On 23 June 2016, the UK electorate voted in favour of exiting the European Union. Whilst the UK will not leave the EU in the immediate future, issuers of, and investors in, existing debt capital market transactions or those issuers contemplating establishing new issuance of debt programmes in the EU will need to consider what this vote means, how quickly this will have an impact on and the potential knock-on effects on investors, and other customers. This article considers certain key legal considerations for debt capital markets issuers in light of the UK electorate's vote to leave the EU ('Brexit'). While the date on which Article 50 of the EU Treaty will be triggered ('Trigger Date') has not been set, the government has now advised that it will not be before early 2017. Prior to this, the government hopes to engage with businesses to understand better the most pressing issues and to negotiate the best deals possible for the UK in general and business in particular.
Currently, the legal and regulatory framework for debt capital market ('DCM') transactions remains subject to EU Directives and Regulations. While all EU Directives are implemented through national laws of the UK, Regulations are directly applicable to all EU Member State parties to a DCM transaction without the need for the UK Parliament to take any further legislative action. As such, it remains to be seen if and how Regulations in the UK will be implemented once the UK is officially out of the EU and whether UK laws implementing EU directives will remain in place. We will continue to publish articles on the key considerations set out below, as policies and laws develop in relation to these issues.
A point on timing
The UK is not in a post-Brexit environment as yet. In order to leave the EU, the UK must invoke Article 50 of the Treaty on European Union.1 Under the terms of Article 50, before the UK leaves there will be a two-year period for the negotiation of a withdrawal agreement with the Council, acting by enhanced qualified majority with the consent of the European Parliament.2 The negotiating period will have a two-year limit, unless the European Council, in agreement with the Member States concerned, unanimously agrees to extend this period. In other words, either an agreement is reached on the terms of withdrawal, including the withdrawal date, within two years of the notification of the Trigger Date, or withdrawal takes place automatically at the end of the two years. The negotiating period may be extended beyond two years if there is an unanimous decision by the remaining 27 EU Member States.
As with existing transactions, some new transactions would not be affected by Brexit itself because of how long it is likely to take for the UK to leave the EU although, as with existing transactions, some may be affected by the uncertainty and financial market volatility.
In the negotiations with the EU on the terms of UK withdrawal, the main question affecting capital markets will be the terms for future UK access to the EU Single Market for financial markets. Currently, UK institutions have unrestricted free access through the "single market passports" as a member of the EU.
In the DCM context, the concept of passporting is particularly relevant when issuers consider an issuance of bonds under a Prospectus Directive ('PD') compliant prospectus to investors in EU Member States. Under the existing PD, if an issuer is offering any PD compliant bonds, as long as the prospectus has been approved by the issuer's 'home' Member State, it can offer the bonds to investors in any other EU Member State without the need to obtain any additional approvals in the investors' Member States.
The existing PD has been implemented into national UK legislation. To the extent that the PD changes after the UK formally leaves the EU, it will be a question for the UK to determine whether it wishes to implement any changes that may positively impact on existing EU legislation that it had adopted prior to Brexit. The European Commission has the power to approve a non-EEA prospectus regime if it meets standards which are equivalent to EU requirements. As such the European Commission could make a finding of "equivalence" with respect to any future UK prospectus regime. It also remains unclear how the European Commission will address the approval of a prospectus for a new issuance under an existing PD compliant programme. We believe there may be grandfathering of prospectuses for pre-Brexit PD compliant programmes. However, it remains to be seen how the European Commission will deal with such prospectuses and from what point in time any grandfathering provisions will be applicable.
2. Clearing of euro-denominated payments
In addition to euro-denominated payments, a significant portion of euro-denominated swaps clear through London. If the UK no longer has access to the single market, it remains unclear (i) whether euro-denominated swaps will continue to clear through London and (ii) how London's role as a significant financial centre for euro-denominated markets will be affected.
3. Prospectus disclosure and Risk Factors
It is possible that some new debt capital markets transactions will specifically contemplate the impact of Brexit as part of the disclosure in prospectuses. However, it seems likely that such disclosure will be reflected only to the extent that it is relevant.
There has been a significant increase in the inclusion of Brexit-related risk factors in prospectuses in the run up to, and following, Brexit (for example in the Prospectus Supplement dated June 30, 2016 issued by Brown-Forman Corporation and the Prospectus Supplement dated June 30, 2016 issued by Omega Healthcare Investors, Inc.). Such risk factors in prospectuses may be appropriate if an issuer considers its business likely to be adversely affected by Brexit. Some issuers may also wish to "flag" the market volatility implications of Brexit. At this stage, however, any such disclosure will necessarily be quite high level given the inherent uncertainties around how Brexit will in fact play out and its appropriateness will need to be carefully considered on a case-by-case basis.
4. Eurobond documentation
It is unlikely that the market disruption following the vote to leave requires market standard force majeure clauses in bond documentation (i.e. the ICMA standard form force majeure clause) to be triggered. However, for bespoke force majeure clauses (which are often found in private placements, equity linked and other "non-vanilla" deals), this will of course depend on the specific transaction and the drafting of the clause.
It is also unlikely that the market disruption following Brexit will be considered severe enough to trigger a breach of market standard material adverse change (MAC) representations or MAC termination rights in bond documentation. Any bespoke material adverse change clauses will of course need to be specifically drafted and analysed.
It also remains unlikely that Brexit will, in itself, trigger an event of default on the grounds of illegality as, from a legal perspective, nothing has immediately changed following the vote to leave. The UK remains a member of the EU and EU laws continue to apply until the UK formally leaves the EU.
Market participants should take comfort from the fact that Brexit will not result in material changes to the English common law principles on which English law governed DCM transaction documentation is based. While future changes to the regulatory landscape are difficult to predict, it is unlikely that Brexit will affect the enforceability of an English law governed contract.
Brexit does, however, raise a number of issues in the context of cross-border transactions such as, whether the courts of other EU Member States would continue to (i) respect a choice of English law as the governing law of a contract, (ii) respect a choice of English courts to settle any disputes and (iii) recognise and enforce English judgments following the UK departure from the EU.
5. Supplemental prospectuses
The mere occurrence of Brexit, of itself, does not trigger the need for an immediate prospectus supplement. This of course depends on the specific circumstances of the relevant transaction and issuer, but Brexit itself is unlikely to be considered a "significant new factor" for Prospectus Directive purposes.
6. Credit ratings
The UK's credit rating by S&P was downgraded from "AAA" to "AA" and the rating agency has warned of possible further downgrades.3 While, at this time, the country's downgrade does not directly impact on corporate issuers, particularly investment grade issuers, there is general concern about how this downgrade will impact on sovereign entity-linked issuers or transactions linked to the ratings of the UK.
7. Capital Markets Union
The Capital Markets Union ('CMU') is part of the EC's efforts to harmonise the European capital markets to, among other things, enable issuers to gain access to funding from a range of investors. The UK was one of the main drivers behind the implementation of the CMU and it is uncertain whether this proposal will continue and in what guise.
Whilst the proposals relating to the Prospectus Regulation will continue moving forward following Brexit, it is highly likely that the UK will step back from negotiations relating to CMU.
"Us and them" – implications for the rest of the EU
According to the International Capital Markets Association's Quarterly Assessment dated 12 July 2016, there are also a number of questions related to Brexit's impact on the EU with implications for the capital markets:
- whether new EU regulations after Brexit would in future be as favourable to international capital markets as at present: while the UK can influence the outcome of negotiations on new EU regulations at present, after Brexit they would be negotiated by the remaining 27 Member States without any UK influence;
- whether the euro-area authorities would take steps to encourage more euro business to be conducted within the euro area; and especially euro clearing
- if so, whether they would be able to agree on a single financial centre for the euro within the euro area and where it would be (e.g. Frankfurt, Paris, Luxembourg or Dublin).4
Quo Vadimus – so where do we go from here?
There will be an extended period of uncertainty and financial market volatility post Brexit. However, Brexit would not trigger concerns about sovereign insolvency, redenomination of debts, or the introduction of capital or exchange controls. As a result, the short to medium term impact of Brexit on existing and new transactions is likely to be limited from a legal perspective, although the associated uncertainty and volatility has lead, and will continue to lead, some businesses to put activity on hold for a period. In the longer term, the impact of Brexit from a regulatory perspective is unclear, but any changes could have significant consequences for debt capital market transactions if the UK's ability to access the single market for financial services is not preserved.
This is a first in a series of articles which will focus on specific developments relevant for debt capital market participants. If there are any queries in the meantime on specific issues, please do not hesitate to contact us.
1 The EU has two Treaties: the Treaty on European Union and the Treaty on the Functioning of the European Union. If and when the UK withdraws from the EU, the Treaties would no longer apply to the UK, and the UK would no longer participate in the EU institutions, such as the European Commission, European Council, Council of Ministers, European Parliament, European Court of Justice and the EIB.
2 ICMA article by Paul Richards – 'The UK vote to leave the EU: implications for capital market regulation'.
3 Standard and Poors press release on 27 June 2016
4 ICMA Quarterly Assessment by Paul Richards – 'The UK vote to leave the EU: implications for capital market regulation' dated 12 July 2016
Client Alert 2016-246
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.