Firms who are UK based, or your counterparties in the UK face considerable uncertainty with the outcome of Brexit. As of writing there is no clear model for the UK relationship with the EU 27. Many firms are choosing to move their booking entity to an EU 27 location, giving them continuity of their EU contracts even if the UK is uncertain. This alone means re-papering new master agreements including their ISDAs, GMSLAs, GMRAs, prime brokerage agreements, futures and listed options agreements, clearing agreements, loan agreements and security agreements.
Each counterparty relationship will need new documentation, new credit lines and new collateral agreements to replicate the current structure with a UK firm. In addition, any Terms of business will need re-issuing to cover the EU entity, for each set of products traded where necessary.
To make things more complicated the process of moving an entity to the EU can be achieved in a number of ways including 1) novating to an existing EU entity 2) transferring the entity from the UK to the EU location 3) Part VII Banking Business Transfer Schemes under the Financial Services and Markets Act 2000 4) a merger, where the UK entity is merged into the EU entity or 5) becoming a Societée européenne.
Time is not on anyone’s side; the UK is scheduled to leave the EU on 29th March 2019 just over a year away. Like many regulatory projects it’s nice to have a deadline and a set of rules to implement. In this case we have a deadline without any rules, leaving UK firms to ‘pull the rip cord’ and implement a default Brexit plan such as the options above. As each firm announces their plans, all their counterparties must react accordingly and like the grain of sand that starts the avalanche, cause a cascade of legal work.
Another legal relationship which remains unclear is that of clearing houses. With SwapClear being the single biggest pool of risk in the world, legally located in the UK, the political debate from Europe on whether to move EUR clearing on-shore also needs resolution. Should LCH also relocate themselves into Europe, all the clearing agreements will also need re-papering to suit their new situation.
With the re-papering, national law may impinge upon agreements bringing modifications from existing documentation. The way in which bankruptcy takes place in Germany is quite different from the UK, which is reflected in the default procedures at Eurex and LCH respectively. This means agreements need executing for the new legal entities, but also review and revision during the re-papering process.
The ISDA Master Agreement under English Law is the basis for most OTC trading relationships but ISDA themselves do not know if the recognition of court judgements will be automatic between the EU and UK. In which case moving your ISDA Master to an EU jurisdiction may also provide a bridge to the future, ISDA are already drafting French and Irish law Master Agreements for this purpose. Most ISDA Masters are under English law, with the UK being an EU member, the judgement of an English court is recognised across the EU. Without this recognition, judgements of an English court may need extra process to be recognised within the EU 27 to be enforceable.
A more practical concern is that some post-trade events on OTC contracts may become regulated activities rather than accepted as a matter of course. Affected activities could include novations, compression runs, extending the maturity of a trade, significant amendments, and some unwind events. All of these are common, and with the UK having passporting rights under MiFID II, firms would need to rely on an equivalence decision, an exemption or a license in their local jurisdiction to carry out those activities.
It seems that legal firms will be faced with a perfect storm with potentially massive changes to how the markets operate and no certainty as to when or how these changes might take place. Some firms are already moving into the EU, you need to be prepared to start the re-papering process immediately as firms move.
Put in place a process to:
- Make a catalogue of existing agreements which may be impacted
- Develop policies for the various scenarios above
- Build a team ready to handle incoming and outgoing Brexit related work
- Estimate the work load resulting from a hard UK Brexit
- Consider using a platform like SmartDX to underpin the re-papering exercise
Want to learn more? Let’s have a conversation today.
References
- AFME “How might wholesale financial services contracts be impacted by Brexit? (https://www.afme.eu/en/reports/publications/how-might-wholesale-financial-services-contracts-be-impacted-by-brexit/)
- ISDA Brexit and Contractual Certainty (https://isda.derivativiews.org/2017/10/09/brexit-and-contractual-certainty/)
- ISDA Brexit and the ISDA Master Agreement (https://isda.derivativiews.org/2018/01/08/brexit-and-the-isda-master-agreement/)
- Financial Times, Banks set to move fewer than 4,600 jobs (https://www.ft.com/content/931b1b1a-df49-11e7-a8a4-0a1e63a52f9c)