There are a multitude of issues to consider for financial institutions affected by a vote to leave the EU. We highlight some of these below.
UK financial institutions, including banks, investment managers and insurance companies, which currently rely on “passports” under the Single Market Directives, such as the Capital Requirements Directive, Market in Financial Instruments Directive (“MiFID”), UCITS Directive, Alternative Investment Fund Managers Directive (“AIFMD”) and Solvency II Directive, may have to restructure their businesses. Currently an institution, which the Prudential Regulation Authority or Financial Conduct Authority have authorised in the UK, has the right to establish a branch or provide services in any other EEA Member State without further authorisation. Similarly, an entity authorised in another EEA Member State has the same type of access rights in the UK.
If the UK structures its relationship with the EU such that it is outside the EEA or does not negotiate a mutual recognition arrangement which has the effect of granting full EU passport rights for all or certain UK financial institutions (such as the EU currently does for Swiss insurance companies), a UK financial institution may need to establish a fully authorised branch or subsidiary in an EU Member State. As part of considering its options, it will have to look at the so-called “third country” provisions in Directives such as MiFID II, the AIFMD and Solvency II Directive which give non-EU institutions rights of access to the EU (although in the case of Solvency II such rights are limited to reinsurers in ‘equivalent’ regimes being treated in the same way as EU reinsurers and does not apply more widely to insurers). The availability of these rights, will be subject to “equivalence” determination – in essence, the EU Commission will need to determine that UK law and regulation provides regulatory protections which are equivalent to those in the EU.
Institutions will also have to take into consideration the effects of Brexit on their relationships with entities in other EU Member States and on transactions in EU Markets. For example, a UK fund manager that has entered into OTC derivative transactions with a French bank would need to reconsider its clearing arrangements. These are currently subject to a single directly applicable EU law, the European Market Infrastructure Regulation. Unless, the EU recognises the clearing rules in the UK as equivalent to those in the EU, the manager would need to renegotiate its agreement with the French bank and the French bank will also have to impose requirements under the Bank Resolution and Recovery Directive on the fund manager by contract. Transactions in instruments traded on EU Markets will continue to be subject to the new EU Market Abuse Regulations which covers behaviour undertaken outside as well as within the EU.
Loan and hedging documentation governed by English law will, broadly speaking, be affected by Brexit in much the same way as other English law contractual documentation.
It does not seem likely that wholesale changes will need to be made to either the LMA or ISDA standard forms of documentation, but each institution should implement a review of the standard forms. The particular areas which we expect to come under scrutiny are: governing law (although the pre-EU position was in practical terms not unlike the EU Rome I and II position), jurisdiction (although there are a number of conventions which could be utilised to fill any gap left by Brexit), enforcement of judgments, increased costs and market disruption.
The standard forms of documents do contain a number of references to EU Regulations and Directives, but the interpretation provisions of the documents will provide that references to laws are to those laws as amended or re-enacted, so while any post Brexit new or replacement laws or regulations will, in time, find their way into revised forms of the standard documentation, any changes in this respect are unlikely to have any significant bearing on existing transaction documentation.
Individual transactions will need to be reviewed in light of Brexit though, and it may be that questions over the effect of force majeure, material adverse effect and early termination rights arise, as, over time, the ramifications of Brexit manifest themselves. The illegality clause may also come into effect, if UK and other European based institutions need to grapple with life after the flexibility offered by the Single Market Directives passporting system.