INTERNATIONAL: ISDA Statement on UK Referendum Vote for Brexit

Monday June 27 2016

As a way of informing 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), ISDA has conducted detailed analysis on the contractual implications of Brexit. ISDA will be organizing member calls to discuss any specific issues.

1. Brexit and the EU Treaties

Although all details are subject to political negotiations that may take place pursuant to an Out vote, the scenario outlined below may appear to be a reasonable assumption:

1. In the case of an Out vote, the UK will cease to be an EU member state around the end of June 2018, the earliest. This requires the UK government to give notice of the UK`s intention to withdraw fairly soon after an Out vote.
2. Although Britain`s EU membership will not automatically cease on the day after an Out vote (ie, on June 24, 2016), the UK government will need to seek to negotiate a framework for a new relationship with the remainder of the EU.
3. Article 50 of the Treaty on the Functioning of the European Union that a member state “shall notify the European Council of its intention”. The EU treaties shall cease to apply to the member state in question from the date of entry of the withdrawal agreement or, failing that, two years after the notification of the withdrawing member state.

2. The EFTA/EEA scenario

If, upon Brexit, the UK were to become a European Free Trade Association (EFTA) member state and part of the European Economic  Area (EEA), several EU instruments would still apply – in particular, the EU directives on financial collateral arrangements (FCAD), winding-up directives for credit institutions (CIWUD), bank recovery and resolution (BRRD) plus the EU regulations on insolvency (EUIR), and choice of law governing contractual and non-contractual obligations (Rome 1 and Rome 2 Regulations) plus reciprocal recognition of commercial judgments (Brussels 1 Regulation). This is especially relevant to the English law ISDA opinions` insolvency analysis, plus the choice of law and forum analysis in the ISDA Master Agreement (ISDA MA) under Sec.13 (a) and (b)(i)(1)(B) and the Convention Court definition in Sec 14.

(i) However, EFTA membership for the UK would neither be automatic nor immediate. The UK was an EFTA member state until its accession to the EU in 1972, when the UK formally left EFTA. A new request for EFTA membership would have to be filed and agreed to by the four other EFTA member states in accordance with EFTA rules and procedures, which are not linked to the EU in any way.

3. The choice of English law as the law governing the ISDA Master Agreement

1. Currently, all EU countries apply the same set of rules to determine the governing law of both contractual and non-contractual obligations. The choice is protected pursuant the EU Rome 1 and Rome 2 Regulations, respectively. Both require the court in question to give effect to the parties` express choice of law in Sec. 13(a) ISDA MA, regardless of whether the contracting parties are located in a member state and regardless of whether the parties have chosen the law of an EU member state.
2. Post-Brexit (and absent any specific EU-UK agreement), both the Rome 1 and Rome 2 Regulations may no longer apply in the UK. It is unlikely that English courts would change their long-standing approach to respecting the choice made by contracting parties as to the choice of law governing contractual obligations. This would be in line with legal tradition.
3. However, it may be less clear with regard to the law governing non-contractual obligations for which there is no English law tradition and that is based solely on the EU Rome 2 Regulation.

4. The choice of English courts/arbitral tribunals as the dispute forum under an ISDA Master Agreement

1. Currently, Section 13(b)(i)(1) of the ISDA MA 2002 provides for the non-exclusive jurisdiction of the English courts if the proceedings do not involve a Convention Court and for the exclusive jurisdiction of the English courts if the proceedings do involve a Convention Court. The Convention Court definition in the ISDA MA 2002 introduces an exclusive jurisdiction clause to English-law-governed ISDA MA entered into between EU-based counterparties. This also provides for reciprocal recognition across the EU of judgments handed down in all member states, including English court judgments.  However, it is possible that this analysis will change on Brexit. Please note that the jurisdiction clause in the 1992 ISDA MA is slightly different.
2. Theoretically, without the EU Brussels 1 Regulation in place, there may be some uncertainty as to whether proceedings must be brought in the place of the domicile of the party unless the contract in question contains a clause conferring jurisdiction on particular country, as in Sec 13(b) of the ISDA MA.
3. Were the UK to become an EFTA member state, the Lugano Convention (as the EFTA equivalent to the EU Brussels 1 Regulation) might preserve the current benefits for the automatic exclusive jurisdiction clause under Sec 13(b)(i)(1)(B) ISDA MA. However, the UK is currently not a state party to that convention. The usual accession procedure by way of bilateral treaty would have to be followed.
4. As part of the EU, the UK is currently bound by the Hague Choice of Court Convention, which protects exclusive jurisdiction clauses with counterparties outside the EU/EEA area. Upon Brexit, the UK would fall outside and would have to accede separately pursuant to the rules under the Hague Convention.
5. Arbitration clauses in an ISDA MA pointing to English law, seat and arbitration rules (cf. ISDA model clause in Appendix B to the 2013 ISDA Arbitration Guide) remain unaffected, as their reciprocal recognition across the EU (and worldwide) is subject to the New York Convention on the Recognition of Foreign Arbitral Awards to which the UK is already a signatory in its own right.

5. Bank resolution issues

1. Contractual recognition of bail-in under Art.55 BRRD requires every contract that is governed by the law of a non-EEA country and contains a liability within scope must include a provision through which the counterparty acknowledges that such liability may be subject to bail-in by the relevant regulator (Please note that the UK authorities are currently conducting consultation on Art.55 and its exact scope, which is currently unclear across the EU). 
2. Upon Brexit, the UK would, in theory, be able to repeal all UK legislation implementing BRRD, which has been based on the European Communities Act 1972. If the European Communities Act were to be repealed, all secondary domestic legislation on resolution (including the Safeguard Order under the UK Banking Act) could be repealed.
3. However, the UK Banking Act 2009 already included many (but not all) recovery and resolution tools (including safeguards for financial contracts) that BRRD subsequently introduced on an EU-wide basis.
4. Upon Brexit, the BRRD system of mutual recognition of cross-border resolution actions across EU/EEA would fall away. While the UK could unilaterally legislate for the (British) recognition of foreign resolution actions, there would be no guarantee for reciprocal recognition of resolution measures taken by the UK. This may call for regulatory requirements to be imposed by British regulators to include contractual recognition clauses in all financial contracts governed by a law of an EU member state.
5. Despite of the continuing uncertainty regarding the scope of Art.55 BRRD, any contract that is governed by a law of a non-EEA country that contains an eligible liability must include a provision through which the counterparty acknowledges that such liability may be subject to bail-in by the relevant regulator. This scenario might apply to English-law-governed contracts (similar to ISDA MA governed by New York law) to the UK post-Brexit and prior to any EFTA membership or party to a special bilateral agreement with the EU).

6. Insolvency issues

1. Harmonized rules for corporate insolvency currently apply via the EU Insolvency Regulation (EUIR). Post-Brexit, the recognition of English insolvency proceedings cannot be guaranteed across the EU/EEA. Absent the reciprocal recognition under the EUIR, general English law rules apply, which are more fragmented.

   The UK has enacted the Cross-Border Insolvency Regulations 2006 (CBIR), which implemented the UNCITRAL Model Law on Cross-Border Insolvencies. Although this provides a certain degree of recognition to foreign insolvency proceedings, the tools are not as powerful as under EUIR, and would only create mutuality with a very limited number of EU member states that have implement the UNCITRAL model law (ie, Greece, Poland, Romania and Slovenia).

2. In the area of insolvency of financial institutions, the EU Winding-up Directives for Credit Institutions and Insurance Undertakings, respectively, provide a harmonized insolvency regime for financial institutions across the EU/EEA. Unlike in the area of corporate insolvency (which is based on the centre-of-main-interest concept), any reorganization or winding-up measure (including resolution actions) should take place in the financial institution`s home jurisdiction (ie, the state in which it is regulated). These directives have been implemented in the UK by regulations based on the European Communities Act 1972 as well. If this act and any secondary legislation were repealed, the CBIR would not be of any help as they apply to corporates only (in line with the UNCITRAL Model Law).
3. Any assistance needed from UK courts, as well as recognition of foreign proceedings (eg, of a UK branch of an insolvent EU/EEA financial institution) would have to rely on English common law rules, which are spotty in this regard. Reciprocity by EU member states would not be guaranteed.

7. Collateral issues

1. The English law regime for title transfer arrangements, as well as other collateral arrangements, has been considered fairly robust prior to the UK implementation of the EU Collateral Directive (FCAD) via secondary legislation.
2. This legislation may have to be upgraded upon Brexit in light of forthcoming regulatory requirements to hold initial margin.
3. The enforcement of English security rights in cross-border corporate insolvency proceedings (eg, the treatment of proprietary rights granted to creditors in respect of assets located in different EU member states when insolvency proceedings commence) would become subject the English law regime that existed prior to the entry into force of the EUIR.

ISDA’s analysis on the contractual issues arising from Brexit is available here

Click on the link above for further details