As at the end of April 2019 we are moving towards a no-deal Brexit on October 31, 2019 with no transitional period unless an alternative route is agreed. A no-deal Brexit is likely to have a substantial impact on the European loan market and the Loan Market Association (LMA) has, by way of a November 30, 2018 paper, served a warning as to the potential ramifications. It remains important for market participants to continue monitoring the potential impact of this event on their business and to continue implementing business plans for a worst-case scenario.
Current snapshot of Brexit developments
Brexit preparations and negotiations have been ongoing since the Brexit referendum in 2016. Listed below are certain key events which have led us to where we are today:
The potential scenarios moving forward are: a Brexit with a deal on or prior to October 31, 2019, “cliffedge” Brexit on October 31, 2019, either of the foregoing if the Article 50 period is further extended or the UK revokes its Article 50 notification (which the European Court of Justice ruled that the UK can do unilaterally). At the time of writing we are looking at a “cliff-edge” Brexit as no other alternative has been agreed which is accordingly the focus of this article.
"Turning off the liquidity tap"
In December 2018 the LMA published its paper “Turning Off the Liquidity Tap” (LMA paper). In the LMA paper it was noted that a no-deal Brexit may result in “substantial market disruption” to the European loan markets. This is due to a number of factors including: the wide usage of wholesale loan products, borrowers often being heavily reliant on funds obtained via loan products, loans often being cross-border in nature, and the differences in regulatory requirements between EU member states.
The LMA paper primarily focuses on the effect of a no-deal Brexit on UK lenders lending into EU-27 countries. It notes that, in respect of EU-27 lenders lending into the UK, EU-27 country lenders are likely to benefit from transitional arrangements to be implemented by the UK regulators.
The LMA paper serves as a clear warning to the loan markets. It notes that in lieu of an agreement between the UK and the EU providing otherwise, complications may arise with respect to UK lenders lending into EU-27 countries following a no-deal Brexit due to:
- Potential UK lenders’ loss of EU passporting rights allowing them to lend to EU-27 borrowers;
- Other regulatory requirements which may result in lending by a UK lender being or becoming impractical;
- Licensing requirements applying to UK lenders in the direct markets and also in the collateralized loan obligations markets;
- Continued validity, effectiveness and enforceability of existing loan contracts; and
- Other ancillary considerations (such as the ability for UK lenders to provide hedging and account bank services, both of which often accompany the provision of loans).
The LMA paper noted that between November 1, 2017 and October 31, 2018, UK lenders provided approximately EUR 40.4 billion of syndicated loan financing to borrowers within the EU-27 countries. Complications encountered by UK lenders noted above may have a substantial impact on such offerings.
The loss of passporting rights, for example, in the absence of transitional arrangements, may have the potential ramification of existing loans becoming legally vulnerable or subject to repayment or restructuring (e.g. pursuant to the illegality provisions commonly found in syndicated loan documentation).
While there are possible solutions to address each of these complications (for example, if a UK lender loses its EU passporting rights it may be able to transfer its loan participations to an affiliate within an EU-27 country and many of the UK lenders have already taken steps to effect such transfers) the LMA paper points that that such solutions are likely to take time to implement.
The LMA has urged the European Commission and the European Supervisory Authorities to assist in coordinating efforts between EU member states to minimize the disruption to the European loan market. Among other actions to be taken, transitional arrangements should ideally be put in place as a coordinated effort, including in consultation with the UK and its regulatory bodies to the extent appropriate, while market participants adjust to what will inevitably be a different landscape.
In the meantime, market participants should continue to monitor the progress of transitional arrangements, while continuing to prepare for a worst-case scenario where no transitional arrangements are put in place.
Borrowers should consider, and where appropriate seek advice, as to how this may impact the loans upon which they are reliant. Borrowers may also wish to consult with their lenders regarding the arrangements they are putting in place to provide for a worst-case scenario Brexit.
Many lenders both in the UK (and in the EU-27 lending into the UK) are now progressing well in their Brexit preparations, with the larger players having dedicated teams and advisors on board to assist with the transition. Continued monitoring of the regulatory complications, implementing worst-case scenario solutions and keeping their clients updated will be of the utmost importance for lenders during this time.