senior notes that were “re-transferred” to BES.
The banking resolution legal framework does not allow a differentiated treatment of creditors of the same ranking, with the exception of depositors that benefit from legal preference over other unsecured creditors and creditors essential to the continuation of the bank’s activities. It is therefore difficult to understand why this measure does not apply to the holders of other senior notes.
It is more than likely that harmed investors will take the matter to the courts and that they will have a strong case against the Bank of Portugal.
Significantly, the Bank of Portugal states in its press release that "it is the responsibility of the Resolution Fund to neutralize, by way of compensation to Novo Banco, the possible negative effects of future decisions, arising from the resolution procedure, which result in liabilities or contingencies"; in other words, the Bank of Portugal is impliedly accepting that some claimants may be successful in court and by this statement wants to assure potential buyers’ of Novo Banco that the bank will not be affected by litigation.
It is generally known that the ultimate responsibility that may arise from claims concerning the resolution of BES will have to be satisfied by the Resolution Fund. By stating it in its press release, the Bank of Portugal seems to indicate that the creditors affected by this latest measure have stronger chances of success when compared with the claims of subordinated creditors now in court.
The Bank of Portugal’s main goal with this measure was to improve Novo Banco’s financial ratios to facilitate its sale.
However, with this decision legal certainty is lost and investors may distrust the word given by the Bank of Portugal and the European Central Bank, which breach the laws that they should protect.
The question remains as to whether Novo Banco’s prospective buyers of should not be aware of a regulator that allowed (and required) a capital increase of a bank with serious internal problems that the same regulator would put into resolution only a few weeks after investors put their money into the bank and a regulator which reverted its own decision more than one year and four months later. Only time will tell.
The announcement by the European Central Bank (ECB) of its quantitative easing programme met the applause, more or less enthusiastic, of those who have been advocating the end of the austerity programs across Europe and in Portugal.
It is expected that the ECB's quantitative easing programme will create a monetary stimulus by allowing banks and other investors to sell certain debt securities to the ECB, which will release funds to finance the economy.