Brexit: What Impact will it have on our Financial Master Agreements?
Following the referendum held in the UK on 23 June 2016, it has been voted that the UK should leave the European Union. This decision may have substantial impacts on the financial markets and the various financial master agreements that are in place. However, it is important to understand that no changes will apply immediately, and the status quo remains as is for up to 2 years.
Whilst the result of the referendum is advisory and not binding on the UK government, it seems at this point that they intend to abide by the result. The exit will happen under Article 50 of the Treaty of Lisbon (which determines the functioning of the European Union) – a sort of 'divorce decree' for the EU that has never before been relied upon. What is first required is for the British government to serve a notice under Article 50 stating its intention to exit. Following the serving of the notice to leave under Article 50, a negotiation process will be entered into whereby the terms of the new relationship between the UK and the EU will be decided.
Whilst the UK remains a full member of the EU for up to 2 years, when one considers the potential impact of Brexit, it may be worth starting to assess how things could change and providing for this accordingly.
EU member states enjoy the benefits of a single EU market and ‘passport’; however this may change for the UK upon their exit. Many financial institutions have set up offices and subsidiaries in London, with the intended purpose of having access to the single EU market. One of the results of Brexit is that entities based in the UK may no longer enjoy access to the single EU market, and this may drive firms to relocate their entities to another country within the EU, where they can continue to benefit from access to the single market. If entities do relocate, they are likely to have to register again under their new home office country’s regulations. Cross border services out of and into the UK may require additional licenses for the both the UK and foreign entities. Such relocation may impact their current legal agreements whereby the counterparty to their contract is now registered, licensed and incorporated in a different jurisdiction, and it may require a review of that country’s netting opinions.
If the UK negotiates to continue bring a European Free Trade Association, then some directives would still apply (e.g. directives on financial collateral arrangements, bank recovery and resolution directives as well as choice of law directives – which ensure English Law contracts would continue to be given recognition in other EU member states' jurisdictions). This would mean that reliance on English Law ISDA® opinions and the insolvency provisions and choice of law provisions in those opinions would stand. However, whether the UK is accepted as a European Free Trade Association would be a matter for negotiation.
English Law governs many financial master agreements. But will English Law still be respected after Brexit? Currently the choice of law is protected and requires courts to give recognition to the parties’ choice of law. After Brexit, enforcement of English court judgments could be onerous and more uncertain. Of course English Law could still be used as the governing law in cross border agreements, but the enforceability of court decisions out of an English court in other EU states may need to be re-assessed.
The jurisdiction clause in the ISDA® Master Agreement refers to the non-exclusive jurisdiction of the English courts if proceedings do not involve a Convention Court, and exclusive jurisdiction of the English courts if proceedings do involve a Convention Court. Thus currently exclusive jurisdiction of the English courts would apply if the agreement is entered into between a UK and an EU counterparty. The application of this clause may change post Brexit, given that English court may not be considered a Convention Court.
From a regulatory point of view, institutions have been spending much time, money and energy understanding and ensuring compliance with EMIR (the European Monetary Investment Regulations). With Brexit, there may be a separate and distinct set of regulations governing UK domiciled entities. Perhaps application would be made for equivalence under EMIR, whereby UK firms would request that EMIR regulators would recognize the UK regulations and declare them to be equivalent. But if equivalence is not granted, it means foreign parties would have to comply with an additional set of UK regulations. Over time we could see a divergence of banking regulations for the UK and the rest of the EU. Under EMIR, UK entities may be considered a Third Country Entity, and consequently regulations would apply differently to the UK entity. Another example would be on UK clearing houses: would they have to consider moving into Europe, since EMIR authority granted to UK clearing houses may no longer apply?
From a contract point of view, will Brexit trigger a Material Adverse Change ('MAC') event in some existing financial master agreements? One will have to interpret the MAC clause to ascertain whether Brexit would in fact constitute a material adverse change. Usually a MAC clause requires a permanent change in circumstances – would this be the case under Brexit or would the change be considered temporary? Bear in mind that there would be substantial reputational risk of triggering such a clause without good reason, thus careful analysis of such clauses would be required. Would Brexit trigger a Force Majeur, Illegality or Impossibility event? One could argue that Brexit would cause a change in law, which means that access to the single EU market ceases.
At this stage there seem to be more questions than answers surrounding the topic of Brexit and the implications of it. Comfort can be taken in the fact that nothing will change in the next 2 years. But what is certain is that Brexit is a new issue that will have to remain firmly on the radar screens of institutions doing business with UK entities.
DeriviDoc offers training sessions and consulting services on EMIR Regulations, Central Clearing and the ISDA® Master Agreements, and will keep up-to-date with the details of Brexit's impact on these topics. For more information on these training sessions or consulting services, please contact us.
For more information on EMIR, register now for the DeriviDoc course:
Regulatory Update - How the Financial Markets Act, EMIR and Dodd Frank
affect OTC Derivatives for SA Entities
For more information on Central Clearing, register now for the DeriviDoc course:
Central Clearing - The Operational and Legal Aspects
For more information on The ISDA Master Agreement, register now for the DeriviDoc course:
The ISDA Master Agreement
Melissa van der Merwe (DeriviDoc Director)
29 June 2016