The Loan Market Association (LMA) has published a paper on the consequences of a no deal Brexit on the European loan market. This news analysis summarises the key concerns highlighted by the paper.
What is the background to the paper?
The LMA has published a paper on the consequences of a no deal Brexit on the European loan market in response to concerns by its members that the UK may withdraw from the EU without a deal being agreed. The paper focuses on the impact of a no deal Brexit on UK lenders lending to borrowers in EU27 jurisdictions (ie outbound lending). The impact on EU27 lenders lending into the UK (ie inbound lending) is expected to be minimised by the government’s proposed temporary permissions and recognition regime which will allow EU27 institutions to continue their financial services activities in the UK for a limited time post Brexit.
The paper highlights the high risk of significant market disruption and loss of liquidity detrimental to both the UK and the EU 27 in the event of a no deal Brexit due to:
- the wide usage of wholesale loan products across the EU27,
- the cross-border nature of lending,
- the differences in loan market regulatory requirements between individual EU member states, and
- the heavy reliance of borrowers on the loan product for their day to day business needs
What key areas of concern does the paper identify?
The paper highlights the following as key areas of concern in a no deal Brexit scenario:
- the risk to new and existing business of the loss of passporting rights,
- risks to the validity and enforceability of existing loan contracts,
- the impact on the syndicated loan market in terms of jurisdiction and enforceability of judgments,
- the fact that ‘lending’ is not carried out in isolation and ancillary products and services may require a licence, even if lending is permitted without one, and
- numerous other ancillary regulatory issues of concern
In what ways is the potential loss of passporting rights an issue?
The paper explains that regulation of cross-border lending by non-EU entities varies across the Member States, with some not imposing any licensing requirements while others require entities providing deposit taking, credit, payment and foreign exchange services to obtain a local licence (if they don’t have a passport). Such restrictions will prevent UK banks from seeking new business from local customers, significantly disrupting their business.
In relation to existing business, the paper notes that it is unclear what happens when the lender ceases to be authorised during the life of a loan. In jurisdictions where authorisation is required to lend, a no deal Brexit may leave the loan legally vulnerable or subject to repayment under existing illegality provisions.
The paper also highlights that the Capital Requirements Regulation, Regulation (EU) 575/2013, (CRR) prevents EU investors from investing in Collateralised Loan Obligations (CLOs) without a minimum risk retention by the sponsor, originator or original lender of the assets. As the risk has to be retained by a MiFID authorised entity, this raises the question of whether EU investors will need to divest themselves of such assets if the sponsor, lender or originator is a UK firm that ceases to be MiFID authorised by reason of Brexit.
The LMA notes that steps are being taken in some Member States to support some continuity of access for UK firms post-Brexit, and to permit UK firms to continue to provide regulated services under agreements entered into prior to Brexit. It urges the European Commission and Supervisory Authorities to seek to coordinate these efforts.
What other regulatory issues of concern are identified?
A no deal Brexit will have implications for lenders beyond the issue of licensing. The paper identifies the following as issues of concern:
- exposures to UK entities—post Brexit, exposures by EU27 institutions to UK entities will only benefit from the preferential capital treatment available under the CRR available to exposures to third country ‘institutions’, if the European Commission adopts an equivalence decision. If it does not, EU27 institutions may be subject to increased capital requirements in relation to contracts with UK counterparties
- contractual recognition of bail-in clauses—the paper highlights that in the event of no deal, EU27 firms, further to the requirements of the Bank Recovery and Resolution Directive, Directive 2014/59/EU, (BRRD), will be required to include contractual recognition of bail-in clauses in English law loan documents that create liabilities for those firms—this is likely to be a very cumbersome exercise. The paper notes that a solution would be for the UK to trigger the exemption in Article 55(1) of BRRD by legislating to recognise EEA resolution actions
- use of UK credit ratings—EU27 institutions will no longer be able to use UK credit ratings (or third country ratings currently endorsed in the UK) for capital purposes unless the European Commission adopts an equivalence decision or if an EU27 credit rating agency obtains permission from ESMA to endorse a UK (or other third country) rating. This could result in EU27 institutions using UK ratings for capital purposes being subject to increased capital requirements in respect of existing and future contracts with any counterparty
- use of UK benchmarks—EU27 supervised entities will not longer be able to use benchmarks provided by UK administrators in new financial instruments after 1 January 2020 unless the benchmark and their administrators are included in ESMA’s list of permitted benchmarks—the paper urges the Commission to start the process for assessing equivalence. This restriction applies to consumer credit rather than wholesale lending, but could have wider implications in terms of affecting firms’ ability to hedge exposures under wholesale loans using OTC derivatives
- collateral and netting—the paper raises the issue that two separate regimes will exist in relation to collateral and netting arrangements following Brexit and suggests that agreement should be reached between the UK and EU27 confirming that collateral and netting rights will be available to entities regardless of their place of incorporation
- GPDR and data transfer—after Brexit, the UK will no longer be part of the EU ‘safe data’, zone under the General Data Protection Regime (GDPR) unless the UK is assessed as having an ‘adequate’, data protection regime. The paper urges the authorities to start this process as soon as possible