Brexit: The Impact on Debt Capital Markets and Loans

The EU–UK Trade and Cooperation Agreement (“TCA”) signed on December 30, 2020 is of limited relevance to financial services and capital markets. Financial services passporting between the EU and UK has ended, with cross-border access between the two markets now governed by their respective third- country regimes including equivalence frameworks in certain areas. The reported negotiations for a further “deal” on financial services (in reality, an agreement to establish a memorandum of understanding setting out parameters for regulatory cooperation by March 2021), if fruitful, are unlikely to change the position in any meaningful respect.

After the end of the Brexit transition period on December 31, 2020 (“IP Completion Day”), existing EU law was on-shored as “retained EU law,” with amendments to reflect that the UK is no longer a member of the EU, effectively creating UK versions of EU regulations. This includes the implementation of certain aspects of the EU’s 2019 revised bank prudential framework which the UK was required to transpose in December 2020, before the end of the transition period.[1] In addition, the UK regulatory authorities have confirmed that certain non-binding EU guidelines and recommendations (for example, EU non-legislative materials) are still relevant, post IP Completion Day. Accordingly, in policy terms, UK law remains largely the same as it was immediately before IP Completion Day and in-step with EU law. However, a broad programme of work has already begun to update the UK’s regulatory framework for financial services for the future. Notably, the Financial Services Bill (the “FS Bill”), introduced to Parliament on October 21, 2020, proposes extensive reforms to the legislative and regulatory framework for financial services. In respect of prudential regulation, the FS Bill proposes to establish the legislative framework for the Investment Firms Prudential Regime and the implementation of the final Basel III standards for banks. In respect of LIBOR transition, the FS Bill introduces certain amendments to the UK Benchmarks Regulation, to provide the Financial Conduct Authority (“FCA”) with additional powers to manage an orderly wind-down of LIBOR. As the UK Benchmarks Regulation prohibits referencing benchmarks administered by a foreign country from 2022 unless one of three “access routes” (i.e., equivalence, endorsement or recognition) is used, the FS Bill also proposes to extend the transitional period for third-country benchmarks from December 31, 2022 to December 31, 2025, addressing concerns that foreign benchmark administrators would not make use of these access routes.

Impact on debt capital markets

The UK Market Abuse Regulation (“UK MAR”) applies to conduct related to financial instruments trading on both UK and EU venues. The general rules on handling of inside information, market soundings, market manipulation and stabilisation continue to apply. Issuers and investors may therefore face the application of dual market abuse regimes. For instance, issuers that have requested, or approved admission to trading or approved trading of their financial instruments on a UK venue, (whether based in the UK, the EU or elsewhere) will be obliged to disclose inside information under UK MAR and to send notifications to the FCA (e.g., to report dealings by senior managers (“PDMRs”) and delays in disclosing inside information) and to provide, on request, insider lists. This will be in addition to any obligation under the EU Market Abuse Regulation (“EU MAR”) to notify an EU competent authority. The FS Bill proposes to implement amendments to UK MAR by clarifying that both issuers and those acting on their behalf or on their account must maintain insider lists and extending the timetable for issuers’ disclosure of transactions by PDMRs from within three business days of the transaction to within two business days of being notified by the senior manager.[2] However, there has not been any official reaction from the government or the FCA on the European Securities and Markets Authority’s final report on EU MAR.[3] The FS Bill also proposes to increase the maximum criminal sentence for market abuse from seven years’ imprisonment to ten years, bringing it in line with comparable economic crimes.

Although the UK’s Prospectus Regulation (“PR”) largely mirrors the EU PR, FCA-approved prospectuses may no longer be passported into the EU (and vice versa). EU issuers offering securities to the public in the UK, or seeking admission to trading on a UK venue, must have a prospectus approved by the FCA, regardless of whether an EU competent authority has already approved the prospectus. Issuers may therefore be impacted by a duplication of effort and deal costs. Prospectuses passported into the UK before IP Completion Day will remain valid in the UK until they would otherwise expire (12 months after first approved), in accordance with the UK’s transitional measures (but any subsequent supplements will not be ‘grandfathered’ and will require approval by both the FCA and the relevant EU competent authority). In contrast, UK-approved prospectuses passported into the EU before IP Completion Day cannot be used after that date, though an issuer may, in principle, submit an FCA- approved prospectus (provided it complies with the EU PR) to the relevant EU competent authority for its approval for use in the EU. ICMA has published updated standard form selling restrictions and legends relating to the PR, the Packaged Retail and Insurance-based Investment Products Regulation and the Markets in Financial Instruments Directive (“MiFID”) and other materials for use in debt capital markets transactions.

Following the end of the Brexit transition period, EU banks are subject to the requirements of Article 55 (contractual recognition of bail-in) of the EU Bank Recovery and Resolution Directive (“BRRD”) in respect of English law governed liabilities. Likewise, UK banks will become subject to the PRA contractual recognition of bail-in rules in respect of liabilities governed by the laws of an EEA member state. However, the UK rules grant relief until March 31, 2022 in respect of EEA-law governed “phase two liabilities (unsecured liabilities that are not debt instruments)”. In contrast, relief is not granted in respect of liabilities that are intended to count towards a bank’s minimum requirement for own funds and eligible liabilities, as this could undermine its resolvability. Accordingly, from the end of transition period, banks will be required to include the bail-in clause in new or materially amended liabilities, other than phase two liabilities. For its part, the European Banking Authority (“EBA”) rejected calls to include Brexit as a situation which makes inclusion of the bail-in clause impracticable under Article 55(2) BRRD on the basis that this was outside the scope of its law-drafting mandate. AFME and ICMA have published model clauses for recognition of EU and UK bail-in clauses for liabilities other than debt instruments or liabilities governed by industry standard master agreements. Their intended uses include contracts related to new issues of bonds, bond issuance programmes and ECP issuance programmes. Joining bail-in clause requirements in the EU will be harmonised rules under Article 71a BRRD for contractual clauses in non-EEA law governed “financial contracts” (such as underwriting agreements between issuers of bonds and syndicate banks in the context of a new bond issue) recognising that the contract may be subject to the exercise of resolution powers by the resolution authority to suspend or restrict the firm’s payment or delivery obligations, or to suspend a counterparty’s termination or security enforcement rights. Member states may also require that parent undertakings ensure that their third-country financial subsidiaries include, within relevant financial contracts, terms to mandate that they cannot engage in early termination, suspension, modification, netting, the exercise of set-off rights or the enforcement of security interests on those contracts, should the resolution authority apply resolution powers to suspend or restrict obligations at the parent undertaking level. Final draft rules on the mandatory contents of the clause were published by the EBA in December 2020.[4] Once more, English law financial contracts will be within scope. In the UK, the PRA had anticipated the new Article 71a in its original implementation of the BRRD and has not, therefore, amended its existing “Stay in Resolution” rules.[5]

The home/host state distinction under the Transparency Directive has fallen away as between the UK and the EU. UK-incorporated issuers with securities admitted to trading on a UK regulated market will be required to use UK-endorsed IFRS (“UK IFRS”) or UK GAAP for their accounts for financial years commencing on, or after, IP Completion Date. EU-incorporated issuers with securities admitted to trading on a UK regulated market are also able to use EU-endorsed IFRS (“EU IFRS”), as the UK government has determined it to be “equivalent” to UK IFRS. The FCA has published an amended list of third countries it regards as equivalent in relation to provisions of the Disclosure Guidance and Transparency Rules (“DTR”) 4. The amendment reflects the equivalence decision adopted in relation to EU IFRS—issuers of securities admitted to trading on a UK regulated market with a registered office in a third country, which report their annual and half-yearly consolidated financial statements following EU IFRS, are exempt from DTR 4.1.6R(1) (Audited financial statements) and DTR 4.2.4R(1) (Preparation and content of a condensed set of financial statements).[6] UK issuers with securities admitted to a regulated market in the EU can use UK IFRS for EU prospectuses, provided the notes to the audited financial statements state they comply with EU IFRS. To date, the EU has not indicated whether it will declare UK IFRS equivalent, but this is not expected in the short- to medium-term. Absenting an equivalence declaration, UK issuers of wholesale debt admitted to a regulated market in the EU should include a statement in their prospectuses that their financial information has not been prepared in accordance with EU IFRS, together with a description of the differences between EU IFRS and UK IFRS. As UK IFRS currently mirrors EU IFRS, this is a consideration for issuers to the extent the UK and EU financial standards diverge.

Impact on loans

The on-shoring of EU legislation has resulted in a complex set of statutory instruments and other legislation. For borrowers and issuers, references to EU legislation in existing and new contracts should be reviewed and amended or replaced as appropriate. In November, the Loan Market Association (“LMA”) produced a Brexit note signalling the changes it intends to make to its syndicated loan documentation post-transition, together with two “destination tables” outlining how certain EU legislative references should be treated in the LMA standard form facility documentation and private placement documentation.[7] Certain technical changes to the Article 55 bail-in clause would also need to be considered by the parties.

In accordance with guidance issued by the LMA and the Law Society,[8] parties to cross-border transactions should carefully consider where proceedings would be brought and where any judgment would need to be enforced, post-Brexit. The Recast Brussels Regulation no longer applies in the UK where proceedings are started after IP Completion Day. Unless the UK’s application to accede to the Lugano Convention is approved (EU Member States have not yet consented), and provided it is applicable, the 2005 Hague Convention on Choice of Court Agreements (the “Hague Convention”) will govern issues relating to jurisdiction and the enforcement of judgments as between the UK and EU states (as well as the  other signatories to the Hague Convention, namely Singapore, Mexico and Montenegro). Parties should be mindful that the Hague Convention will only apply where: (i) there is an exclusive choice of court agreement (it does not apply to an asymmetric or unilateral jurisdiction clause, where one party must bring proceedings in a designated court but the other party has a choice of where to being proceedings), (ii) the dispute falls within the subject matter scope of the Hague Convention; and (iii) the exclusive choice of court agreement was entered into after the Hague Convention came into force for the country whose courts were chosen. Note also that, unlike the Recast Brussels Regulation, the Hague Convention only applies to final judgments and does not govern the enforcement of interim measures (for example, interim freezing orders granted pending final judgment in proceedings). The enforceability of interim measures in EU courts will therefore depend on the local rules in each jurisdiction. There are conflicting views on whether the Hague Convention will apply to choice of court agreements in favour of UK courts concluded from October 1, 2015 when it entered into force for the UK as an EU member state (the position of the UK),  or only from January 1, 2021 when it entered into force for the UK in its own right (the position of the EU Commission). Despite this uncertainty, it is clear that under the Hague Convention EU courts will generally respect exclusive English choice of court agreements which were concluded after IP Completion Day and will enforce the consequent judgments.

Where the Hague Convention does not apply, the UK and EU courts will apply their own national rules in relation to jurisdiction and the enforcement of judgments in the absence of any specific treaty between the UK and the relevant jurisdiction. It is worth noting that the English common law rules are a sophisticated and well-tested system of rules which have continued to be applied alongside the EU regime where the EU rules did not apply. However, there may be more opportunities for litigants to mount jurisdictional challenges, including on the grounds of forum non conveniens and the risk of litigants attempting to bring parallel proceedings in other EU jurisdictions may increase. That being said, the English court is likely to once again issue anti-suit injunctions to restrain parties from pursuing parallel litigation in the EU in breach of an English jurisdiction agreement, which could prove to be a powerful deterrent.

Frequently asked questions

1. Should I still use English law as the governing law of loan and facility agreements?
   
   English law remains a popular choice for market participants given English law’s long history of upholding and respecting parties’ commercial bargains. The courts in EU member states will continue to give effect to English law as the parties choice of law. Rome I Regulation, which requires EU member states to give effect to the parties’ choice of law, has been retained as domestic law and will continue to apply regardless of whether that law is the law of an EU member state or the law of a third country such as New York law or English law post-Brexit.
2. What about the jurisdiction provisions in the LMA’s form of facility documentation?
   
   Many of the LMA’s recommended forms of English law facility documentation use one-sided exclusive jurisdiction clauses. One of the main reasons for lenders preferring a one-sided exclusive jurisdiction clause is to maximise the lender’s ability to take action against the debtor group in any jurisdiction in which the debtor group has assets.
   
   For the reasons set out above, parties choosing a non-Hague compliant jurisdiction clause (e.g., a one-sided exclusive jurisdiction clause in favour of UK courts) would need to consider whether such a clause would be enforceable under the national rules of the EU member state where enforcement of judgment is sought. Some of the questions that the parties should consider include:

I. Whether the enforcement of an English judgment in an EU member state is sufficiently important in the context of the transaction (e.g., are there significant assets of the borrower group located in that EU member state?);

II. Whether the national rules of the relevant EU member state permit enforceability of an English judgment once the Recast Brussels Regulation no longer applies to English judgments; and

III. If the answer to the second question is in the negative or uncertain, whether a two-way exclusive jurisdiction clause or an arbitration clause should be used

The LMA has introduced an optional two-way exclusive jurisdiction clause pursuant to the Hague Convention for use where the parties consider such a jurisdiction clause to be appropriate for their transaction.

[1] See our alert memorandum: The UK’s Post-Brexit Financial Services Regulatory Framework – HM Treasury Consults on the Transposition of CRD V.

[2] This post-Brexit requirement is in line with the corresponding requirement under EU Regulation 2019/2115.

[3] See: MAR Review report.

[4] See: Draft regulatory technical standards on the contractual recognition of stay powers under Article 71a(5) of Directive 2014/59/EU. 

[5] See: Bank Recovery and Resolution Directive II

[6] It also makes certain amendments in relation to the exemption granted in relation to the United States, to clarify that the exemption from DTR 4.1 (Annual financial report) in respect of Section 13(a) of Securities Exchange Act of 1934 and the rules governing financial reporting for issuers of securities in the US, does not extend to DTR 4.1.7R(4) (Auditing of financial statements). See: Equivalence of non-UK regimes.

[7] See: Market Loan Association - Brexit.

[8] See: The Law Society guidance on “End of transition period guidance: choice of court agreements” and “End of transition period guidance: enforcement of foreign judgments.”