The Brexit decision will inevitably have some impact on businesses that are based in, trading with or investing in the UK. However, the political landscape is so uncertain that it is not yet possible to determine exactly what effect it may have on the debt finance landscape.
So, what can you do if you have an existing debt facility or new loan facility in the pipeline? We recommend that you read through the following article and contact us if you have any concerns. Rather than try to predict the future, we have instead aimed to provide a framework that can be used as part of your risk assessment reviews.
2. Facility documents
The referendum decision may have been delivered but legally there have been no changes yet to English contract law, statute or regulation. Documentation changes will therefore be limited in the immediate future to those driven by the commercial impact of the 'leave' decision. Points to consider are:
- recently negotiated transactions may have included a 'Brexit break clause' allowing the lender to withdraw from the facility in the event of a leave decision. These may appear as a contingency to funding or a type of 'material adverse event' clause. The clauses are being invoked in some cases and parties should make themselves aware of whether this option exists;
- it is too early to say whether 'Brexit' provisions will be required in deals going forward. Anything less than an explicit 'exit' material adverse event provision would be at risk of putting the lender in an uncomfortable enforcement position. However, from a borrower's perspective, an explicit 'exit' material adverse event would give a significant degree of uncertainty to the funding stream. We have not yet seen parties wishing to exit completed transactions for Brexit related reasons in circumstances where these have not been drafted into the contract in advance. As time goes on however, there may be a risk that instability in the economy will drive requests for exit from financial transactions;
- where there are multi-currency elements to a transaction, we suggest that you review how the facility manages currency exchange risks and make yourself aware of the terms of the currency indemnity provisions;
- whether the increased costs provisions cover any change of law connected to Brexit. This will only be relevant to medium or longer term deals and views will differ on whether an increased costs clause should extend to the cost of repealing EU law and instating new laws on substantially the same terms. Lenders will, of course, need to be able to demonstrate that the increased costs are connected to the ongoing provision of that facility. Previous market practice with regard to significant regulatory change has been to exclude costs once the relevant regulations are available and their scope understood, at which point they can be factored into the pricing of loans. For now, we can only keep this on the radar.
- in deals funded by banks, which have been subject to a ratings downgrade or are subject to a negative outlook, be aware of any thresholds that could trigger either a replacement of the lender or the need to move cash deposits in order to qualify as 'cash' for covenant purposes (under 'yank the bank' and Acceptable Lender' provisions). It is possible that these clauses will be included and invoked more frequently if the economic position worsens for financial institutions;
- similarly, a rated bond issuer may find itself subject to the bondholders ability to call on bonds or affect pricing, if its rating is downgraded as a consequence of "Brexit" fallout. Certain sectors will be more vulnerable than others, particularly any sector funded in whole or part by public sector grants or other funding and, as such, affected by any sovereign rating downgrade;
- whether you need to sense check your documentation for references to EU member states (or similar definitions).
3. Liquidity and pricing
Whilst there are no immediate concerns over liquidity, parties should be aware of the potential impact that the leave decision could have on the pricing of transactions.
The Bank of England has made a well-publicised pledge to inject £250bn in order to support the functioning of markets and believes that the banks are more resilient and have greater capital and liquid assets than at the time of the financial crisis in 2008, which will allow them to continue to lend to businesses and households during challenging times. Its latest financial stability report, released on 5 July 2016, states that it has relaxed the capital control rules on UK banks in an effort to raise bank's capacity for lending by up to £150bn. Its view seems to be that the credit market will be driven by demand, not supply.
The demand for credit will be influenced by the uncertainty in the economy as the environment becomes more 'risk averse' and it may be that parties to ongoing transactions will want to see a degree of calm return to the market before completing. Whilst interest rates remained unchanged after the meeting of the Monetary Policy Committee on 14 July, the perceived increased risk of an interest rate cut at the next meeting has the possibility to dampen banks' interest in lending as it becomes harder to achieve profitability. This is also against the backdrop of the downgrading of credit ratings of various financial institutions and indeed the UK.
Whilst pricing prior to the referendum did not appear to have a Brexit mark up, taken together, it is possible that the political, economic and potential regulatory uncertainty will lead to a rise in the cost of funds for lenders that will need to be passed on in future transactions.
There has been no change to the law governing English law security and so it is likely to be economic factors that drive any changes required to security packages in the immediate future. These are not expected to be commonplace, but a fall in asset prices could trigger a review of any net asset or loan to value ratios and potentially give rise to concerns about whether lenders would be able to realise the full value of security in the unfortunate event of enforcement action being taken.
In the longer term, an exit from the EU would require a review of cross border security packages in facilities extending beyond the exit date. This is in order to assess whether any changes to cross border insolvency regimes would cause enforcement issues in what is already a complex area of law. We would hope however that any replacement legislation would aim to mirror the current regime.
In these uncertain times, businesses can do far worse than to arm themselves with information so that they are able to take action swiftly (or respond to events occurring around them) when the time is right.
Our recommendation is that you:
- make yourself aware of risk factors affecting existing or ongoing facility documents;
- do what you can to maintain an open dialogue between the parties to a loan transaction;
- talk to government, lobby groups and professional trade bodies to ensure that any concerns are aired with the political decision-makers.