With the exit date of 29 March 2019 fast approaching and the UK government
currently looking to renegotiate certain terms of its EU withdrawal
agreement, there is no certainty that the UK and the EU will reach an
agreement, and as a result, the UK could leave the EU without a deal (a
Regardless of whether the UK leaves with a deal or without a deal, what is
clear is that (a) businesses and financial institutions have or are
starting to implement contingency plans and (b) other than as set out
below, the legal and practical analysis remains the same for financial
institutional clients, as the withdrawal agreement does not deal with what
happens after the end of the implementation period.
This client briefing sets out the current state of play for financial
institutions and lending entities regarding (A) passporting rights and
lending to European entities; (B) current contractual arrangements; (C) new
contractual arrangements; and (D) derivatives transactions.
Access to the Market: Passporting Rights
As widely reported, Brexit gives rise to a host of issues for non-EU
lenders lending into Europe, particularly where the lender’s only European
office is based in London. Currently, a lender licenced in the UK may use
its UK licence as a passport” to conduct business in other EU Member
States. Often, financial institutions are only licenced in the UK and use
their UK licences to conduct such business.
Passporting rights will cease immediately with effect from the exit date in
a no-deal Brexit. However, if the withdrawal agreement passes the House of
Commons, the UK and the EU will enter into an implementation period
continuing until 31 December 2020. Financial institutions will continue to
benefit from passporting between the UK and the EU during the
implementation period. It is, however, unclear what passporting rights
financial institutions would have after the implementation period.
To address this issue as a result of Brexit (whether in a no-deal Brexit or
if the implementation period kicks in), financial institutions in the UK
who lend into Europe have or have started to either (a) set up a licenced
operation through a separate group company within an EU Member State or (b)
transfer employees/business lines to another subsidiary already established
in the EU. This EU entity can then continue to make use of the passporting
rights afforded to it or its subsidiary by that EU Member State. Where an
entity is set up for these purposes, the European Central Bank has warned
against the use of companies acting as an “empty shell.” Such an EU entity
would therefore need to have adequate local risk management, employees and
Effect on Existing Contractual Arrangements
Among other uncertainties of a No-Deal Brexit is the effect it will have on
existing contractual arrangements and transactions that mature after the
exit date. Brexit should not have an effect on the rights and obligations
of parties to such existing contractual arrangements and transactions which
are governed by English law. However, specific provisions may be affected
by a no-deal Brexit, but this will largely depend on the specific
circumstances and drafting.
It is unlikely that a no-deal Brexit would trigger the standard mandatory
prepayment or event of default provisions under existing loan documents or
bond documents. However, such transactions may be vulnerable to mandatory
prepayment if, due to the loss of passporting rights, it becomes illegal
for lenders licenced in the UK to lend to EU borrowers. However, as
discussed above, many financial institutions have prepared or are now
starting to prepare for this by transferring transactions to newly
incorporated EU operations or subsidiary entities.
There is the potential for a no-deal Brexit to trigger a material adverse
change (“MAC”) clause; in particular if the business of the borrower
depends on the free movement of goods, capital and people which will be
lost in a no-deal Brexit. Such clauses would need to be considered on a
transaction-by-transaction basis, as it will depend on the drafting of the
relevant MAC clause and the borrower’s specific circumstances.
The business of borrowers could also be adversely affected, which could
lead to higher levels of defaults.
Effect on Contractual Arrangements
The effect on new contractual arrangements and transactions will not become
entirely clear until the terms of the exit arrangements are decided. The
discussion above in respect of existing transactions applies to new
transactions as well. However, some parties may defer transactions as a
result of the uncertainty, while some banks have started inserting clauses
into new contracts to guard against a no-deal Brexit. These provisions
require careful drafting to minimise potential disputes, especially as
there will be no “standard” Brexit provisions to incorporate.
For derivatives transactions, many financial institutions have started to
enter into two identical agreements with a counterparty under which
derivatives transactions can be entered into: one with a UK entity and the
other with a newly incorporated EU entity or EU subsidiary. Their intention
is to continue entering into derivatives under the agreement with the UK
entity, and after the exit date, to enter into derivatives under the
agreement with the EU entity/subsidiary.
Many EU countries are also looking to implement national legislation to
protect against a major disruption in securities, bonds and derivatives
markets as a result of a no-deal Brexit. Countries like Germany, France and
Sweden are working on national legislation that would protect existing
derivatives transactions and allow such contracts to continue after Brexit.
The preparations other EU countries are taking have helped calm
participants in the financial markets.
In addition, the
European Securities and Markets Authority (ESMA) confirmed on 18 February
2019 that it would give immediate formal recognition to the UK clearing
houses (LCH, ICE Clear Europe and LME Clear) in a no-deal Brexit. EU banks
and investment managers welcomed ESMA’s decision, as UK clearing houses play an important role in financial
markets, with LCH clearing over 90 percent of Europe’s interest rate swaps (over $350 trillion in notional amount).
Whether the UK leaves the EU with or without a deal, what is clear is that
the current impasse and a risk of a “cliff edge” have prompted financial
institutions and businesses to no longer “wait and see.” Instead, they have
or they are starting to implement contingency plans to address the risks
imposed by the Brexit process.