Two months on from the UK electorate’s decision to leave the European Union, the exact effect of Brexit remains highly dependent on the result of the UK’s negotiations with the EU as well as the final form of the post-Brexit relationships between the UK and the European Member States. The Brexit vote had an immediate impact by initiating substantial volatility in the financial markets. However, in the months following the initial after-shocks, those monitoring the post-Brexit climate are generally in consensus that the impact “could be large, but should still be manageable”, as per the IMF report on the Country's Financial System. It has now been established that an actual UK exit from the European Union is unlikely to happen before late 2018, leading many to anticipate and carefully contemplate the long-term implications of Brexit on Ireland’s Banking Sector. Four key areas must be referenced in considering the impact of Brexit on Ireland’s Banking Sector; Transaction Documentation, Passporting, Trade Reporting and Material Adverse Change provisions in existing Loan Agreements.
In discussing the implications of Brexit on Transaction Documentation, we must look to the issues of governing law and jurisdiction. Considering that the United Kingdom will be the first Member State to ever leave the EU, and the fact that the withdrawal process is likely to be lengthy and complex, it will undoubtedly take even longer than the two year post notification timeline envisaged by Article 50 of the Lisbon Treaty. The UK Parliament must agree on which EU laws it intends to preserve, modify and repeal, which, given the immense body of EU law, will no doubt be a gradual process. Traditionally the English Courts have maintained respect of the choice of law of contracting parties, and one would expect that it is unlikely that approach will change under any UK legislation implemented on withdrawal of EU Membership. However, the future approach in non-contractual matters is almost certain to be called into question, as prior to the implementation of Rome II, English Courts did not give non-contractual parties the discretion to select governing law. A major concern for Irish financial services in a post-Brexit legal landscape will be the enforceability of English governing law should the UK legal system become completely disconnected from that of the EU, and should the UK no longer be subject to the EU Recast Brussels Regulation (which determines the court of jurisdiction over a particular matter). As the UK and Ireland are intertwined by shared common law, it is likely that confusion will arise in some cases, in determining the applicable governing law and the relevant court of jurisdiction.
Other matters that will exercise legal minds include the question as to whether COMJ representations will continue to apply to UK entities or Irish Borrowers if the EU Regulation on Insolvency procedures no longer form part of UK law.
If the UK fails to either secure an EEA state status or negotiate a regime similar to that of the current “passport”, there will be negative implications for Ireland’s Banking Sector, specifically for Irish entities that have set up UK branches or sell into the UK on a freedom of services basis. Passporting exists under the Markets in Financial Instruments Directive (MiFID) whereby EU/EEA Member State financial service providers have capacity to conduct business and provide services throughout the European Union without the need to obtain licences in each EU/EEA Member State. The "passport" regime has in the past served as motivation for many financial services providers based in non-EU states to establish subsidiaries in EU Member States. The anticipated MiFID II which is expected to come into effect in 2018 will establish stricter requirements for third country entities. If the UK should not negotiate an EEA membership, it could then be expected to meet the regulations of a third country entity under MiFID II. Should the UK’s exit from the EU effect the passporting regime, Irish financial service providers may only be able to access the UK markets to the degree allowed by arrangements made by the UK governing access by non-UK regulated persons, which would create difficulty for Irish Banks.
It is worth remarking that in the case of a failure on the UK’s part to maintain access to EU Markets on a similar scale to that of the passport regime, there may be positive consequences for the Irish financial sector. As gaining the status of third country entity under the Directive is a laborious process, it may be necessary for UK financial service providers to set up subsidiaries in EU Member States. It is reasonable to conclude that a number of UK and International Banks seeking to maintain the level of access provided by the passport regime would choose to locate in Dublin pursuant to a number of factors, namely; the proximity of Dublin to the UK, the existence of a favourable tax regime, and the fact that Ireland is the only other English-speaking country in the EU. In a statement made before the referendum, Jamie Dimon, CEO of JPMorgan, estimated that as many as 4,000 financial sector employees could be forced to exit the UK on the event of a Brexit. If this expectation should come to fruition, the Irish banking sector could see a significant increase in growth, employment and investment as a direct consequence of the Brexit.
Any changes to the current regulation on Trade Reporting would undoubtedly have an impact on the Irish Banking sector, especially on Irish financial service providers with UK counterparts. Under the European Markets Infrastructure Regulation (EMIR) which entered into force on the 16th of August 2012, information on all European derivative trade contracts must be reported and made available to all superior authorities, including the European Securities and Markets Authority. In the event of a Brexit, the UK would no longer be subject to the comprehensive rules of EMIR. However, as the Regulation was adopted with a view to enabling the European Union to meet its commitments under G20, of which the UK is a member, and in circumstances where the UK was one of the prime movers in enacting the Regulation, it is probable that the UK will either transpose much of EMIR into domestic legislation, or implement similar legislation. These options would seem preferable to the UK than the alternative of being classified as a “third party central counterparty” which would create extensive barriers for banks trading derivatives and may result in supplementary trade reporting requirements. Should the UK implement differing Trade Reporting legislation or gain the status of a third party central counterparty, Irish financial service providers may be expected to comply with additional requirements in transactions with UK entities.
Material Adverse Change Clauses
In preparation for the UK’s exit from the European Union, Ireland’s Banking sector will need to examine existing documentation and agreements to identify a need for amendments or supplementary protocol. In particular, the issues of Material Adverse Change (MAC) clauses and termination rights in ISDA Master Agreements must be considered. The general assumption is that it is unlikely that a Brexit event would constitute a MAC in and of itself. However, it is possible that the consequences of Brexit would meet the thresholds of existing documentation with specific MAC Clauses. The issue here would be whether legal changes brought about by Brexit either caused a material adverse change or impacted a borrower’s ability to perform its obligations under an agreement. It is possible that a specific outcome of the UK’s exit from the EU would constitute a MAC, for example; the imposition of tariffs, ratings downgrades or regulatory change. It may also be the case should the UK’s withdrawal agreement lead to ratings downgrades that the incitement of additional termination rights in ISDA Master Agreements could result in early termination of contracts. The ISDA Master Agreements of 1992 and 2002 are the most commonly used master service agreements for OTC Derivatives Transactions internationally, created with the view to making the documentation of OTC Derivatives easier and more flexible. While engaging in Derivatives transactions, it is normally obligatory for both parties to a contract to represent that they have obtained all necessary legislative authorisation. Although it would seem unlikely that Brexit would constitute grounds for early termination as an Illegality or Force Majeure event in itself, resulting changes such as the disapplication of EU legislation under a Brexit regime, could remove the consent necessary to meet obligations under an ISDA Master Agreement, resulting in a counterparty having the right of early termination. The ISDA Master Agreements do not reference the use of a provision of law in its amended or re-enacted form, therefore Irish financial service providers would have to actively monitor any references to EU legislation rendered obsolete or incorrect by incoming Brexit legislation, although it is expected that ISDA would provide online protocol to financial service providers as guidance.
As previously stated, it must be remembered that the exact result of the UK’s exit from the EU remains highly reliant on the outcome of the UK’s negotiations with the European Union. Despite the negative effects expected to impact Ireland’s Banking Sector, it is encouraging that in a recent PwC Financial Services Attractiveness Indicator, Dublin ranked second behind London of the major financial centres in Europe, when measured in terms of market access, ease of doing business and strength of legal rights. Financial technology companies are increasingly considering positioning in Ireland ahead of the UK’s departure from Europe, but, although the Central Bank recently released a statement defending its preparedness, there are concerns the Irish regulatory system cannot restructure itself quickly enough to meet the demand.
In conclusion, the UK’s exit from the European Union is bound to have implications for Ireland’s Financial Sector. However, these effects are unlikely to have an impact until negotiations between the UK and the EU are in the closing stages. Given that the UK Prime Minister, Theresa May, recently confirmed that official talks with the rest of the EU would not begin in 2016, and that the process of preparing the UK for Brexit would require “serious and detailed work”, it is unlikely there will be certainty as to what form Brexit shall take and its implications for Ireland’s Banking Sector for several years to come. Considering the negotiations surrounding the UK’s accession into what was then a much smaller European Community took significantly longer than two years, and as the UK will be the first Member State to leave the EU, it is worth noting that the later stages of negotiations are unlikely to take place in accordance with the timeline provided by Article 50.