In 2016, following the result of the EU Referendum, the Loan Market Association issued a note to members highlighting the main areas in industry-standard documentation which would be affected by the UK leaving the EU. The shape of that exit would impact on the changes required and given discussions around a withdrawal deal, the conclusion was to hold fire on making changes to English law LMA documentation until any proposed change to English law takes effect.
The position has been updated in 2018 and further supplemented this year. While there is still a sense that an industry-wide approach to changes would be preferred, including in a no-deal scenario, there are some key areas that will be considered and there are likely to be developments in market practice to deal with some of the consequences of Brexit. We have highlighted key points below.
1. Documentary changes.
Inevitably certain provisions of the LMA standard documentation will need to be adapted to operate effectively in the event of a no-deal Brexit. Examples include:
a. EU references in documentation will need to be substituted and it is anticipated that the LMA will produce a table of references for this purpose to ensure consistency industry-wide;
b. Jurisdictional clauses. In anticipation of rule changes associated with the recognition of court judgments, we may see 'two way' exclusive jurisdiction clauses, preventing both lender and borrower from commencing proceedings in any court other than in the jurisdiction specified in the Agreement. At present 'one-sided' exclusive jurisdiction clauses in favour of the lender are the norm. Arbitration is an option which avoids some of the difficulties associated with existing rules ceasing to apply to the UK under a no-deal Brexit. However, parties to funding arrangements have historically preferred resolution of disputes through court procedure rather than arbitration; and
c. Inclusion of Article 55 bail-in clauses. Bail-in clauses have been required to ensure the smooth operation of bank recovery and resolution procedures introduced following the financial crisis by the European Commission where counterparties to funding documentation are outside the EU. While the UK remains within the EU there is no requirement for lending with UK credit institutions to include Article 55 contractual bail-in clauses in lending documentation, other than in respect of finance documents governed by the laws of a non-EEA jurisdiction entered into by an EU financial institution. However, with the UK departure from the EU in a no-deal scenario, such clauses may be required and consideration should be given to including such clauses in documents now.
Some amendments will be technical in nature, others more commercially sensitive. Changes are likely to be dealt with as part of a refinancing or facility extension or simply by agreement between the parties to ensure the loan operates effectively. Although focusing on loan documentation, consideration should also be given to mandate and commitment letters where arranging of the underwriting of investor commitments are anticipated.
2. Change in the regulatory landscape.
Licences are needed for lending or associated services in certain EU jurisdictions. While part of the EU, UK institutions have been able to provide services to customers in other EU member states through the passporting regime. The regime is only available to entities within the EU. The loss of passporting of services by UK institutions if the UK leaves the EU with no deal means that local licences may be required to continue to provide those services. The provision of services within the UK by such UK entities would remain unaffected.
3. Tax changes such as withholding tax treatment.
The standard LMA documentation allows payments to be made without withholding tax deductions, provided such payments are made to qualifying lenders. The LMA documentation provides in certain circumstances for the grossing up of payments to take account of a tax deduction. Such a gross-up should not be triggered by the change in status of a lender as a qualifying lender, unless that change in status is triggered by the change or application of a law or treaty. There is potential for a no-deal Brexit having such an effect. While in many instances, withholding tax arrangements (and in particular exemptions from having to make withholding tax deductions from interest payments and grossing up such payments under loan documentation) should remain unaffected, the position should be checked in each instance where dealing with EU27 entities.
4. What might change in practice?
With a view to satisfying local licensing requirements for relevant regulated activities, we may see the transfer of existing lender or lender agency roles to appropriately licensed affiliates situated within the relevant EU27 countries. Standard LMA documentation provides for this, although consents may be required and all relevant activity may not be entirely encapsulated in the facility documents under which that transfer is effected. Care should be taken to ensure all interests are dealt with. Standard LMA documentation also allows for the change of a branch through which the lender acts for that particular transaction. This may be sufficient to allow the lending arrangements to continue through the appropriately licensed branch, although local advice should be sought to ensure this is correct.
There is likely to be an increased focus and controls around accession of borrowers within a multi-jurisdictional group facility, to the extent that any borrowers are situated within EU27 jurisdictions where lending services require to be licensed and not all funders hold the required licences. This can be mitigated by the methods mentioned above but also by isolating licensed lending activity to appropriately licensed lenders under a syndicated facility through agreed tranching of facilities.
We may also see deals being structured so as to avoid unlicensed providers of finance being lenders under the facility documentation. It is possible for institutions to participate in a facility without becoming lenders. There is a well-established market in loan participation. This structure would allow the sub participation in loans potentially avoiding regulated activity in EU27 countries. Essentially the lenders in this case would be fronting the lending arrangements while the risk in those loans sits with the sub participant. Whether this is effective in satisfying regulatory requirements in every case will depend on local rules which should always be considered. There are commercial factors to consider too. For example, the lender substitutes borrower covenant risk with lender counterparty risk.
5. Triggering the illegality clause.
The standard LMA documentation anticipates repayment of the debt to the extent that provision of the debt becomes unlawful. The loss of passporting of services for some lenders, in respect of EU27 borrowers where a relevant local licence is not in place, may potentially trigger the illegality provisions. Maintaining lending arrangements may not require a licence but to the extent that an existing debt is acquired through novation or increased facilities are provided (or where associated services such as provision of bank accounts, letter of credit or bank guarantee issuance and facility or security agency may be a regulated activity in particular jurisdictions in the EU27) the position would need to be considered.
A no-deal Brexit will also impact on the market and wider economy and there may be some sector or industry-specific challenges that will affect documentation and market practice. Until the alternative arrangements that do not rely upon passporting are embedded, there is potential impact on liquidity of the European loan markets and related pricing. Ensuring short to medium term financing requirements of businesses are in place is important now, more than ever.
Brodies LLP is a member of the Loan Market Association.
