In all the maelstrom of debate about the future of global financial services in light of Brexit, one key point is often forgotten. That is, that the UK’s common law, pragmatic approach to law and regulation is intrinsically the safest for financial services, and conducting financial business under other available regimes introduces dangerous risk into the system which cannot be quantified or managed. For the common law is the bedrock supporting the global financial market. This system, based on judicial precedent, targeted statutory intervention, and a respect for the terms of commercial contracts, is in use throughout most of the US and Commonwealth. But it is the forms used in England and New York that are by far the most popular. Underpinned by strong governance capable of withstanding special interests, national, international, or commercial, they have proved their ability to evolve flexibly with the markets while achieving an appropriate degree of predictability. English law is particularly pre-eminent.
Numerous market developments have been made possible by English common law. For instance, it developed a regime for the netting of derivatives exposures, which is vital to facilitating legally certain exposures to financial risks and reducing a multiplicity of exposures between two parties to a single net sum. Similarly, English judicial precedent has developed for the safe holding of financial securities and collateral, evolving to permit the securities markets to become dematerialised in the 1990s and now adjusting again for crypto assets. English trust law protects client assets from the insolvency of the firm which holds them, and also allows for the parcelling up of risk amongst different investors through securitisation and other structures.
The alternative systems, which are code-based, are in use on the continent of Europe (including in the EU itself), as well as other countries deriving their legal culture from French or German law, such as Japan, China and those of South America. These involve an attempt to impose on commerce rationalist and scientific approaches to law deployed in France and Germany in the 19th century, through a codified operating system which is constantly being upgraded in an effort to keep up with the market. Yet this method is markedly less versatile and can create financial risk.
Take, for example, German law, based on a method of codification first effective in 1900. The use of standard agreements for financial derivatives was disrupted by a German court in 2016 when it declared that a netting provision widely adopted in those agreements was invalid in certain circumstances as it did not comply with the German Insolvency Code. Sudden market disruption arose, bringing with it risk and cost. The German regulator issued a decree that the judgment should essentially be ignored whilst the legislature amended the code to remedy the issue. Similarly, in 1989, German legislation had to be enacted to address a concern arising from a German federal court decision of 1970. The new legislation had to make clear that derivatives contracts are not caught by provisions of the German civil code that state that no obligations are created on the basis of gambling, a concern which threatened the validity of all German law derivatives.
The phenomenon is global. In Japan, which applies the civil law based on both the German and French methods, a judicial decision that Bitcoin is not property in the context of the bankruptcy of Mt Gox, the Bitcoin exchange, caused uncertainty which still lingers, despite regulatory legislation passed after that decision in 2016. A different result was reached in the Hangzhou Internet Court in China, despite the law in question being very similar, which shows the unpredictability of the approach.
The common law has been able to address all of these issues through judicial decisions, forming new precedent for new situations, while also taking into account analogous situations under prior case law. Although, on occasion, decisions can side with one line of reasoning over another, a commercially sensitive judiciary has generally been pragmatic. Financial business is safest within a truly common law environment. The unfurling blanket of EU law means that the only remaining pure common law system within the EU, the Irish law system, is being rapidly eroded by the EU code-based approach. The UK, while within the EU, was able to implement this code in a pragmatic way through its first-rate regulators and supervisors, who interpreted and applied the rules based on the common law method. However, Ireland is within the eurozone and its supervisors are overseen by (and in some instances, form part of) the European Central Bank and the pan-EU supervisory bodies, who continue to roll out more and more rigid financial codes.
The EU’s code-based legal architecture for the eurozone itself also illustrates the dangers of its more politicised approach. It splits sovereignty between monetary matters for the euro, treating those as federal, while leaving fiscal matters predominantly to the member states. It then treats each element as entirely sovereign, in a form of double counting. By ignoring the now sub-sovereign nature of member debt, it injects vast systemic risk into the EU and the global financial system.
The UK should now ensure that the global financial market continues to have a safe home within its English law system. That means emphasising the superior safety of the common law method. EU efforts to grab financial business and place it within its code-based regime are dangerous for the financial markets. It is vital that the vast majority of financial business continues to be conducted under common law systems for the sake of global wellbeing and growth