The United Kingdom public have voted to leave the European Union. The next two years will see a period of negotiated withdrawal - with the UK Government deciding which parts of EU law to adopt into domestic legislation, which parts to jettison and which parts to park, for now at least. It is likely to be a long process. In this note, we provide a quick overview of the possible impact of the "Leave" vote (and ultimately of actual Brexit in the relatively near future) on financing arrangements and loan documentation.
No immediate impact on current loan relationships
Typical loan relationships, based on standard Loan Market Association (LMA) terms (or similar) will be unaffected by the leave decision of itself. The decision to leave the EU will not of itself trigger a material adverse change event of default allowing lenders to accelerate facilities. Brexit itself i.e. the ending of the UK's membership of the EU, will be of equally neutral effect. If, however, a borrower is particularly reliant on EU legislation - for example because it provides access to critical markets - then the repeal of that legislation could result in a material adverse change. Equally, a borrower may have represented that all necessary authorisations for carrying on its business are in place. In due course, Brexit may result in a requirement for borrowers to obtain new authorisations.
The commercial impact may of course be quite different to the legal aspects. Fluctuations in stock market prices may, for example, trigger margin calls while a rating downgrade could result in higher borrowing costs. Currency movements may affect the economics of a financing and, with Sterling weakened, overseas investors may seek to acquire UK businesses
As mentioned above, the next 2 years are likely to see a period of negotiated withdrawal. The first step in the process is that the UK Government must serve notice on the European Council that the UK wishes to leave the EU, triggering a period of up to 2 years during which the UK and the remaining 27 Member States will negotiate the steps for the UK's withdrawal. We do not know when the UK Government will send this notice and, accordingly, when that period will commence. As evidenced since last Thursday's vote, we do expect market volatility during this period. So what can the lending community expect to see during this period:
- Where loans mature in the next 2-3 years, lenders may see borrowers commencing amendment and extension processes sooner to avoid accessing funding at a time when market volatility is at its highest.
- We may also see the re-emergence of forward start facilities, which became commonplace post-Lehman, as borrowers look to lock in bank liquidity while it remains available.
- Equally, borrowers may look to exercise (or seek to include in new documentation) extension options to give them the flexibility to extend maturities beyond this potential period of market volatility.
- Finally, accordion features which have been introduced in many recent corporate refinancings could also be exercised by borrowers to top up existing facilities.
As evidenced post-Lehman, certain lenders retracted from certain markets or reduced their participations in certain sectors. Accordingly, there may be opportunities to develop new relationships with borrowers seeking new lender relationships.
EU legislation embedded in current loan documentation
A large number of current facility agreements will bridge a Brexit date. LMA based documentation is very light on provisions which rely, directly or indirectly, on EU legislation. Standard LMA construction provisions provide that "a provision of law is a reference to that provision as amended or re-enacted" - and this will be helpful in smoothing over Brexit transition "bumps". The following considers typical areas of loan finance documentation which rely on EU derived legislation:
- Increased costs provisions: LMA documentation is drafted widely and generically, to require that borrowers compensate lenders for increased capital costs during the life of the facilities. In negotiated documents, however, European legislation which implements globally recommended standards for bank capital and liquidity is often directly referenced. There is no doubt that equivalent legislation will be adopted in the UK and the lenders' ability to claim for such increased costs will be similarly covered.
- Sanctions: There is no single set of standard sanctions provisions for loan documentation provisions relating to economic sanctions. Negotiated documents routinely provide that the borrower group complies with sanctions legislation administered by a number of sanctions authorities, including the European Union. Brexit will have no effect on that position due to where the banking community operates.
- EU provisions relating to choice of auditor: Recently adopted EU Regulations concerning statutory audits of annual accounts and relating to public-interest entities limit the degree to which lenders can influence a borrower's choice of auditor. Lenders can still impose qualitative/capability requirements though and we have not found that this legislation has caused real difficulties for lenders or borrowers. The EU measures were introduced to improve competition (in particular expanding competition beyond the big-four accountancy firms) and it seems likely that equivalent provisions would be retained in respect of audits relating to UK entities post Brexit.
- Appropriation as an enforcement remedy: In a secured financing, it is routine for security documents to include a right to appropriate financial collateral (eg. shares). This right derives from the Financial Collateral Arrangements (No 2) Regulations 2003, made under the European Communities Act 1972 and therefore now due for repeal. Our view is that the Financial Collateral Regulations are of clear benefit to the UK financial services industry and therefore would be adopted into national law post Brexit.
- Bail-in: Article 55 of the EU Bank Recovery and Resolution Directive 2014/59 requires EEA financial institutions to include a "bail-in clause" in documents under which they have liabilities and that is governed by the law of a non-EEA country. Under that provision, the financial institution's counterparties acknowledge that the institution's obligations are subject to an EEA regulator's exercise of write-down and conversion powers. If the UK does not rejoin the EEA, then loan documents under English law will routinely need to include bail-in clauses. We anticipate such language being included as standard until such time as the UK's position vis-ŕ-vis the EEA is settled.
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.