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Article: ISDA Brexit FAQs

10 April 2018 | ISDA Feed
 

These FAQs address the possible UK position post-Brexit, i.e. after the conclusion of the exit process under Article 50 of the Lisbon Treaty. There is still considerable uncertainty as to the form of the UK’s relationship with the European Union after the conclusion of the exit negotiations, including as to whether the proposed transitional period until 31 December 2020 (as set out in the draft Agreement on the withdrawal of the UK from the EU and European Atomic Energy Community dated 19 March 2018 (the “the “Draft Withdrawal Agreement”)), during which passporting rights of UK and EU firms, respectively, would be maintained, will in fact come into force. Consequently, the responses to these FAQs involve an assessment of the various outcomes of the exit negotiations and the consequences of those outcomes and it is not possible in all cases to give a definitive answer. We have divided the FAQs into ‘The short read’ and ‘The long read’, with the former being a summary of the latter and the latter only available to ISDA members.

Market participants should take independent legal advice on the points addressed in these April 2018 FAQs.

On November 20, 2017, ISDA hosted an update Webinar on Brexit. To listen to the webinar, click here.

Disclaimer: This page does not contain legal advice and merely is intended as an information resource to assist market participants in planning for the exit of the UK from the EU following the official notification on March 29, 2017 of the UK’s intention to withdraw from the EU, the confirmation from the European Council on 15 December 2017 that sufficient progress had been made to move to the second phase of negotiations (relating to (i) transition, and (ii) the framework for the future relationship between the UK and the EU), and publication of the Draft Withdrawal Agreement.

Note that the Draft Withdrawal Agreement is a political document and not legally binding. Unless stated otherwise, reference to a position taken in the Draft Withdrawal Agreement should be assumed to be agreed at negotiators’ level between the UK and the EU27.

 Contractual points under ISDA Documentation

  1. Could Brexit constitute a Force Majeure, Impossibility or an Illegality Termination Event under the ISDA Master Agreement?

A Force Majeure Termination Event requires a practical impediment to payment/delivery which seems unlikely to occur in most cases, even if the UK does not retain its passporting rights for investment services. An Illegality Termination Event is a possibility if Brexit results in a total loss of access for UK financial services firms to EU financial markets and the consequence of this is for performance of a Transaction to become illegal in the relevant EU member state. Such an outcome is generally unlikely in respect of the performance of pre-existing contractual obligations (not involving a dealing type activity that in effect involves entry into a new trade in a “financial instrument”), although there is a risk that certain EU regulators may determine otherwise and this will depend on local law and regulation in the jurisdiction of performance. See Question 16 (Access to the EU financial markets) for further detail on access to the EU financial markets.

  1. Could Brexit constitute a Tax Event Termination Event under the ISDA Master Agreement?

The occurrence of a Tax Event depends on whether any withholding tax arises which would affect the underlying Transactions, either as a result of a change in domestic law in the UK or elsewhere, or because an existing exemption ceases to apply to UK entities. The occurrence of a Tax Event in these circumstances will depend on the change in law or application of the exemption in question (which in turn may depend on the outcome of the exit negotiations), and whether withholding tax would affect payments made on the underlying Transactions.

  1. Could there be a breach of the representation under Section 3(a)(iii) (No violation or Conflict) or Section 3(a)(iv) (Consents) of the ISDA Master Agreement as a consequence of Brexit?

A breach of the ‘no conflict with applicable law’ representation is unlikely to arise as, assuming that this representation is true and accurate when given and repeated pre-Brexit (including on entering into each new Transaction), then existing Transactions will not cause a Misrepresentation Event of Default simply by virtue of such representations becoming untrue at a subsequent date as a result of Brexit (if, for example, in the absence of passporting rights for UK financial services firms, performance of a Transaction conflicts with local law due to a local authorisation requirement – as to which, please refer to the answer to Question 1 (Force majeure, Impossibility or Illegality Termination Event)).  The same is true of the representation on consents in Section 3(a)(iv). Caution should be exercised in respect of any novation or modification of an existing Transaction, or any other dealing type activity with respect to an existing Transaction, to the extent this is actually the entry into of a new Transaction, at which point these representations will be deemed to be repeated. For more on this point, see Question 16 (Access to the EU financial markets).

  1. Could there be a Breach of Agreement under Section 5(a)(ii) in respect of the obligations in Section 4(b) (Maintain authorisations) or Section 4(c) (Comply with Laws) of the ISDA Master Agreement as a consequence of Brexit?

It is unlikely that there would be a Breach of Agreement as a result of a failure to maintain authorisations pursuant to Section 4(b) or a failure to comply with law pursuant to Section 4(c) in the event of a loss of access for UK financial services firms to the EU financial markets. This is because the performance of pre-existing contractual obligations (not involving a dealing type activity that in effect involves entry into a new trade in a “financial instrument”) in relation to Transactions generally ought not to be subject to local authorisation requirements, although there is a risk that certain EU regulators may determine otherwise and this will depend on local law and regulation in the jurisdiction of performance. However, even if, post-Brexit, there were an obligation on one party to seek authorisation locally in order to perform the Transaction, the Illegality Termination Event would probably be available to the party that had lost its passporting rights, which would, in accordance with the hierarchy provisions in Section 5(c), prevail over any possible Breach of Agreement Event of Default. For more on this point, see Question 16 (Access to the EU financial markets).

  1. Could Brexit trigger an event of default or termination event under the ISDA/FIA Client Cleared OTC Derivatives Addendum? 
  • In addition to the Events of Default/Termination Events under the ISDA Master Agreement (which apply only to the Client under the ISDA/FIA Client Cleared OTC Derivatives Addendum) covered in the preceding Questions, it is theoretically possible that a Cleared Transaction Illegality/Impossibility event (if specified as being applicable) could be triggered by loss of the ability for UK financial services firms to provide investment services cross-border into the EU. However, this eventuality seems improbable in most instances for the same reasons as outlined for an Illegality Termination Event under the ISDA Master Agreement (although as noted with respect to that Termination Event, there is a risk that certain EU regulators may determine otherwise).
  • A CM Trigger Event could occur if the loss of passporting rights causes the party which is the Clearing Member to be in default under the rules of an EU CCP and that EU CCP formally declares such Clearing Member to be in default of its rules, triggering its default management process (or such process is triggered automatically as a result of the loss of passporting rights by the Clearing Member).
  • A CCP Default could occur if a UK CCP loses its rights to offer clearing services pursuant to EMIR, is not granted recognition pursuant to the third country provisions of EMIR (as to which see Question 19 (Clearing pursuant to EMIR by a UK CCP)) and the rules of that CCP entitle Clearing Members to terminate their transactions with that CCP (or such termination takes place automatically) as a result.
  1. Could Brexit trigger any other provisions in the ISDA Master Agreement/Credit Support Documents? 

Market movements could trigger increased margin calls or trigger provisions linked to ratings.

  1. Does Brexit impact any of the provisions of the ISDA Definitions booklets?

The eventual market impact may result in additional Credit Events pursuant to the 2014 Credit Derivatives Definitions. Adverse consequences for the financial markets may also result in the occurrence of one or more of the Additional Disruption Events pursuant to the 2002/2011 Equity Derivatives Definitions.

  1. Should parties consider including any additional termination rights based on Brexit? 

If, post-Brexit, parties are unable to perform cross-border Transactions, they will probably be able to rely on the Illegality Termination Event. To remove any uncertainty as to whether the law of the place of performance constitutes an “applicable law” for such purposes, parties to a 1992 ISDA Master Agreement may consider including an Additional Termination Event covering this eventuality.

Parties may also wish to consider additional termination rights to address the inability to clear derivative Transactions through EU CCPs (in the case of UK entities) or UK CCPs (in the case of EU entities) or the inability to report Transactions to UK/EU trade repositories (please see Question 19 (EMIR clearing/reporting by UK CCPs/trade repositories) and Question 20 (EMIR clearing/reporting by EU CCPs/trade repositories)).

  1. What is the impact of Brexit on the parties’ choice of English law as the governing law of the ISDA Master Agreement?

9.1 Will the Rome I and Rome II Regulations still apply post-Brexit?

If proceedings are brought before an EU court: The Rome I[1] and Rome II[2] Regulations continue to apply in the EU and so English law clauses specifying the governing law of the contractual and non-contractual obligations will continue to be recognised by EU courts, as is currently the case. This is irrespective of the domicile of the parties. 

If proceedings are brought before a UK court: Once the UK has left the EU, and at the end of any proposed transition period, the Rome I and Rome II Regulations will no longer have direct effect in the UK. It should be noted that the Draft Withdrawal Agreement states that Rome I shall continue to apply in the UK post-Brexit in respect of contracts concluded before the end of the transition period, and Rome II shall continue to apply in the UK post-Brexit in respect of events giving rise to damage which occurred before the end of the transition period.

The European Union (Withdrawal) Bill (the “Withdrawal Bill”), if passed into law in its current form, will generally speaking preserve existing UK domestic legislation that implements EU laws (e.g. UK legislation implementing an EU directive) and incorporate directly applicable EU legislation (such as an EU regulation), so far as operative immediately before exit day, into UK domestic law on the exit day. Whilst this is the case, the Withdrawal Bill also gives the UK government powers to amend “deficiencies” in existing UK law, and retained EU law, so that they work appropriately once the UK has left the EU. These powers go beyond fixing technicalities to encompass, for example, reciprocal arrangements tied to the UK’s EU membership which a minister considers to be no longer “appropriate”. However, as neither Rome I, nor Rome II, depends on reciprocity in their operation, the most likely outcome seems to be that, to preserve continuity, the same provisions as are currently set out in the Rome I and the Rome II Regulations will be retained as part of UK domestic law pursuant to the Withdrawal Bill. Following the publication of the Withdrawal Bill, the UK government’s position paper entitled “Providing a cross-border civil judicial cooperation framework” published on 22 August 2017 has confirmed that it is the intention of the UK to incorporate Rome I and Rome II into domestic law. If this happens, English law clauses specifying the governing law of contractual and non-contractual obligations (which fall outside of the scope of the provision in the Draft Withdrawal Agreement, to the extent that it is applicable) will also continue to be recognised by the English courts pursuant to such rules. If, contrary to the UK’s stated intention, the provisions of the Rome I Regulation and Rome II Regulation are not retained as part of UK domestic law, then in respect of a choice of English law to govern contractual obligations, English common law will apply and there is unlikely to be any change in approach from the status quo. In respect of non-contractual obligations, the rules set out in Part III of the Private International Law (Miscellaneous Provisions) Act 1995 will be applied by the English courts in determining the proper governing law of non-contractual obligations. An express choice of English law to govern non-contractual obligations is likely to be influential, but not determinative, in this assessment.

9.2 Can the UK enact legislation replicating Rome I and Rome II entirely so as to maintain the status quo?

Yes, as discussed above the effective operation of Rome I and Rome II does not depend upon reciprocity. Accordingly, in order to preserve continuity, the UK government is to able retain the rules set out in Rome I and Rome II as part of UK domestic law within the framework of the Withdrawal Bill and has indicated an intention to do so.

9.3 Is it advisable for parties to continue to amend the governing law clause of the ISDA Master Agreement to include an express choice of law for non-contractual obligations?

There is no reason not to continue including a choice of law for non-contractual obligations. This choice will be recognised by the EU courts and, under the current terms of the Draft Withdrawal Agreement, will continue to be recognised by the English courts if the ISDA Master Agreement is entered into before the end of the transition period.

Further, a choice of law for non-contractual obligations will be recognised by the English courts if Rome I and Rome II are incorporated into English domestic law, which is the UK government’s stated intention. Even failing such incorporation into English domestic law or if such rules are subsequently repealed by the UK Parliament, such choice of law is likely to be taken into account in the UK post-Brexit.

9.4 Is it advisable to change the governing law of the ISDA Master Agreement to (i) New York law or (ii) the law of an EU member state?

Selecting New York law as the governing law (which would mean, unless agreed otherwise, a choice of court in favour of New York courts) is a possibility but there would be no real advantages in terms of the recognition of judgments of the US courts by either the EU or the English courts, particularly if Rome I and Rome II are incorporated into UK domestic law, which is the UK government’s stated intention.

Subject to the paragraph below, it is not advisable to change to any other governing law without legal advice as the ISDA Master Agreement has been drafted to operate under the legal regimes of New York and English law. Any such change from English law or New York law to a third country governing law would also necessitate further consideration of the jurisdiction clause, the application of ISDA commissioned netting and collateral opinions and the requirement of any contractual recognition provisions relating to bank resolution (see Question 26 (Additional provisions for inclusion in the ISDA Master Agreement)).

ISDA has commissioned the preparation of template French law and Irish law ISDA Master Agreements (and related collateral documentation). Those templates will therefore be governed by (and jurisdiction for disputes may be submitted to the courts of) an EU member state and will also form part of the ISDA framework – in particular, it is envisaged that the ISDA legal opinions will be updated in due course to contemplate these templates. Members should consider the impact of changes made to the English law ISDA Master Agreement in order to effect the transition to French or Irish law, as applicable, and of the underlying legal principles in these jurisdictions, on their derivative transactions.

  1. Will the jurisdiction clause of the ISDA Master Agreement still confer jurisdiction on the English courts where the parties to the ISDA Master Agreement are established in the EU? 

Currently, EU courts are bound to respect jurisdiction clauses in favour of another EU court on the basis of the Brussels I Recast Regulation. Post-Brexit, and if no other agreement is reached for its retention (or an equivalent arrangement) in respect of the UK, this Regulation will no longer directly apply to the UK. The provisions included in the Draft Withdrawal Agreement relating to the applicability of the Brussels I Recast Regulation post-Brexit (including in the proposed transition period) are not currently agreed between the UK and the EU27, although discussions are ongoing. The current draft provides that, post-Brexit, the UK and EU courts will be bound to respect jurisdiction clauses in favour of the EU and UK courts (respectively) if that jurisdiction agreement was concluded prior to the end of the transition period. The present position pursuant to the Brussels I Recast Regulation shall also apply to UK and EU courts in respect of the recognition and enforcement of judgments given in legal proceedings instituted before the end of the transition period. The 19 March 2018 draft therefore seems to represent a softening of the position adopted by the EU27 in the draft published on 28 February 2018, in which it was proposed that the provisions in the Brussels I Recast Regulation would only apply to the judgments of UK courts if those judgments had been handed down prior to the end of the transition period.

The position following the transition is less clear. The UK government’s position paper entitled “Providing a cross-border civil judicial cooperation framework” published on 22 August 2017 states that the UK will seek an agreement between the UK and the EU27 that allows for close and comprehensive cross-border civil judicial cooperation on a reciprocal basis, which reflects closely the substantive principles of cooperation under the current EU framework (the major component of which is the Brussels I Recast Regulation). The UK therefore proposes a bilateral, reciprocal agreement with the EU27 which replicates the existing rules on jurisdiction and the recognition and enforcement of judgments. If no agreement for retaining the current regime (or an equivalent arrangement) post-Brexit can now be reached (for example, if the EU27 does not agree to negotiate the terms of a replacement regime until the terms of the UK’s withdrawal are agreed) it is unlikely that the UK government would consider that unilateral retention of its rules as part of UK domestic law would be appropriate within the framework of the Withdrawal Bill since the Brussels I Recast Regulation depends upon reciprocity in order to function appropriately (for general observations on the UK government’s powers to correct “deficiencies” under the Withdrawal Bill, see Question 9.1 (Will the Rome I and Rome II Regulations still apply post-Brexit?) above). Also, even if the UK did act unilaterally it would not mean that the UK would continue to be treated as if it were an EU member state by the remaining nations. Consequently, any unilateral incorporation of the current rules into English law would, in any event, be of limited effect and would not mean that proceedings in, and judgments of, UK courts would continue to be treated in the same way as proceedings in, and judgments of, EU courts, when it comes to matters of jurisdiction and the recognition of judgments in civil and commercial matters within the EU.

If (a) the current Draft Withdrawal Agreement does not take legal effect; (b) there is no agreement as to the applicability of the Brussels I Recast Regulation post-Brexit; and (c) if the rules in the Brussels I Recast Regulation are not retained as part of UK domestic law then, before the English courts, the English law ISDA jurisdiction clause is nevertheless likely to be respected on the basis of English common law rules. Whether or not those rules are adopted by the UK, in EU courts the UK will be a third country so recognition of an English exclusive jurisdiction clause will depend on the national position and it is not certain that an EU court would be obliged to decline jurisdiction in favour of the English courts or, in respect of a non-exclusive jurisdiction clause, to stay proceedings on the basis that the English courts are first seised.

  1. What is the impact of Brexit on arbitration clauses in an ISDA Master Agreement which select England as the seat of arbitration? 

None.

11.1 Where parties currently have an English governing law and jurisdiction clause in their ISDA Master Agreement, is there merit in retaining a choice of English law, but inserting an arbitration clause into the ISDA Master Agreement? 

Possibly, for MiFID II equivalence.

  1. What are the consequences of Brexit for the recognition and enforcement of judgments where:

 12.1 enforcement of a judgment issued by an English court is sought in an EU court?

The provisions included in the Draft Withdrawal Agreement relating to the applicability of the Brussels I Recast Regulation post-Brexit (including in the proposed transition period) are not currently agreed between the UK and the EU27. Under the current draft of the Draft Withdrawal Agreement, if the judgment is issued by the English court before the end of the transition period, the EU court will be required to recognise and enforce that judgment, in accordance with the Brussels I Recast Regulation.

If the terms contained in the current draft of the Draft Withdrawal Agreement are not agreed, or with respect to judgments issued by the English court after the end of the transition period (were the Draft Withdrawal Agreement agreed in its current form), and assuming that no other agreement is concluded or implemented in respect of the UK, this will depend on the rules of private international law of the jurisdiction in which enforcement is sought. There will likely be more procedural and substantive conditions to enforcement. For a number of EU jurisdictions, no significant hurdles are anticipated but for others the outcome will be uncertain. Local law advice will be needed on a jurisdiction-by-jurisdiction basis.

12.2 enforcement of a judgment issued by an EU court is sought in the English courts?

The provisions included in the Draft Withdrawal Agreement relating to the applicability of the Brussels I Recast Regulation post-Brexit (including in the proposed transition period) are not currently agreed between the UK and the EU27. Under the current draft of the Draft Withdrawal Agreement, if the judgment is issued by the EU court before the end of the transition period, the English court will be required to recognise and enforce that judgment, in accordance with the Brussels I Recast Regulation.

If the terms contained in the current draft of the Draft Withdrawal Agreement are not agreed, or with respect to judgments issued by an EU court after the end of the transition period (were the Draft Withdrawal Agreement agreed in its current form), and again on the assumption that no other agreement is concluded or implemented in respect of the UK, EU judgments will continue to be enforceable by the English courts based on common law, especially where the judgment is from a court chosen by the parties.

  1. Are there any other factors which will determine the choice of law/jurisdiction clause in an ISDA Master Agreement post-Brexit? 
  • There may be circumstances in which the recognition of third country jurisdiction clauses by courts of a particular jurisdiction and/or enforcement of judgments in such jurisdiction may lead the parties to consider whether an alternative governing law/jurisdiction clause is suitable. In this case, a careful analysis of the enforcement of netting, and collateral, as well as how claims would be considered under a different system of law would need to be undertaken.
  •  Post-Brexit, UK entities relying on the MiFID II[3] equivalence regime to conduct MiFID II business in the EU may have to offer clients the ability to submit disputes to the jurisdiction or arbitral tribunal in an EU member state. There are also other provisions of EU legislation under which it may be beneficial for the governing law to be that of an EU member state.
  1. What amendments can parties make to Section 13 (Governing Law and Jurisdiction) to mitigate the uncertainty surrounding recognition of English choice of law/jurisdiction clauses? 

Parties may consider removing uncertainty as to the treatment of Section 13(b) post-Brexit themselves by making any of the following changes:

  • inserting a fully exclusive jurisdiction clause without the current references to the European legislation to avoid any question of whether the clause elects for exclusive or non-exclusive jurisdiction in the EU; 
  • inserting a fully non-exclusive jurisdiction clause which would also remove any uncertainty as to exclusivity/non-exclusivity in the EU and gives parties the maximum range of options to bring proceedings against their counterparty where it has assets; 
  • inserting an asymmetrical clause which provides for exclusivity for proceedings commenced by one party but non-exclusivity for the other party; or 
  • inserting an arbitration clause which would be unaffected by the UK’s withdrawal from the EU.

    15. What impact would Brexit have on insolvency proceedings involving either a UK entity or an entity incorporated in an EU member state?

  • Unless otherwise agreed as part of the UK’s withdrawal from the EU, the EU Recast Regulation on Insolvency Proceedings (the “EIR”) would cease to apply to the UK once it leaves the EU, with the result that UK insolvency officeholders would no longer automatically be recognised in the remaining EU member states as having the power to deal with assets located in those EU member states or as having the right to enforce insolvency-related judgments against entities located in those EU member states.
  • A UK officeholder seeking recognition may therefore, as was the case before the EIR came into force, have to seek recognition under the local domestic law of the relevant EU member state. The exact requirements for recognition will vary from jurisdiction to jurisdiction. Recognition of certain English insolvency proceedings in the EU would consequently become more complicated.
  • Insolvency officials in EU member states would no longer benefit from automatic recognition in the UK pursuant to the EIR, but they could still benefit from the (more limited) recognition provisions contained in the UNCITRAL Model Law on Insolvency, which the UK has implemented in the form of the Cross-Border Insolvency Regulations 2006. Such recognition would, however, not extend to the automatic recognition of insolvency judgments in the UK.
  • The position in relation to recognition under the Credit Institutions (Reorganisation and Winding-up) Directive and the Solvency II Directive will depend on whether the UK choses to repeal the statutory instruments under which those EU directives became part of the UK’s domestic legislation. If the relevant statutory instruments were to be repealed, recognition of foreign insolvency proceedings involving EEA credit institutions and certain insurers would revert back to the common law position, as such entities are carved out of the Cross-Border Insolvency Regulations 2006.
  • Recognition of schemes of arrangement would become more difficult if the recognition provisions contained in the Brussels I Recast Regulation ceased to apply post-Brexit, although the negative impact of this could be mitigated if the UK agreed to become a convention state under the Lugano Convention 2007 and/or the 2005 Hague Convention. The continuing application of Rome I Regulation may also assist where schemes relate only to contracts governed by English law.

Access to the EU financial markets

  1. What is the impact of Brexit on the ability of financial services firms established in the UK to enter into OTC derivatives with counterparties established in the EU?
  • Passporting rights: When the UK leaves the EU, the EU financial services directives will no longer grant passporting rights to UK investment firms and credit institutions or UK branches[4]. UK firms/branches wishing to enter into OTC derivatives with counterparties in the EU would then be subject to the regulations in such EU member state, many of which do not allow third country firms without a passport or other licence to enter into derivatives with locally resident counterparties except on a reverse-solicitation basis, or on the basis of narrowly defined local law exemptions.
  • MiFID II/MiFIR: The UK may request an equivalence decision pursuant to MiFID II[5]/MiFIR[6], which would allow UK firms to register with the European Securities and Markets Authority (“ESMA”) to provide investment services to eligible counterparties and professional clients in the EU. The UK regime should, objectively, be equivalent for the purposes of such an equivalence decision but in practice there is no guarantee that one will be granted and there is still potential gap risk due to what has historically been a lengthy time period involved in making an equivalence decision and firms then becoming registered with ESMA. However, not all of MiFID II is covered by the equivalence regime, for example, dealings with retail clients and elective professional clients are not covered.
  • CRD IV[7]: CRD IV contains no provisions for third country equivalence. In the absence of an agreement between the UK and the EU to extend the CRD IV passport for banking[8] services to the UK, a UK credit institution would either have to provide banking services on a wholly unsolicited basis, or on the basis of narrowly defined local law exemptions, or would need to establish a subsidiary and obtain authorisation in an EU member state to provide those services.
  • Energy and commodities: Where the OTC derivative transaction is a physically-settled transaction relating to energy or a commodity, there may be certain additional regulatory considerations. These include, potentially, in the case of a transaction relating to emissions allowances, the need to open a trader account in a ‘part’ of the Union Registry administered by an alternative EU member state (or, in due course, a third country linked in accordance with the relevant legislation)

16.1 Will EU firms without a UK branch still be able to carry out derivatives business in the UK?

If the transitional period proposed in the Draft Withdrawal Agreement comes into force, EU firms would still be able to rely on their existing passporting rights during that period. The Bank of England announced on 28 March 2018 that it is reasonable for EU firms currently relying on passporting rights to provide services in the UK to assume that PRA authorisation will only be needed by the end of this transitional period, and the FCA separately announced on 28 March 2018 that firms need not apply for authorisation at this stage.[9] Further, the UK Government announced on 20 December 2017 that it will, if necessary, bring forward legislation to enable EU firms operating in the UK to continue to do so after the UK leaves the EU under a “temporary permission”[10].

The UK has a wide overseas persons exemption and it is possible that OTC derivatives business could be conducted by EU firms with UK counterparties on that basis following expiry of any such transitional period or temporary permission (or, failing any transitional relief being negotiated or temporary permission being available, from when the UK leaves the EU).

16.2 Will EU firms still be able to carry out derivatives business through a UK branch post-Brexit?

EU firms that carry on investment business from their UK branches will likely need to re-apply for authorisation in the UK if the EU passport is withdrawn.

On 20 December 2017, HM Treasury, the Bank of England, the PRA[11] and the FCA[12] issued a series of announcements, including statements that:

  • the PRA is consulting on a revised approach to branch authorisation and supervision that, importantly, envisages allowing third country (including EU) banks to operate in the UK through branches, rather than having to establish a subsidiary, except where material retail banking business is conducted in the UK; and
  • if necessary, the UK Government will legislate to enable EU firms that operated in the UK before the UK leaves the EU to continue to undertake activities in the UK within the scope of their existing permissions for a limited period of time (“temporary permissions”).

On 28 March 2018, the PRA issued a further series of announcements[13] setting out its approach to branch authorisation and supervision and confirmed that EU banks and insurers may (if they are not conducting material retail business) apply for authorisation to operate a branch in the UK. Whether the PRA authorises such branch will depend on a number of factors, and particularly whether the relevant branch is a ‘systemic wholesale branch’ (i.e. a branch of an international bank undertaking wholesale activities in the UK which are determined to be systemically important), the equivalence of the regulatory regime in the bank’s home jurisdiction with the UK and whether there is felt to be sufficient supervisory cooperation between the PRA and the bank’s local regulator. Where the PRA is not satisfied, the PRA may impose specific regulatory requirements at the branch level or, if such requirements prove to be ineffective, the PRA would likely be prepared to authorise the firm only as a subsidiary. EU firms should consider the scope of activities they are intending to carry out through UK branches across their group in light of these statements.

  1. Will UK OTC derivative counterparties still be required to comply with the clearing, reporting and risk-mitigation requirements under EMIR?

Not directly, although it seems likely that the UK will retain these requirements as part of the incorporation of directly application EU legislation into UK domestic law via the proposals under the Withdrawal Bill so that in practice, at least initially, UK entities will still need to comply with these requirements.

Even if that is not the case, a UK derivative counterparty entering into an OTC derivative contract with another non-EU entity (including another UK counterparty) may be subject to requirements under EMIR (including the mandatory clearing obligation, if applicable) in certain circumstances, where such contract has a direct, substantial and foreseeable effect within the EU or for anti-avoidance purposes.

  1. What are the consequences of Brexit on the phase-in of the initial margin rules under EMIR?

The initial margin rules form part of directly applicable EU legislation and therefore are expected to be incorporated into UK domestic law pursuant to the Withdrawal Bill. However it should be noted that the Withdrawal Bill will only apply directly applicable EU legislation, such as the collateral regulatory technical standards under EMIR, if that legislation is “operative immediately before the exit day” which means that in the case of anything that comes into force at a particular time and is stated to apply from a later time, it is both in force, and applies, immediately before the exit day. Consequently the Withdrawal Bill, if enacted in its present form, would only incorporate into UK domestic law those initial margin requirements that had been phased in prior to the exit day. Initial margin requirements that had not been phased in before the exit day would not be incorporated into UK domestic law via the Withdrawal Bill but, given that the EU margin rules derive from BCBS-IOSCO, the UK is likely to adopt similar provisions.

  1. Will EU entities be able to satisfy the EMIR clearing obligation by using a UK CCP or the EMIR reporting obligation using a UK trade repository?

This depends on the negotiated position and any equivalence decision granted to the UK under EMIR. Should an equivalence decision be made, a UK CCP or UK trade repository would be able to apply to ESMA for recognition under EMIR, which, if granted, would allow EU counterparties to continue clearing and reporting through UK CCPs and trade repositories. Under a European Commission proposal, a third-country CCP determined by ESMA to be systemically important (or likely to become so) would be required to meet additional requirements for that CCP to be recognised by ESMA. Under those proposals, a CCP determined to be of “substantial” systemic importance may be refused recognition and instead require to become established in the EU in order to provide clearing services there.

  1. Will UK entities be able to satisfy any applicable UK clearing obligation by using an EU based CCP or the EMIR reporting obligation using an EU based trade repository?

Recognition of EU CCPs and trade repositories by the UK will depend on the rules on third country equivalence implemented by the UK, the outcome of the exit negotiations and, potentially, any reciprocal recognition of UK CCPs/trade repositories by the EU.

  1. Are there any other issues in respect of the clearing obligation that members should consider? 

Members of one or more CCPs should review the rules of each of those CCPs to determine whether Brexit is likely to result in them being in breach of those rules.

  1. Will compliance with UK clearing rules similar to those in EMIR be sufficient as substituted compliance for Dodd-Frank clearing obligations? 

It would depend on the location of the CCP through which a party clears its trade. If the CCP is located in the UK, there would need to be an application to the US to have it determined that trades cleared through a UK-based CCP would be deemed compliant with the Dodd-Frank clearing obligations. EU-based CCPs that are also registered in the U.S. as Derivatives Clearing Organizations currently benefit from that substituted compliance regime. If (as seems likely: see Question 17 (Compliance with EMIR)) the UK implements broadly similar CCP requirements and related clearing rules to those under EMIR, it ought to be capable of being granted a substituted compliance determination from the U.S., but this cannot be guaranteed and achieving such a determination from the U.S. may take time.

Collateral 

  1. Are there any consequences of Brexit for parties which have entered into the English law ISDA Credit Support Documents for collateral arrangements which are currently financial collateral arrangements under the Financial Collateral Directive?

The Financial Collateral Directive has been implemented in the UK through the Financial Collateral Arrangements (No 2) Regulations (“FCAR”). Given the importance of the protections provided to collateral-takers by the FCAR, and the risk of invalidity of certain unregistered security interests in the absence of the FCAR, it is likely that these regulations will be retained under the provisions of the Withdrawal Bill that preserve existing UK laws that implement EU directives.

  1. Are there any consequences of Brexit for participants of UK or EEA systems under the Settlement Finality Directive? 

The Settlement Finality Directive[14] has been implemented in the UK through The Financial Markets and Insolvency (Settlement Finality) Regulations 1999 (“SFR”). Systems established in the UK pursuant to the SFR will, post-Brexit (and absent any agreement between the EU27 and the UK), most likely fall outside the scope of the Settlement Finality Directive as implemented in EEA jurisdictions (although this will depend on whether, when implementing the Settlement Finality Directive, the particular EEA jurisdiction has looked to extend recognition to systems established in third countries, which then may capture systems established in the UK). In such circumstances, insolvency courts in those jurisdictions would not be required to recognise the protections under the applicable implementing legislation afforded with respect to systems established in the UK when an insolvent participant is based in their jurisdiction, although the outcome will depend on the position under local insolvency law.

Bank Recovery and Resolution Directive 

  1. Post-Brexit, what additional provisions will counterparties need to include in their ISDA Master Agreements to address requirements under the BRRD when facing an EU counterparty?

EEA credit institutions and large investment firms will need to include contractual recognition of bail-in for the purposes of national rules implementing Article 55 of the EU Bank Recovery and Resolution Directive (“BRRD”) into English law governed ISDA Master Agreements.

  1. Are there any additional provisions which UK entities will need to include in their ISDA Master Agreements when facing an EU counterparty to address requirements under the UK bank recovery and resolution regime (pursuant to the Banking Act 2009 or PRA rules)?

Whilst this question concerns the location of the counterparty, the determining factor will be the governing law of the contract and the same reasoning would apply regardless of whether the counterparty is located inside or outside the EU. The UK bank recovery and resolution rules currently include requirements for contractual recognition of stays in non-EEA law governed contracts. Post-Brexit, this rule may be extended to also include contracts governed by EEA law (i.e. any law other than English law). In the absence of legislation effecting these changes, however, amendment of this additional category of contracts will not be mandatory under English law (other than the existing requirement for contractual recognition of stays for non-EEA law governed contracts).

  1. Is there any impact on the ISDA 2014 Resolution Stay Protocol, ISDA 2015 Universal Resolution Stay Protocol, the ISDA Resolution Stay Jurisdictional Modular Protocol (the “Stay Protocols”), the ISDA 2016 Bail-in Article 55 BRRD Protocol (Dutch, French, German, Irish, Italian, Luxembourg, Spanish, UK entity version) or the ISDA 2017 Bail-in Article 55 BRRD Protocol (Austrian, Belgian, Danish, Swedish entity version) (the “Bail-in Protocols”)?

No, there is no current impact on those protocols.

Amendments to the ISDA Master Agreement and transfers of existing contracts

  1. What amendments, if any, should market participants consider making to their ISDA Master Agreement?

    None immediately. However, there are amendments which parties may consider making depending on the likely outcome of the exit negotiations. Please see the answers to Question 8 (Inclusion of additional termination rights), Question 9.3 (Choice of law for non-contractual obligations), Question 9.4 (Merits of amending the governing law), Question 11.1 (Insertion of arbitration clauses), Question 13 (Consideration of the jurisdiction clause), Question 14 (Amendments to the jurisdiction clause), Question 16 (Access to the EU financial markets) Questions 25, 26 and 27 (BRRD amendments)

  2. Should references in ISDA documentation to EU legislation be updated to contemplate equivalent UK legislation after the UK’s withdrawal from the EU?
    It would be helpful at least in some instances for references to EU legislation in ISDA documentation (including protocols) to be updated to contemplate the equivalent UK legislation after the UK’s withdrawal from the EU. It may be that the UK government considers this issue from a more general perspective and the feasibility of this will depend on the progress of the exit negotiations.
  3. What is the process for transferring derivative transactions from an entity established in the UK to an entity established in the EU?
    UK market participants may consider transferring their derivative relationships with EU counterparties from a UK established entity to an EU established entity by way of (i) individual novations of existing transactions, (ii) a court-sanctioned banking business transfer scheme pursuant to Part VII of the Financial Services and Markets Act 2000 (a “Part VII Scheme”), (iii) a cross-border merger of the two entities or (iv) relocation of a Societas Europaea.

    A novation will require specific consent to the transfer from the transferor (i.e. the UK entity), the transferee (i.e. the EU entity) and the remaining counterparty. This can be achieved using the 2002 ISDA Novation Agreement or the 2004 ISDA Novation Definitions, both of which are available on the ISDA website.

    A Part VII Scheme involves a lengthy procedure involving two court hearings but has the advantage of certainty of outcome and convenience versus the individual re-papering exercise required for novating existing transactions. However, a number of conditions need to be satisfied before a Part VII Scheme can be used, including that the business being transferred includes an authorised deposit-taking business.

    Other transfer mechanisms, such as a court-sanctioned scheme of arrangement under Part 26 of the Companies Act 2006 may also be considered.

    A cross-border merger of a UK company into a company incorporated in another EU member state would also involve a lengthy procedure. A cross-border merger would result in all the assets and liabilities of the transferor company being transferred to the transferee company with the transferor company ceasing to exist on completion of the merger. Shares in the transferee company must be issued in exchange to the shareholders of the transferor company (unless the transferor is already a wholly-owned subsidiary of the transferee). Cash can also be paid as part of the consideration. Like a Part VII Scheme, this process also has the advantage of certainty of outcome but there is no scope to select only some of the assets to be merged. In terms of process, pre-merger certificates are required to be issued by the ‘competent authority’ in the jurisdiction of the transferor and transferee (being, in the UK, a court). A joint application is then made to the competent authority of the transferee company for approval of the merger.

    Another alternative would be the relocation of the business of a UK public limited company to another EU member state through (a) the conversion of the UK public limited company to a Societas Europaea (“SE”) under the EU Societas Europaea legislation and the associated UK regulations and (b) the transfer of that SE’s registered office to another EU member state. The SE regime contains a process to facilitate employee participation in management. To date, not many SEs have been set up in the UK or other EU member states (with Germany and the Czech Republic being the exceptions).

  4. Will any new arrangements be required to clear derivative transactions in the future?
    To the extent that (i) clearing of one or more classes of derivatives is no longer permitted in the UK (e.g. euro denominated derivatives (see Question 19 (Will EU entities be able to satisfy the EMIR clearing obligation by using a UK CCP or the EMIR reporting obligation using a UK trade repository?), which refers to recent European Commission proposals in relation to this)) and a clearing member clearing those classes of derivatives in the UK is not a clearing member of an alternative EU based CCP clearing those classes of derivatives, (ii) UK based clearing members are no longer permitted to satisfy their clearing obligations at EU CCPs, (iii) EU based clearing members are no longer permitted to satisfy their clearing obligations at UK CCPs, (iv) EU clients are no longer permitted to use UK clearing members to satisfy their clearing obligations, or (v) UK clients are no longer permitted to use EU clearing members to satisfy their clearing obligations, yes.
  5. What is the impact of Brexit on use of an index which is considered to be a benchmark for the purposes of the European Benchmark Regulation?
    From 1 January 2018, pursuant to the European Benchmark Regulation, EU supervised entities (which includes certain credit institutions, MiFID II investment firms, UCITS, pension funds and alternative investment funds) will:
    • only be permitted to use a ‘benchmark’ if the administrator appears on the register maintained by ESMA (the “Register”). UK administrators will, post-Brexit, become third country administrators and will have to seek one of the three routes to entry on the register available to such third country administrators; and
    • be required to produce and maintain robust written plans on the action they would take in the event that either the benchmark materially changes or ceases to be provided or the administrator loses its authorisation or registration, including the provision of alternatives where feasible and appropriate. This will be particularly relevant for EU market participants referencing benchmarks administered by a UK administrator given the possibility that, as a third country administrator post-Brexit, such administrator may no longer be admitted to the Register.

 

[1]   Regulation 593/2008/EC of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (“Rome I”)

[2]    Regulation (EC) No 864/2007 of the European Parliament and of the Council of 11 July 2007 on the law applicable to non-contractual obligations (“Rome II”)

[3] The Markets in Financial Instruments Directive II – Directive 2014/65/EU

[4] It is possible that the passporting rights of UK firms into the EU (and EU firms into the UK) will continue, after the UK leaves the EU, during a limited transitional period to be negotiated between the EU and the UK.

[5] The Markets in Financial Instruments Directive II – Directive 2014/65/EU

[6] The Markets in Financial Instruments Regulation – EU Regulation 600/2014

[7] The Capital Requirements Directive IV – Directive 2013/36/EU

[8]   meaning taking deposits and granting credit for its own account

[9]   https://www.bankofengland.co.uk/-/media/boe/files/prudential-regulation/letter/2018/firms-preparations-for-the-uk-withdrawal-from-the-eu-update-march-2018.pdf?la=en&hash=FD310274EDB28E2A0440228F3DD928E4BB725457 and https://www.fca.org.uk/news/statements/fca-statement-eu-withdrawal-following-march-european-council

[10] http://www.parliament.uk/business/publications/written-questions-answers-statements/written-statement/Commons/2017-12-20/HCWS382/

[11] International banks: the Prudential Regulation Authority’s approach to branch authorisation and supervision

[12] https://www.fca.org.uk/news/statements/fca-statement-eu-withdrawal

[13]   https://www.bankofengland.co.uk/news/2018/march/update-on-the-regulatory-approach-to-preparations-for-eu-withdrawal?utm_source=Bank+of+England+updates&utm_campaign=1e9517753e-EMAIL_CAMPAIGN_2018_03_28&utm_medium=email&utm_term=0_556dbefcdc-1e9517753e-113373738

[14] Directive 98/26/EC

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