Brexit: the implications for banking

The UK: No longer a gateway to Europe?

For UK banks operating internationally, or overseas banks operating through UK subsidiaries, probably the single most important aspect of the UK’s membership of the EU was access to the “single passport”. This is the name given to the system of mutual regulatory recognition which enables banks providing financial services in one Member State to operate in other Member States without having to seek authorisation in each and every Member State in which they wish to operate. Many non-EU banks have taken advantage of this system and used the UK as their gateway to Europe, thus enabling them to benefit from the four freedoms of movement which membership of the EU confers.

Now that the UK is to leave the EU, UK based banks (including non-EU banks operating through UK subsidiaries) will lose that passport. This means that they will need to establish operations in an EU Member State in order to maintain access to markets in other EU Member States. Alternatively they will have to revert to individual applications for authorisations in individual countries (with the time, relocation and cost consequences which this would entail).

This may well have very significant consequences for the financial services industry in the UK. As the Association of Foreign Banks has put it: “If Britain withdraws from Europe, then foreign banks may reassess their reasons for maintaining their business in Britain and may decide to continue their business elsewhere”. A survey conducted for City UK prior to the referendum suggested that 37% of financial services companies said that they were very likely or fairly likely to relocate staff if the UK left the EU.

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What are some of the key EU Regulations and Directives concerned?
  • Capital Requirements Regulations (CRR) and the Capital Requirements Directive (CRD IV)

    These apply to banks and certain other types of financial institutions or investment firms. As a Regulation, the CRR is already directly applicable in the UK (and will remain so until the formal exit from the EU). This is reflected in the current regulatory requirements contained in the FCA Handbook and/or the PRA Handbook, as are the provisions of CRD IV. Brexit is unlikely to trigger any immediate requirements for change. Over time however, it is possible that regulatory requirements in the EU and those in the UK may diverge. In any event, UK banks will continue to need to comply with Basel Committee Guidelines.

    Bank Recovery and Resolution Directive

    This Directive has already been implemented in UK law though secondary legislation and amendments to primary legislation, and is reflected in the regulatory requirements of the FCA and the PRA. It seems unlikely that there would be any immediate change but once again there is scope for future divergence.

    EU Insolvency Regulation and EU Reorganisation and Winding Up Directive

    As a member of the EU, the UK benefitted from the EU Insolvency Regulation which is designed to harmonise insolvency regimes across the EU (except Denmark) and to facilitate cross-border insolvencies. It applies to individuals and corporates but not to banks, insurance companies and certain other forms of financial institution. While not relevant where a bank is itself the subject of insolvency proceedings, it will be relevant to banks in their dealings with their borrowers with operations in other Member States. Unless replaced by an alternative agreement with the EU or individual EU Member State, banks lending to such borrowers who take enforcement proceedings and/or institute insolvency proceedings in the UK may find themselves exposed to the risk of competing insolvency proceedings being commenced in one or more other jurisdictions and of not being able to rely on the primacy of the UK proceedings.

    Bank insolvencies are subject to separate legislation introduced in order to implement the EC Reorganisation and Winding Up Directive applicable to Credit Institutions. These currently address the question of which Member State’s insolvency laws will prevail in any insolvency of an EU bank with cross-border operations or cross-border banking groups. As a Directive, this is currently reflected in UK law but post Brexit, even if the UK retains the same or similar arrangements, whether these would be recognised by the EU and other Member States is unclear.

    Other key Directives (and the implementing UK legislation) which will need to be considered include the Consumer Protection Directive and the Mortgage Lending Directive.

What will it mean for loan documentation?
  • Existing loan documentation is based on both EU legislation and domestic UK legislation and so market participants will need to analyse the documentation to see what changes will need to be made. Apart from the obvious need to remove and/or replace redundant references to EU Regulations and EU Directives and any relevant national implementing legislation or regulations, particular areas which will or may need to be considered include:

    • increased costs clauses and references to CRD IV
    • tax matters such as withholding tax and VAT provisions although the existing network of UK double tax treaties should avoid the need for wholesale changes to the withholding tax provisions (for more details, see the section entitled Brexit and tax)
    • interest rate setting mechanisms and related definitions (if market practices need to change to reflect the post Brexit world)
    • generic and specific covenants relating to compliance with laws (for more details, see "What will it mean for existing transactions" below)
    • confidentiality and data protection provisions (for more details, see Brexit and Data Protection)
    • consumer protections provisions which are the subject of various forms of EU legislation, and
    • governing law and jurisdictions clauses and issues concerning the enforcement of judgements (for more details, see Brexit and dispute resolution).
What will it mean for existing transactions?
  • Interpretation

    Questions of interpretation will inevitably arise in relation to existing loan documents which will refer to one or more aspects of EU legislation which may be repealed or replaced as a result of Brexit. Most documentation will generally contain a provision to the effect that references to legislation are to that legislation as amended, re-enacted or replaced and so this may offer protection where the relevant legislation is replaced with new legislation. But what is to happen if the legislation is not replaced? How should the parties interpret the contract then?

    Covenants to comply with the law

    Of particular concern to borrowers may be covenants and repeating representations relating to compliance with law. Repealing legislation should make borrowers lives easier when it comes to the compliance covenant. Even the introduction of new legislation should not really be too problematic to the extent that the new legislation is simply a question of implementing existing requirements already covered by EU Regulations or is otherwise a like for like replacement. What happens, however, if it is not a like-for-like replacement and the borrower has to adjust its working practices to accommodate the changes? Transitional provisions may offer protection but, nevertheless, the borrower may find itself technically subject to an event of default and/or drawstop until it is able to adjust its procedures and practices to reflect any change in law.

    Also of concern may be covenants to comply with EU law. The fact that the borrower may no longer be required to comply with EU law as a matter of law because that law no longer applies to it does not necessarily mean that it is relieved from its contractual obligations to comply with that law.

    Material adverse change clauses

    Borrowers with material adverse change provisions may be concerned to know whether the referendum result or Brexit itself can be invoked as a material adverse change. As always, this will be a question specific to the facts and circumstances but case law has established that, as a matter of law, a lender cannot trigger such a clause on the basis of circumstances of which it was aware at the time of the agreement because there can have been no change in circumstances. As a result, lenders entering into new agreements post the referendum would not be in a position to invoke material adverse change on the grounds of Brexit. What is the position for existing agreements however? This may turn on whether the lenders can be regarded as having been on notice of a possible Brexit at the time the loan was made and this leads to a debate about the point at which a Brexit became a real possibility. Borrowers with longer standing facilities may wish to seek clarification from their existing lenders that they do not intend to use Brexit as an opportunity to invoke material adverse change clauses.

    Market disruption clauses

    Another potential area of concern for borrowers lies in market disruption clauses. What impact will the referendum result or Brexit itself have on the markets? Could borrowers find themselves exposed to the risk of lenders invoking market disruption procedures?

    Illegality clauses

    Similarly, illegality clauses may be another area of potential concern. The loss of the passport may mean that lenders or their affiliates no longer have the necessary authorisations to perform their obligations and/or continue as lenders or counterparties. This is more likely to be relevant to lenders in the context of consumer lending rather than corporate lending but it is an issue which would need to be considered nonetheless.

    Amending agreements

    A borrower may look to amend its agreements to ensure that they reflect the post Brexit position. While this would be simple enough between willing parties to a bilateral contract, making amendments to syndicated documents (particularly for larger syndicates) may not be quite so easy. Bond issuers may find themselves in the position of having to try to persuade their  trustee(s) to agree to such changes without referring the matter to bondholders. This will generally require their trustee(s) to be prepared to form the view that the changes are of a formal, minor or technical nature or otherwise not materially prejudicial to holders and this is something which trustees are increasingly unwilling to do except in the most clear cut of cases.

For further information, please refer to Brexit: the legal implications.

This document (and any information accessed through links in this document) is provided for information purposes only and does not constitute legal advice. Professional legal advice should be obtained before taking or refraining from any action as a result of the contents of this document.