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Commercial Awareness: The Fortnightly Round-Up (w/b 19th June)

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About The Author

Jack Turner (Commercial Awareness Guru)

Jack is a law graduate from the University of Manchester and is currently working for as an analyst for a 'Big 4' accountancy firm. He has an interest in current affairs, business and commercial law, while also being a talented and passionate musician.

This article is part of the 'Commercial Awareness Fortnightly Round-Up' series, edited by Jack Turner.

Every two weeks, Keep Calm Talk Law will bring you an overview of main commercial stories that have occurred. Detailing the main players involved, the interesting and salient facts, and the main points of discussion that arise from each story, this round-up is intended to be vital tool for developing that commercial knowledge and awareness demanded by the country’s top law firms.

Other articles from this series are listed at the end of this article.

Euro Clearing

Traditionally London has been seen as the financial capital of Europe. The ease of doing business in the City, the talent on offer, and its attraction as an international gateway has made London home to some of the world’s largest banks and financial institutions. However, Brexit has thrown a spanner in the works for London’s continued dominance in financial services.

Most of the focus in relation to what the UK financial services sector stands to lose from Brexit has centred on passporting rights. An EU passport permits a financial institution based and regulated in the UK to do business in other member states without having to establish themselves elsewhere in the EU. Britain’s exit from the EU means it could stand to lose these rights.

However, this fortnight the focus has been on the future of London’s lucrative euro clearing business. Clearing is the process by which an organisation acts as an intermediary between the buyer and seller of financial contracts. For example, one party may use a lot of coal to produce a product which they sell. In order to make a profit, they need the price of coal to stay below €50. They decide to hedge their bets by entering into a contract to buy coal at €45 at a certain date in the future. The other party that enters into the contract may be a market speculator who believes that the price of coal at that date in the future will actually be €30; they hope to make a profit of €15 on the transaction. Aware that there is a risk that the other side in this transaction may not be able to meet their obligation at the agreed date in the future and knowing how complex and time-consuming the managing and execution of a financial contract can be, both parties to the transaction deal with a clearing house rather than each other. The clearing house manages the transaction and bears the risks if one side doesn't pay up. In return, both parties have to keep money in an account with the clearing house in case there are problems. The clearing house also charges a fee for its services.

London plays a vital role in the clearing of euro-denominated financial contracts. Euro clearing forms an important part of London’s financial services sector and the volume of business can top $900bn a day. The EU is concerned that once the UK sits outside EU jurisdiction, London, through its role in euro clearing, will be a pillar of the EU securities and derivatives market and will be vital for maintaining financial stability in the Eurozone, without being covered by the bloc’s rules. In response, the EU revealed plans to give EU regulators enhanced powers to vet overseas clearing houses. Clearing houses deemed to be “systematically important” will be subject to stricter regulatory requirements in relation to things like the type and value of collateral held by the clearing house to guarantee a trade. Clearing houses of “specifically substantial systemic significance” could be forced to relocate their business to the EU.

EU regulators will decide whether a clearing house is “systematically important” by assessing factors such as its size and the amount of business it clears, how many of its clearing members are EU entities, and what the impact on the EU financial market would be if the clearing house fails.

Talking Points

Lawyers’ reactions to these plans have been somewhat mixed. On the one hand, some lawyers are relieved by the proposals; many had predicted that the EU would make a strong grab for London’s euro clearing business and force most of the business to relocate. However, the approach taken by the EU is a lot less aggressive than originally presumed. The EU is allowing access to EU markets in financial services for non-EU companies that subject themselves to its supervision. It is encouraging London’s success in financial markets as long as it has a say in its regulation. Not only is this a significant concession from the EU, it could also indicate that the EU is willing to compromise and work collaboratively with the UK in relation to the future of financial services post-Brexit.

It is not entirely surprising that the EU has been less aggressive in its approach, as breaking up clearing houses by forcing euro clearing to take place in the EU would burden European banks. The more business a bank does with a clearing house, the less collateral you have to deposit as security for the transaction. Therefore, it makes sense for banks to use the same clearing house for all their derivatives contracts, not just euro-denominated ones.

On the other hand, some lawyers are still wary of the EU’s proposals as it still clearly lays out the possibility of forced relocation. Similarly, the proposals give significant powers to EU regulators to control the way that clearing houses conduct their business. Clearing houses in London will need to come to terms with the fact that they will be subject to regulation that they have had no say over and will have very little influence over in the future.  

Firms with a strength in financial services include, amongst many others, Clifford Chance, Linklaters, Allen & Overy, Freshfields, Slaughter & May, Norton Rose Fulbright, Hogan Lovells, Shearman & Sterling, and Simmons & Simmons.

Amazon – Whole Foods

Jeff Bezos chose Amazon as the name of his company to symbolise how large and diverse he wanted his business to be. This fortnight Amazon reminded us again how it is living up to its name. The company announced that it is buying upmarket American supermarket chain, Whole Foods Market, for $13.7bn in an all-cash deal. Amazon will finance this deal with debt, including a bridging loan (a short-term loan used until Amazon can secure permanent financing) financed by Goldman Sachs and Bank of America Merrill Lynch.

Amazon has been trying to make inroads into the food & grocery sector through its grocery delivery service AmazonFresh. However, it has been criticised for having a lack of choice and only being available in a handful of cities around the world. For Amazon, buying Whole Foods will give it the volume and scale to reach more customers, provide greater variety, and cut costs. It will also give them a bricks-and-mortar retailer to experiment with as the company begins to trial a number of physical stores.

John Mackey, co-chief executive and founder of Whole Foods, described the proposed combination with Amazon as “love at first sight” at a company town hall meeting. It’s more likely that what Mackey is feeling is relief rather than love; the company has been facing strong competition from rivals such as Aldi and Lidl, especially since they have begun stocking high-end products, and pressure from an activist investor calling for a sale of the company. Activist investors didn’t have to shout too loudly to get the board to approve this deal, however, the deal still needs shareholder and regulatory approval. There is still time for a counter-bid to be tabled as big retailers, such as Walmart or Costco, may want to gate-crash the deal to keep Amazon out of their business.

Talking Points

Amazon was one of the many targets of Trump’s aggressive election campaign. Trump said that the company would have “such problems” when he took the White House due to their history of antitrust issues. This should cause concern for the parties to this deal and their lawyers. However, the markets are reacting like the deal has been already completed; boosting Amazon and Whole Foods’ share price and cutting the share price of its competitors. The reality is that although Amazon is a prime target for regulatory investigation, this deal doesn’t present any obvious concern. Amazon, through its AmazonFresh service, occupies just 0.2% of the grocery market and Whole Foods occupies just 1.2%. Similarly, it is an internet retailer, traditionally focussed on electronics, books and movies, buying a bricks-and-mortar food retailer – the markets are considered different.

But Amazon doesn’t feel small and unthreatening. It clearly has the power to dominate e-commerce and abuse the market. There are concerns that through its scale and operations, Amazon can undercut competitors and run them out of business, leading to less choice for customers and the ability to boost its prices without challenge. Amazon also has a reputation for upending established businesses and causing job displacement. This is certainly something that was felt by high-street book and video stores when Amazon entered the market.

The disruption Amazon causes to traditional business models is not a bad thing from an antitrust perspective if it leads to price efficiencies for consumers. However, its conduct and pricing strategies once it enters the market must be carefully monitored by regulators, as it is through its dominance that it has the ability to abuse the market. Amazon’s growth and ambition may lead to it becoming too big for its own good; eventually, it will be big enough for regulators to take action and it will not be allowed the ease of expansion that it currently enjoys.

Amazon isn’t just acquiring physical assets from Whole Foods, it is also acquiring data regarding its customers’ shopping habits. The concern for antitrust authorities should be how Amazon can use this data to manipulate behaviour, cross-sell their products and reduce competition in the marketplace. Perhaps Amazon will be able to see that a customer is buying vegetarian food and use this information to advertise vegetarian cookbooks from their website. Equally, they could see that a customer has purchased a book about getting over a break-up and use this advertise the new Bridget Jones movie and Ben and Jerry’s cookie dough ice cream. This accumulation of data from a wide-range of consumers across multiple markets may warrant a new approach from antitrust authorities when examining a deal. Rather than focussing mainly of market share, authorities should also take into account the extent of firms’ data assets and how they could use them to limit competition. 

Sullivan & Cromwell are advising Amazon in the deal, while Wachtell Lipton Rosen & Katz are advising Whole Foods. Latham & Watkins are advising Evercore Partners in its role as financial adviser to Whole Foods. Paul Hastings are advising Goldman Sachs in its role as financial adviser to Amazon. Weil Gotshal & Manges are acting for Bank of America Merrill Lynch and Goldman Sachs, on the provision of a bridging loan.

Barclays charged over Qatar fundraising

Barclays, its former chief executive John Varley and three other ex-senior executives have been charged with fraud by the Serious Fraud Office (SFO). This is the first time a UK bank and its senior executives have faced criminal charges directly related to the financial crisis. However, ironically, the charges are not related to the cause of the financial crisis. Instead, the SFO’s allegations focus on the steps the bank took to stop itself from collapsing.

In 2008, in the midst of the financial meltdown, Gordon Brown created a £50bn fund to bail out UK banks. After just two days, RBS became the schemes first customer. It was followed shortly after by Halifax and the bank that had just agreed to buy them, Lloyds. Barclays was determined not to become the next bank to be bailed out by the tax payer so they made a desperate attempt to raise capital as quickly as possible. One of the sources Barclays chose was the state of Qatar. In June 2008 the bank raised £4.5bn from investors in the country, including Qatar Holding, part of the state’s sovereign wealth fund, and Challenger Universal, the investment vehicle of former the Qatari PM. Barclays returned again in October, this time raising £7.3bn. There were also a number of side deals made between Barclays and the Qatari investors. The bank paid Qatar Holding a total of £322m as part of an “advisory services agreement” for their help in boosting Barclays’ business in the Middle East. Barclays also agreed to provide a $3bn loan facility to the state of Qatar.

These side deals are central to the SFO’s charges.  First, the SFO claim conspiracy to commit fraud by false representation in relation to the £322m payment as part of the advisory services agreement. The suggestion is that Barclays did not properly disclose this payment to the markets and actually made the payments to secure the Qatari's support for the fundraising.

Second, the SFO claim unlawful financial assistance contrary to S.151 of the Companies Act 1985 in relation to the $3bn loan to the state of Qatar. Only Barclays, John Varley and Roger Jenkins (the orchestrator of the deal) have been charged with unlawful financial assistance. This provision prohibits companies from lending money for the purchase of their own shares. The allegations made by the SFO are that the $3bn loan to Qatar was then reinvested in the bank during its rescue. The rationale for this provision is that if a company supports the purchase of its own shares, it causes a reduction in the company's value in the hands of other shareholders.

Talking Points

This is possibly the SFO’s boldest prosecution to date. As noted above, it is the first time a UK bank and its senior executives have faced criminal charges directly related to the financial crisis and legal precedent for the case is limited. 

The future of the organisation was in doubt as the Conservative party had pledged in their election manifesto to incorporate the SFO into the National Crime Agency. This was despite the organisation having a successful start to 2017 by securing a deferred prosecution agreement with Rolls-Royce and Tesco. However, the pledge to scrap the SFO was absent from the Queens Speech suggesting that the policy may have been dropped.

This story is a reminder of the importance of the SFO in ensuring the UK can effectively fight fraud and financial crime. The SFO plays a vital role in ensuring good corporate governance and maintaining the UK’s reputation as a fair and transparent place to do business. The Conservative party’s plans could have damaged the UK’s effectiveness in tackling economic crime and protecting the markets. Many lawyers have welcomed the news that it was not part of the Queens Speech.

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Tagged: Banking & Finance, Brexit, Commercial Awareness, Commercial Law, Legal Careers, Trade

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