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Don't Hedge Your Bets for Brexit – Financial Implications for Corporates

Don't Hedge Your Bets for Brexit – Financial Implications for Corporates

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With uncertainties surrounding a "no deal" Brexit meanwhile culminating in fears of a "super hard" Brexit, financial institutions in the UK, the EU27 and beyond are eager in search of solutions that preserve continuity of contracts and that contain the numerous legal and regulatory risks for institutions on both sides of the Channel.

In some areas, European and national law-makers are enacting legislation addressing specific risks: On an EU level, a draft equivalence decision for CCPs (central counterparties for cleared derivatives) and CSDs (central securities depositories) is scheduled to be adopted by the College of Commissioners on 19 December. The equivalence decision is contingent on failure to reach a deal on Brexit. Also, some lawmakers in the EU27, including in Germany, France, the Netherlands, Sweden, Finland, Ireland and Italy, have proposed or already enacted (or are rumored to be about to enact) legislation aimed at insulating local financial institutions from the cliff-edge-effects of a no-deal scenario. 

However, beyond regulated financial institutions, we observe that financial risks potentially caused by Brexit may not necessarily enjoy top priority in corporate risk management and internal control functions of CEE/SEE businesses. Looking at the number of lending and treasury relations between local businesses (but also sovereigns and sub-sovereign entities), London banks and investment firms as well as the fact that many of those transactions are regulated (banking or securities) services in many CEE/SEE jurisdictions, this lack of attention is somewhat surprising. 

Certainly, financial services regulation is not the focus of the customer of financial institutions, i.e. the borrowing or hedging corporate. But can unregulated corporates really turn a blind eye to these aspects of Brexit and afford the luxury of focusing on other, more apparent, impacts of Brexit on their business, for example around customs duties for their supply / offtake relations, implications on their staffing, etc.? 

The answer is a lawyerly one: It depends – on several factors. 

If a corporate borrower's working capital (general corporate purpose) revolving credit facility is from a local (or EU27) lender, it will likely remain available after 29 March 2019. Also, if that corporate's hedging is with a local bank, there is not much they can do about whether that local bank can continue to centrally clear those hedging (derivative) transactions with a London central counterpart after 29 March 2019. 

On the other hand, the higher the portion of revolving commitments and/or hedging arrangements from UK banks in the EU27 borrower's debt capital structure, the more acute the Brexit issue potentially is. This is because in a no-deal scenario, those lenders (and hedge counterparties) will lose their passporting rights under EU law and may therefore no longer be able to lawfully fund their revolving commitments (or may face regulatory limitations to continue the hedging beyond certain "life-cycle-events"). 

For the loan product, the industry's pre-eminent body, the Loan Market Association, proposes to address this – as well as other regulatory limitations that may exist – by the so-called "designated entity" concept. In short, if relevant language is included in the finance documentation, this will allow (but will usually not oblige) the UK lender to nominate a local / EU27 affiliate to participate in the relevant loan(s). If the relevant language was not slotted in the finance documents, a transfer of the lending relation to a local / EU27 lender (affiliated or not) appears to be the route to go. 

In the derivatives space, a legal transfer of the hedge counterparties' position is the route to go - if necessary, given the nature of the hedging arrangement and applicable law. 

In either instance, implementing the relevant changes to the lending syndicate and/or hedge counterparties may pose several issues, including operational and (withholding) tax, that need careful addressing – and it will take time to do so. 

Therefore, to the extent corporate treasury has relevant relations with UK financial institutions and where those consultations are not yet sufficiently advanced, with only three months remaining it is probably about high-time to address those issues with the corporate's banking relations.

By Martin Ebner, Partner  Schoenherr

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