BREXIT Hedging and Swaps – considerations as a result of a no deal Brexit

23.08.19

Whether hedging exposures associated with interest rates and currency exchange fluctuations or changes in commodity prices, most corporate and institutional businesses have entered into risk mitigant arrangements to manage these exposures.  Many exposures are mitigated through hedging arrangements relying upon the international swaps and derivatives association (ISDA)  documentation. 

Most ISDA transactions are documented under English law governed or New York law governed ISDA Master Agreements with reference to a related ISDA Schedule and confirmations for individual transactions or long form confirmations.  Documentation is supplemented by reference to an array of ISDA ancillary documentation including Definitions, Credit Support Annexes and Protocols.

ISDA documentation draws to a certain extent on European legislation and operates within a legal and regulatory framework that assumes the UK is part of the EU.  Brexit will impact on the way the documentation operates.  Counterparties should be reviewing documentation now. 

In July, ISDA updated its FAQs note in respect of the consequences of Brexit.  It has also published amendments to standard ISDA documentation dealing with some of the consequences of a no-deal Brexit.  The following sets out some key points to consider and action which can be taken at this stage to ensure hedging arrangements and swap contracts continue to operate as the parties intended post 31 October (assuming that remains exit day).

  1. Consider whether to make remedial amendments to take account of Brexit triggering potential Termination Events and close out of swaps.  The ISDA Master Documentation, whether based on 1992 or 2002 architecture, contains provisions which can trigger early close out.  These Termination Events may be triggered by Brexit depending on the particular arrangements and counterparties involved.  Early dialogue with counterparties may be appropriate to ensure correct outcomes occur.
  2. An amendment anticipated by the draft ‘Amendment to ISDA Documentation No-deal Brexit Version 1’ issued by the association earlier this year related to transactions involving EEA credit institutions and investment firms; and in particular the requirement to include contractual recognition of bail-in and resolution stays in their EEA law governed agreements.  These provisions relate to recognition of certain regulator bail-in powers and the priority to be given to such arrangements.  They stem from the banking crisis and the need to ensure an orderly resolution for banks and investment firms should a similar crisis arise.  The relevant provisions are incorporated by reference to various ISDA protocols.    Following exit from the EU, the application of the relevant bail-in provisions to UK entities will change and it is recommended that parties consider incorporating contractual recognition of bail-in and resolution stays expressly.  Other ‘updating’ could be considered taking into account new UK legislation designed to substitute  equivalent EU legislation to the extent it no longer has direct application in the UK post Brexit. 
  3.  Parties may feel it appropriate to consider further additional termination events, incorporating a choice of law in respect of non-contractual obligations arising from the contract (to the extent not already incorporated) and potential inclusion of an arbitration clause to the extent that recognition of choice of jurisdiction may not produce the results required in the existing documentation.
  4. Amendments of or transfer of interests under existing hedging documentation need to be considered carefully post Brexit.  While in most cases existing arrangements should remain unaffected, any subsequent changes to documentation or transfers may trigger the swap being classified as a new transaction for relevant regulations.   The lack of passported operations into the EU after a no-deal Brexit may affect the ability of entities relying upon passporting arrangements to effect such transactions other than through a locally regulated and authorised group entity. Much will depend upon how the new transaction is procured.   
  5. The European Market Infrastructure Regulation on derivatives, central counterparties and trade repositories (EMIR) requires certain transaction information to be shared with trade repositories. With the UK departure from the EU in a no-deal scenario, UK trade repositories do not fall within the scope of EMIR and so documentation should be reviewed to ensure they still permit this type of disclosure and information sharing in the UK.  Confidentiality waivers need to be reviewed in the documentation to ensure that they operate properly. It is essential for the proper operation of markets that confidentiality waivers permit reporting to UK trade repositories post Brexit. This may not operate automatically by simply adopting the relevant provisions of EMIR directly into UK law. EU counterparties will also need to satisfy reporting to an EU trade repository separate from the UK requirement in order to continue to comply with EMIR.
  6. The parties may also want to consider the implications of changes to insolvency law (and in particular rules associated with the recognition and priority of insolvency proceedings in multiple jurisdictions) where dealing with international counterparties and also the effectiveness of security interests constituted by credit support in key jurisdictions affected by the transaction.

Advice should be sought in respect of specific transaction documentation and implications of the changes highlighted above and also considering any transaction specific consequences of Brexit.    

Should you have any queries or are looking for more information please contact a member of the Brodies Derivatives team