ISDA Brexit Briefings
On June 29, the International Swaps and Derivatives Association held a webinar to discuss the potential implications of the UK’s vote to leave the European Union on the derivatives markets and broader financial industry. A recording of the call and the presentation, featuring ISDA executives and partners from law firm Linklaters, is available here.
On September 13, ISDA held a second webinar entitled “Brexit: Governing Law, Jurisdiction and Arbitration Clauses under the ISDA MA”. A recording of the call and materials from Linklaters are available to members here.
ISDA Brexit FAQs – December 2016
A ‘long read’ version of these FAQs is available for ISDA members HERE.
These FAQs address the possible UK position post-Brexit, i.e. after conclusion of the exit process under Article 50 of the Lisbon Treaty. There is still considerable uncertainty as to the format of the UK’s relationship with the European Union after conclusion of the exit negotiations. Consequently, the responses to these FAQs involve an assessment of the various outcomes of the exit negotiations and the consequences of those outcomes and it is not possible in all cases to give a definitive answer.
Market participants should take independent legal advice on the points addressed in these FAQs December 2016.
Disclaimer: This page does not contain legal advice and merely is intended as an information resource to assist market participants in assessing the impact of the Brexit referendum and in planning for the exit of the UK from the European Union (EU) following the referendum of June 23, 2016 (Brexit referendum) and prior to the official notification pursuant to Art.50 Lisbon Treaty. ISDA is organising a series of member calls and meetings to discuss specific issues.
Contractual points under ISDA documentation
1. Could Brexit constitute a Force Majeure, Impossibility or an Illegality Termination Event under the ISDA Master Agreement?
A Force Majeure Termination Event requires a practical impediment to payment/delivery which seems unlikely to occur, even if the UK does not retain its passporting rights for investment services. An Illegality Termination Event is a theoretical possibility if Brexit results in a total loss of access for UK financial services firms to EU financial markets and the consequence of this is for performance of a Transaction to become illegal in the relevant EU member state. Such an outcome is unlikely in respect of the performance of pre-existing contractual obligations, but will depend on local law in the jurisdiction of performance.
2. Could Brexit constitute a Tax Event Termination Event under the ISDA Master Agreement?
The occurrence of a Tax Event depends on whether any withholding tax is introduced which would affect the underlying Transactions, either as a result of the change in domestic law in the UK or because an existing exemption under certain EU laws ceases to apply to UK entities. The occurrence of a Tax Event in these circumstances will depend on the change in law or application of the exemption in question, which in turn will depend on the outcome of the exit negotiations, and whether withholding tax would affect payments made on the underlying Transactions.
3. Could there be a breach of the representation under Section 3(a)(iii) (No violation or Conflict) or Section 3(a)(iv) (Consents) as a consequence of Brexit?
A breach of the ‘no conflict with applicable law’ representation is unlikely to arise as, assuming that this representation is true and accurate when given and repeated pre-Brexit (including on entering into each new Transaction), then existing Transactions will not cause a Misrepresentation Event of Default simply by virtue of such representations becoming untrue at a subsequent date as a result of Brexit (if, for example, in the absence of passporting rights for UK financial services firms, performance of a Transaction conflicts with local law due to local authorisation requirement – as to which, please refer to the answer to Question 1 (Force majeure, Impossibility or Illegality Termination Event)). The same is true of the representation on consents in Section 3(a)(iv). Caution should be exercised in respect of any novation or amendment of an existing Transaction to the extent this is actually the entry into a new Transaction, at which point these representations will be deemed to be repeated.
4. Could there be a Breach of Agreement under Section 5(a)(ii) in respect of the obligations in Section 4(b) (Maintain authorisations) or Section 4(c) (Comply with Laws) of the ISDA Master Agreement as a consequence of Brexit?
It is unlikely that there would be a Breach of Agreement as a result of a failure to maintain authorisations pursuant to Section 4(b) or a failure to comply with law pursuant to Section 4(c) in the event of a loss of access for UK financial services firms to the EU financial markets. This is because the performance of pre-existing contractual obligations in relation to Transactions ought not to be subject to local authorisation requirements, although this will depend on local law in the jurisdiction of performance. However, even if, post-Brexit, there were an obligation on one party to seek authorisation locally in order to perform the Transaction, the Illegality Termination Event would probably be available to the party that had lost its passporting rights, which would, in accordance with the hierarchy provisions in Section 5(c), prevail over any possible Breach of Agreement Event of Default.
5. Could Brexit trigger an event of default or termination event under the ISDA/FIA Client Cleared OTC Derivatives Addendum?
(i) In addition to the Events of Default/Termination Events under the ISDA Master Agreement (which apply only to the Client under the ISDA/FIA Client Cleared OTC Derivatives Addendum) covered in the preceding Questions, it is theoretically possible that a Cleared Transaction Illegality/Impossibility event (if specified as being applicable) could be triggered by loss of the ability for UK financial services firms to provide investment services cross-border into the EU. However, this eventuality seems improbable for the same reasons as outlined for an Illegality Termination Event under the ISDA Master Agreement.
(ii) A CM Trigger Event could occur if any loss of passporting rights causes the party which is the Clearing Member to be in default under the rules of an EU CCP and that EU CCP formally declares such Clearing Member to be in default of its rules, triggering its default management process (or such process is triggered automatically as a result of such a loss of passporting rights by the Clearing Member).
(iii) A CCP Default could occur if a UK CCP loses its rights to offer clearing services pursuant to EMIR, is not granted recognition pursuant to the third country provisions of EMIR (as to which see Question 19 (Clearing pursuant to EMIR by a UK CCP)) and the rules of that CCP entitle Clearing Members to terminate their transactions with that CCP (or such termination takes place automatically) as a result.
6. Could Brexit trigger any other provisions in the ISDA Master Agreement/Credit Support Documents?
Market movements could trigger increased margin calls or trigger provisions linked to ratings.
7. Does Brexit impact any of the provisions of the ISDA Definitions booklets?
The eventual market impact may result in additional Credit Events pursuant to the 2014 Credit Derivatives Definitions. Adverse consequences for the financial markets may also result in the occurrence of one or more of the Additional Disruption Events pursuant to the 2002/2011 Equity Derivatives Definitions.
8. Should parties consider including any additional termination rights based on Brexit?
(i) If, post-Brexit, parties are unable to perform cross-border Transactions, they will probably be able to rely on the Illegality Termination Event. To remove any uncertainty as to whether the law of the place of performance constitutes an “applicable law” for such purposes, parties to a 1992 ISDA Master Agreement may consider including an Additional Termination Event covering this eventuality.
(ii) Parties may also wish to consider additional termination rights to address the inability to clear derivative Transactions through EU CCPs (in the case of UK entities) or UK CCPs (in the case of EU entities) or the inability to report Transactions to UK/EU trade repositories (please see Question 19 (EMIR clearing/reporting by UK CCPs/trade repositories) and Question 20 (EMIR clearing/reporting by EU CCPs/trade repositories)).
Choice of law, jurisdiction and recognition of judgments
9. What is the impact of Brexit on the parties’ choice of English law as the governing law of the ISDA Master Agreement?
9.1 Will the Rome I and Rome II Regulations still apply post-Brexit?
(i) If proceedings are brought before an EU court: The Rome I and Rome II Regulations continue to apply in the EU and so English law clauses specifying the governing law of the contractual and non-contractual obligations will continue to be recognised by EU courts, as is currently the case. This is irrespective of the domicile of the parties.
(ii) If proceedings are brought before a UK court: The Rome I and Rome II Regulations will no longer apply in the UK. In respect of a choice of English law to govern contractual obligations, English common law will apply and there is unlikely to be any change in approach from the status quo. In respect of non-contractual obligations, the rules set out in Part III of the Private International Law (Miscellaneous Provisions) Act 1995 will be applied by the English courts in determining the proper governing law of non-contractual obligations. An express choice of English law to govern non-contractual obligations is likely to be influential, but not determinative, in this assessment.
9.2 Can the UK enact legislation replicating Rome I and Rome II entirely so as to maintain the status quo?
The UK could enact the rules set out in Rome I and Rome II rules into domestic legislation. There is some indication from the government that this could be done as part of the adoption of “rights acquis” announced by the Prime Minister at the Conservative Party Conference on 2 October 2016. The re-enactment would replicate the existing rules but without the European Court of Justice (“CJEU”) having jurisdiction to determine disputes about the new domestic legislation. However, the legislation could require the CJEU’s decisions to be taken into account.
9.3 Is it advisable for parties to continue to amend the governing law clause of the ISDA Master Agreement to include an express choice of law for non-contractual obligations?
There is no reason not to continue including a choice of law for non-contractual obligations. This choice will be recognised by the EU courts and is likely to be taken into account in the UK post-Brexit.
9.4 Is it advisable to change the governing law of the ISDA Master Agreement to (i) New York law or (ii) the law of an EU member state?
Selecting New York law as the governing law (which would mean, unless agreed otherwise, a choice of court in favour of New York courts) is a possibility but there would be no real advantages in terms of the recognition of judgments of the US courts by either the EU or the English courts. It is not advisable to change to any other governing law without legal advice as the ISDA Master Agreement has been drafted to operate under the legal regimes of New York and English law. Any such change from English law or New York law to a third country governing law would also necessitate further consideration of the jurisdiction clause, the application of ISDA commissioned netting and collateral opinions and the requirement of any contractual recognition provisions relating to bank resolution (see Question 24 (Additional provisions for inclusion in the ISDA Master Agreement).
10. Will the jurisdiction clause of the ISDA Master Agreement still confer jurisdiction on the English courts where the parties to the ISDA Master Agreement are established in the EU?
Currently, EU courts are bound to respect jurisdiction clauses in favour of another EU court on the basis of the Brussels I Recast Regulation. Post-Brexit, this Regulation will no longer apply to the UK. Before the English courts, the English law ISDA jurisdiction clause is likely to be respected on the basis of English common law rules. In EU courts, the UK will be a third country so recognition of an English exclusive jurisdiction clause will depend on the national position and it is not certain that an EU court would be obliged to decline jurisdiction in favour of the English courts or, in respect of a non-exclusive jurisdiction clause, to stay proceedings on the basis that the English courts are first seised.
11. What is the impact of Brexit on arbitration clauses in an ISDA Master Agreement which select England as the seat of arbitration?
11.1 Where parties currently have an English governing law and jurisdiction clause in their ISDA Master Agreement, is there merit in inserting an English arbitration clause into the ISDA Master Agreement?
Possibly, for MiFID II equivalence.
12. What are the consequences of Brexit for the recognition and enforcement of judgments where:
Please see materials for the September special webinar on the effect of Brexit on the English choice of law and dispute forum clauses posted HERE.
13. Are there any other factors which will determine the choice of law/jurisdiction clause in an ISDA Master Agreement post-Brexit?
(i) There may be circumstances in which the recognition of third country jurisdiction clauses by courts of a particular jurisdiction and/or enforcement of judgments in such jurisdiction may lead the parties to consider whether an alternative governing law/jurisdiction clause is suitable. In this case, a careful analysis of the enforcement of netting, and collateral, as well as how claims would be considered under a different system of law would need to be undertaken.
(ii) Post-Brexit, UK entities relying on the MiFID II equivalence regime to conduct MiFID II business in the EU may have to offer clients the ability to submit disputes to the jurisdiction or arbitral tribunal in an EU member state.
14. What amendments can parties make to Section 13 (Governing Law and Jurisdiction) to mitigate the uncertainty surrounding recognition of English choice of law/jurisdiction clauses?
Parties may consider removing uncertainty as to the treatment of Section 13(b) post-Brexit themselves by making any of the following changes:
(i) inserting a fully exclusive jurisdiction clause without the current references to the European legislation to avoid any question of whether the clause elects for exclusive or non-exclusive jurisdiction in the EU;
(ii) inserting a fully non-exclusive jurisdiction clause which would also remove any uncertainty as to exclusivity/non-exclusivity in the EU and gives parties the maximum range of options to bring proceedings against their counterparty where it has assets;
(iii) inserting an asymmetrical clause which provides for exclusivity for proceedings commenced by one party but non-exclusivity for the other party; or
(iv) inserting an arbitration clause which would be unaffected by the UK’s withdrawal from the EU.
15. How will English insolvency proceedings in respect of a UK entity be recognised in the EU post-Brexit?
(i) The EU Regulation on Insolvency Proceedings, the Credit Institution Winding–up Directive and the Insurance Company Winding-up Directive will no longer cover the UK and the provisions in those instruments on the recognition of English insolvency proceedings by an EU court would no longer apply. Recognition of certain English insolvency proceedings in the EU would consequently become more complicated.
(ii) In respect of recognition of EU insolvency proceedings by the UK courts, in the absence continuity legislation retaining the provisions of the above instruments, recognition of foreign insolvency proceedings would fall back to the common law position.
(iii) The Cross-Border Insolvency Regulations 2006 (which adopt the UNCITRAL Model Law on Cross-Border Insolvency) will apply in the UK and provide for recognition of certain insolvency proceedings between signatory states. However, only four of these are EU member states and so it is of limited application within the EU.
Access to the EU financial markets
16. What is the impact of Brexit on the ability of financial services firms established in the UK to enter into OTC derivatives with counterparties established in the EU?
(i) Passporting rights: When the UK leaves the EU, the EU financial services directives will no longer grant passporting rights to UK investment firms and credit institutions or UK branches. UK firms/branches wishing to enter into OTC derivatives with counterparties in the EU would then be subject to the regulations in such EU member state, many of which do not allow third country firms without a passport to enter into derivatives with locally resident counterparties except on a wholly unsolicited basis, or on the basis of narrowly defined local law exemptions.
(ii) MiFID II/MiFIR: The UK may request an equivalence decision pursuant to MiFID II/MiFIR, which would allow UK firms to provide investment services to eligible counterparties and professional clients in the EU. The UK regime should, objectively, be equivalent for the pursues of such an equivalence decision but in practice there is no guarantee that one will be granted and there is still potential gap risk due to the lengthy time period involved in making an equivalence decision. However, not all of MiFID II is covered by the equivalence regime, for example, dealings with retail clients and elective professional clients are limited.
(iii) CRD IV: CRD IV contains no provisions for third country equivalence. In the absence of an agreement between the UK and the EU to extend the CRD IV passport for banking services to the UK, a UK credit institution would either have to provide services on a wholly unsolicited basis, or on the basis of narrowly defined local law exemptions, or would need to establish a subsidiary and obtain authorisation in an EU member state to provide those services.
16.1 Will EU firms without a UK branch still be able to able to carry out derivatives business in the UK?
The UK has a wide overseas persons exemption and it is possible that OTC derivatives business could be conducted by EU firms with UK counterparties on that basis.
16.2 Will EU firms still be able to carry out derivatives business through a UK branch post-Brexit?
EU firms that carry on investment business from their UK branches will likely need to re-apply for authorisation in the UK if the EU passport is withdrawn.
17. Will UK OTC derivatives counterparties still be required to comply with the clearing, reporting and risk-mitigation requirements under EMIR?
No, although it is likely that the UK will enact either continuity legislation or similar rules.
18. What are the consequences of Brexit on the phase-in of the margin rules under EMIR?
The EU margin rules derive from BCBS-IOSCO and so even in the absence of continuity legislation post-Brexit, the UK is likely to implement equivalent provisions, as has the US, Canada and Switzerland, for example.
19. Will EU entities be able to satisfy the EMIR clearing obligation by using a UK CCP or the EMIR reporting obligation using a UK trade repository?
This depends on the negotiated position and any equivalence decision granted to the UK under EMIR. Should an equivalence decision be made, a UK CPP or UK trade repository would be able to apply to ESMA for recognition under EMIR, which, if granted, would allow EU counterparties to continue clearing and reporting through UK CCPs and trade repositories.
20. Will UK entities be able to satisfy any applicable UK clearing obligation by using an EU based CCP or the EMIR reporting obligation using an EU based trade repository?
Recognition of EU CCPs and trade repositories by the UK will depend on the rules on third country equivalence implemented by the UK, the outcome of the exit negotiations and, potentially, any reciprocal recognition of UK CCPs/trade repositories by the EU.
21. Are there any other issues in respect of the clearing obligation that members should consider?
Members of one or more CCPs should review the rules of each of those CCPs to determine whether Brexit is likely to result in them being in breach of those rules.
22. Will compliance with UK clearing rules similar to those in EMIR be sufficient as substituted compliance for Dodd-Frank clearing obligations?
It would depend on the location of the CCP through which a party clears its trade. If the CCP is located in the UK, there would need to be an application to the U.S. to have determined that trades clearing through a UK-based CCP would be deemed compliant with the Dodd-Frank clearing obligations. Clearing through an EU-based CCP would continue to be deemed compliant with the Dodd-Frank clearing obligations.
23. Are there any consequences of Brexit for parties which have entered into the English law ISDA Credit Support Documents for collateral arrangements which are currently financial collateral arrangements under the Financial Collateral Directive?
The Financial Collateral Directive has been implemented in the UK through the Financial Collateral Arrangements (No 2) Regulations (“FCAR”). Given the importance of the protections provided to collateral-takers by the FCAR, and the risk of invalidity of certain unregistered security interests in the absence of the FCAR, it is likely that these regulations will be retained by continuity legislation.
Bank Recovery and Resolution Directive
24. Post-Brexit, what additional provisions will counterparties need to include in their ISDA Master Agreements to address requirements under the BRRD when facing an EU counterparty?
EEA credit institutions will need to include contractual recognition of bail-in for the purposes of Article 55 of the EU Bank Recovery and Resolution Directive (“BRRD”) into English law governed ISDA Master Agreements.
25. Are there any additional provisions which UK entities will need to include in their ISDA Master Agreements when facing an EU counterparty to address requirements under the UK bank recovery and resolution regime (pursuant to the Banking Act 2009)?
The UK bank recovery and resolution rules currently include requirements for contractual recognition of stays for non-EEA entities. Post-Brexit, this rule may need to be extended to EEA entities. In the absence of legislation effecting these changes, however, such additional provisions will not be mandatory under English law (other than the existing requirement for contractual recognition of stays for non-EEA entities).
26. Is there any impact on the ISDA 2014 Resolution Stay Protocol, ISDA 2015 Universal Resolution Stay Protocol, the ISDA Resolution Stay Jurisdictional Modular Protocol (the “Stay Protocols”) or the ISDA 2016 Bail-in Article 55 BRRD Protocol (Dutch, French, German, Irish, Italian, Luxembourg, Spanish, UK entity version) (the “Bail-in Protocol”)?
No, there is no current impact on those protocols.
Amendments to the ISDA Master Agreement
What amendments, if any, should market participants consider making to their ISDA Master Agreement?
None immediately. However, there are amendments which parties may consider making depending on the likely outcome of the exit negotiations. Please see the answers to Question 8 (inclusion of additional termination rights), Question 9.3 (choice of law for non-contractual obligations), Question 9.4 (merits of amending the governing law), Question 11.1 (insertion of arbitration clauses), Question 13 (consideration of the jurisdiction clause), Question 14 (amendments to the jurisdiction clause), Questions 24 and 25 (BRRD amendments).
 Regulation 593/2008/EC of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (“Rome I”).
 Regulation (EC) No 864/2007 of the European Parliament and of the Council of 11 July 2007 on the law applicable to non-contractual obligations (“Rome II”).
 The Markets in Financial Instruments Directive II – Directive 2014/65/EU
 The Markets in Financial Instruments Directive II – Directive 2014/65/EU.
 The Markets in Financial Instruments Regulation – EU Regulation 600/2014
 The Capital Requirements Directive IV – Directive 2013/36/EU.