As to what the UK referendum in favor of leaving the EU has in store for M&A, the word “uncertainty” is how practitioners are most likely to respond. “No one knows,” is another popular answer, followed closely by “This will take some time to sort itself out.”

It is not, at least according to some metrics, as if dealmaking involving UK entities had been proceeding particularly well before the Brexit vote. Mark Thierfelder, the chair of Dechert’s global corporate and securities group, with its 225 lawyers across the United States, Europe, Asia and the Middle East, and chair of its global private equity practice, puts it this way: “All that happened on the morning of the Brexit results was that the uncertainty became certain. The amount of in-bound UK cross-border M&A activity had already fallen by approximately 70 percent.” Douglas Getter, head of Dechert’s US corporate practice in Europe and its corporate team in London, points out, “We’re talking about year-on-year where 2015 was an excellent year for the UK and M&A in general, followed by a major league drop off for UK deals in the run-up to Brexit.” Adds Mr. Thierfelder: “If the vote had been to remain, all the uncertainty would have been cleared up, but now with the vote to leave, the uncertainty has crystallized and all we know now is that there is uncertainty.”

The head of KKR’s European operations, Johannes Huth, famously announced that his firm would not be making any UK investments before the Brexit referendum because of what he called the dire consequences of a successful vote to leave the EU. Mr. Huth said that KKR was investing $65 million in a UK cybersecurity company known as Darktrace. Mr. Huth says that the target has a global customer base stretching from New York, London, Milan, Mumbai, Paris as well as Sydney and Tokyo, among other cities and that Darkspace is poised for yet more expansion around the world. The Brexit vote, he argues, is still fraught with peril and reiterates his view that KKR might well consider moving to other EU cities in either Ireland or France. Which of his impulses will prevail among other dealmakers, his high-profile acquisition or his pessimism about the future of the UK and Europe itself?

Matthew Herman, the head of Freshfields’ US corporate practice in NY, has specialized in cross-border M&A for the past 15 years, and has a more bullish outlook. “Since the vote, we have continued to see—in particular for well-placed corporates with substantial non-US trapped cash—opportunities to take measured risk in quality assets in the UK and in Europe at attractive valuations. And those are even more compelling when the target business is part of a diversified global asset portfolio. To be sure, we have seen and expect to continue to see near- to medium-term volatility, but we nevertheless take comfort from public statements from M&A participants emphasizing their commitments to previously announced transactions. This is a window for seasoned M&A players that have built Brexit volatility into their M&A models. And on the flip side in the cases where we see if announced transactions start to wobble, or where M&A sale processes begin to break, we are seeing a lot of interest by serious potential buyers—both corporates and financial sponsors—looking to step in. This is not to say that deal execution will be easy; to the contrary, it is near certain that trends will continue: for example, we continue to see enhanced regulatory (antitrust, foreign investment/national security, bribery and corruption) review of transactions and of businesses and when you fold in currency volatility and macro economic uncertainty that comes with shocks like the Brexit vote, these transactions are not for the timid, who are unwilling to take risk.”

Although there has been a large decline in transactions in the U.K—so far cut in half from 2015’s $73.3 billion and now at its lowest level since 2011—its M&A record over the past 12 months has included a not insignificant number of mega-deals. These include Ab InBev and SAB Miller worth $107 billion; BG and Shell at $70 billion, the merger of the London Stock Exchange and Deutsche Bourse that hit $20 billion, and the Sysco and Brakes Group at $3 billion, to name just a few. Since the Brexit vote, that brought with it a drop in the value of the pound and a fall in share prices, several deals have managed to raise their heads above the trenches. Bargain hunters as well as strategic buyers—the former looking to buy on the cheap and the latter searching for a union that makes sense despite Brexit—are on safari, as writers Arash Massoudi, James Fontanella-Khan and Michael Pooler pointed out in their July 15 article in the Financial Times. China’s richest man, has agreed to buy the UK’s Odeon & UCI Cinemas Group from private equity group Terra Firm, for example.

Bargain hunters, however, typically find their prey and move on. Strategic buyers won’t just buy anything. Their targets will be similar to KKR’s Darkspace and will be global companies or those with global prospects. Alan Klein, of Simpson Thacher, was quoted in the Financial Times article as pointing out that cheaper sterling can only take the market so far. “The situation is more nuanced. Brexit will not impact companies that generate most of their revenues outside the UK, so the devaluation of the pound certainly makes them more attractive buyers,” he told the FT.
Mr. Klein told The M&A Journal that he remembers arriving at his firm’s London office 22 years ago “just at the front end of the process of EU integration that was taking place.” There was as yet no euro and passport officials still manned the borders of European countries. Now he is co-head of the firm’s mergers and acquisitions practice, a member of the firm’s executive committee, a past chair of the International Bar Association’s Corporate and M&A Law Committee, and has chaired that association’s Annual Mergers and Acquisitions Conference in New York for the past seven years.
Mr. Klein describes the storm in the stock markets immediately after the Brexit vote as “the emotions of the equity markets caused by being totally blind-sided by a result that everyone had been assuring each other wasn’t going to take place.” He points out that on the day of the vote itself the polls showed a four-point lead for the “remain” camp. “For the polls in the U.K. to be that wrong—and this is the second major election in a row that they’ve blown—is quite stunning,” he says. “It shows how closely divided the electorate is there—as it is here on so many issues. People were putting a lot of faith in the betting markets and they were putting a degree of faith in the polling. The consensus was that it would be reasonably close, but that it would come out the right way. I think there was a degree of complacency because the rational outcome was so clear. People thought the conclusion was foregone and they woke up to find out they were horribly mistaken.”

What will the consequences actually be? Over the next possibly two years of negotiations, M&A experts will be watching for major changes in merger regulation. There may well be new and different, but perhaps not all that different, regulatory overlay, Mr. Klein says. “Mergers that only needed to be reviewed at the EU level may now need to be reviewed by both the EU and the UK. There is a level of financial institution regulation, which may now be bifurcated between both the EU and the UK. It’s highly unlikely that the movement of capital will be tremendously impeded. I don’t think we’re going back to currency controls that existed forty years ago. I don’t think the free movement of goods is going to be impeded. Nobody has said they want tariffs put on the things that they buy from continental countries. There is certainly the free flow of goods and capital between the US and the EU and there’s no reason to think that won’t be the case between the US and the UK.”

Mr. Klein predicts that “the biggest kicker is really the degree to which there can be the free flow of people.” There are thousands upon thousands of people who work in London, from the financial services industry to restaurants and whatever level of anger and frustration was being expressed through this vote, I don’t think people wanted to go into their favorite restaurant and have to serve themselves. And, for that matter, bankers and lawyers need to find a way to have professionals in London. Mr. Klein points out that “shocking changes” are not inevitable as the multi-year process through the nitty-gritty gets underway. He notes that traveling to Switzerland, which is not in the EU, requires no passports from citizens of EU member countries. Similarly, there are myriad merger regulatory regimes throughout the world and deals still get done. There is a lot of hysteria right now. But no one is talking about shutting down the Channel Tunnel.”

Nothing will change for some time, says Mark Compton, a partner in the financial services regulatory enforcement practice at Mayer Brown’s London office. “For the time being, we’re still part of the EU and we will still be part of the EU until we formally notify the EU that we want to leave under Article 50 of the treaty. At that point the exit negotiations would take place, which could easily take up to two years. We’ve been told by our politicians that we’re not going to notify the EU until the end of the year at the earliest. The EU can’t force us to speed up the process. So anything happening in that period, in the next two-and-a-half years, is going to be fully under EU law. Nothing will change in that respect.”

Mr. Compton also argues that what change that might ensue may not turn out to be the great schism some fear. “There are a lot of reasons why we may well still be subject to full or close to full EU legislation,” he says. The financial services industry is massively important to the UK economy, for example, at around 12 percent of GDP. The sector is also the country’s largest single taxpayer. The UK is therefore going to want to keep that sector as healthy as possible. “That means almost certainly trying to agree a situation where we keep access to what’s called ‘the EU passport,’ ” Mr. Compton says. “This allows a financial services company that is set up and regulated in one EU member state to offer its services freely throughout the EU without having to get a license in any other country. Now then, if we leave the EU, obviously we’re no longer a EU member state, and technically we would lose that license. But there are other alternatives, like becoming a member of the European Economic Area, the EEA, like Norway, which would give us access to the passport as long as we accepted EU legislation in full. Many of the politicians are talking about this, either as the starting point of the negotiation or something they’re aiming for. If we were to enact legislation very similar to that of the EU, we would then be likely to be declared ‘equivalent’ to the EU, with the privileges that would entail, even if we were not to become a member of the EEA. So, it’s likely—although you can’t guarantee anything—that even after two-and-a-half years of negotiations—we would either still be subject to EU legislation or something close to it. You can’t rule out the fact that very little might change. Still, Article 50 looms.”

Mr. Compton believes that the options he describes are technically possible but will not be easy to put in place. “The EEA Agreement allows for the suspension of some of the obligations most likely to run counter to Brexiteer desires, such as the free movement of people. Articles 43 and 112 of the Agreement allow for the suspension of the obligations, known as the ‘freedoms,’ ” he explains. and capital under Articles 43,” he explains. “In the past, Iceland has suspended the free movement of capital during the height of the financial crisis and Liechtenstein has suspended the free movement of people. But this would require political will on both sides and the current statements from both the EU and Prime Minister Theresa May would suggest the option is not likely to win much support on either side. Having said that, the political landscape has changed so quickly that I wouldn’t place bets on anything.”

Richard Lever, a partner in Goodwin’s London office, believes that the future of regulation could go in a number of directions. “Nobody knows where we’re going to come out. Obviously, the first option is we stay as we are and we don’t leave. The referendum does not have the force of law, after all, and is merely advisory. Scenario Two is that we leave and we negotiate a revised deal with Europe. Part of any deal to gain access to the single market is we have to accept the regulations that the EU imposes on its members, including somebody that wants to trade within its market but is not a member, which would be where the UK would find itself. There may be a situation where those regulations stay in place. If we leave, that’s probably the most likely option. Scenario Three is we become some kind of mega off-shore entity that has some kind of relationship that allows people to access Europe but is not subject to EU regulatory regimes. I would say that is probably less likely if we are to remain under some kind of trading terms within that single market. I don’t think the European Union would allow that.

Mr. Lever questions the foresight of the “leave” camp and the inability of the “remain” to sense what was to come. “We didn’t see this happening,” he says. “We assumed this vote wouldn’t happen because everyone knew there would be considerable economic uncertainty, and because of the obvious economic benefit to everybody to be in the EU. As for the people who voted for Brexit and the people who were leading the campaign, I don’t think they completely formulated where they wanted to be. You haven’t seen the end of this. It’s very much a moving thing. It’s exactly like the dog chasing the car that doesn’t know what to do with it once it catches it, other than lose a few teeth, which is likely to happen before this is over.”

Once the politics on both sides of the Atlantic ceases its roiling confusion, there might even turn out to be a bump in deals. “This isn’t to say that people won’t be irrational and panic unnecessarily. That can always happen, says Simpson’s Mr. Klein. “But it’s conceivable that you could look out towards December and January, when there will be a new UK government and a new US government and there will at least be some certainty as to who’s in charge, whether you like the two outcomes or not, and you could potentially see a big bump in activity. Now, that presumes there isn’t something exogenous, like a credit crunch for some reason, or some other instability. But if this is all there is, and if you end up with what appears to be a rational UK government and a rational US government, there will be a lot of pent-up demand. So, we could be looking at quite a very different landscape come the end of the year and the beginning of next year.

Mr. Klein points out that deal activity is always affected at the margin by US presidential elections. “Whether activity levels are going to decline by five percent, or ten percent, or twenty percent is hard to know right now, but it was going to happen starting without question after Labor Day as the election really heats up. September and October in election years, particularly when there is no incumbent, are slower. Whether it’s totally dead or just moderated is always open to question and depends on the level of uncertainty. So the market instability and general uncertainty may bleed into the period coming out of the conventions where the uncertainty around the US election will be due to kick in.”

Goodwin’s Michael Kendall recently did a practice group update at his firm. “We forecast our business for the coming year, among other matters, and I had occasion to spend some time looking at Q4 last year and Q1 this year. It looks like M&A, including the US and Europe, is down potentially significantly in the first quarter. But if you pull it apart, if you analyze the number of deals that were done and the size of those deals, you see significant compression at the very top of the market. Deals that are over a billion dollars compressed significantly in the first quarter and close to 20 percent down. But in the middle market, it was more like two or three percent. Our particular private equity practice is a middle market practice—a hundred million to a billion. Our view of the world is that business is flat, but not really up or down. I’ve talked to a lot of clients today and they’re trying to digest the news. The private equity funds are waiting to see what happens next. That is certainly the view they take at the funds. From the strategics, I think the view that they take may be a little bit more long term. The deals that we’re working on all seem to be going forward. I think there is a little bit of nervousness. I think there is no question that it’s going to put a damper on deals. We saw a damper heading into this vote and a downturn in M&A activity in the UK and I don’t think we’re going to come storming out of it. I think we’re going to go through a period of uncertainty and a period of slow down until we have a better idea of what it’s going to look like when the UK comes out on the other side.

Dechert’s Mr. Getter argues for the happy medium and says that those on each extreme are likely to be missing the point. “I think those who espouse gloom and doom are probably going too far,” he says. “And those who are telling you this is not going to have any effect, that it will soon return to business as normal, I think they are being wildly optimistic.”

Mr. Herman of Freshfields in New York acknowledges that while Brexit proved to be “a tough day” for globalization, he has not joined other camps in slipping into a general gloom. “Globalization, like anything else,” he says, “will have good days and bad days. We are at the front end of a transition period that has a lot of unknowns—unknowns which create both risk and opportunity. It is a clearly big event that will shape the UK’s and Europe’s economic, political and social future, but at the same time, it is important to keep in mind that this is not a credit crisis. This is not a crisis of liquidity. This is not a cratering of our globally interconnected financial system. This is not, in short, 2008. And I take a lot of comfort in the fact that ultimately globalization as a business matter is still where the world is headed.”

Mr. Herman also points out that the times will prove a great testing ground for the younger practitioners in M&A—bankers, lawyers, consultants. “It’s obviously not business as usual,” he acknowledges, “but if you talk to great M&A bankers and lawyers, they didn’t cut their teeth doing deal after deal after deal solely in the good times. You get good by building scar tissue when stuff is hard, and things are consequential to your clients. I was talking to some of our junior lawyers after the vote, and I said, “You know, I’m not saying that we need to be happy with any of the misfortune that will come out of this, but we’re pretty well placed for this, with clients that turn to us when times are tough, and this provides you guys with a seminal opportunity to really get great experience when it matters the most for our clients.’.”