Corporate Borrowers and a No-Deal Brexit
As a no-deal Brexit seems more likely, UK lenders are starting to reveal details of their contingency plans. These contingency plans allow UK lenders to continue to provide banking services to European customers in the case of a no-deal Brexit.
Barclays recently announced contingency plans to transfer assets linked to around 5,000 customers worth £166bn to Dublin; Royal Bank of Scotland has started a legal process to move a third of its investment bank clients out of the UK to Amsterdam; Lloyds has applied for a German banking license; and HSBC Bank is moving the activities of various branches to Paris. It is reported that other banks are setting up subsidiaries in the EU, fueled by the desire to not lose out on lucrative deals outside the UK. There will be a significant reallocation of staff and, in my view, this will result in increased focus on these new EU locations and reduced effort and investment in the UK market. The risk, in my opinion, is that a lack of staff dedicated to UK corporate lending will lead to reduced competition for a share of local corporate lending.
While talks are continuing, the UK government has proposed draft legislation to implement transitional provisions to allow financial institutions remaining in the EU to continue to lend and provide financial services in the UK after Brexit, even in a ‘no deal’ scenario. Unfortunately, the position of UK-based lenders post-Brexit will depend on the exit deal agreed between the UK and the EU. It is this lack of transitional provisions from the EU that poses the greatest risk to UK corporate lenders based on the feedback I have received from corporate lending insiders.
There are several factors that will influence the availability and pricing of loans in the case of a no-deal Brexit. I am confident that most corporate loan administration and day-to-day banking services will not change drastically but expect that wide-scale restructuring of banking services and lending divisions will impact the market and ultimately the cost of corporate lending in Northern Ireland.
Northern Ireland is particularly exposed to changes to borrowing across the EU given the prevalence of cross-border group structures, trade and financing arrangements. I deal with cross-border transactions daily for both lender and borrower clients and some believe that Brexit will create a resurgence of attractive corporate loans to Northern Irish businesses given Northern Ireland’s unique position due to the fiercely debated ‘backstop’ and the possibility of decreased regulation. I expect Brexit will create significant opportunities for alternative lenders particularly in the short-term secured loan market. Corporate lending conditions in Northern Ireland and the UK more generally could improve but given the current political and regulatory uncertainty I would not dismiss the risks of higher financing costs and difficulties in raising new corporate debt post-Brexit.
Loss of Passporting Rights
Currently, cross-border banking from UK lenders relies on EU-level legislation governing financial services. Certain protections including the ‘passporting’ of rights across the EU may come to an end if a no deal Brexit occurs. Passporting allows firms to conduct business across the EU without having to obtain multiple licences to comply with the individual requirements of each member state.
It is common for UK lenders to rely on passporting to avoid the need for specific licences to facilitate cross-border corporate lending. If there is a no deal Brexit, protection of passporting rights will be lost and UK lenders will be reliant on temporary measures, if any, agreed with the EU. Given the continuing uncertainty over corporate lending between the UK and the EU several UK lenders have relocated some of their business to the EU to retain passporting rights as part of their contingency plans for a no deal Brexit. These relocations, in my view, are strategic and necessary as UK banks face a significant risk to market access and the loss of profitable business.
Invalidity or Illegality
Brexit could have a significant impact on existing corporate loans and the rights of lenders. For example, Brexit may have the unintended consequence of allowing borrowers to exercise early termination rights if a lender is relying on an authorisation that is removed as a result of Brexit. Depending on the applicable licensing regime, it might become illegal for a lender to exercise or enforce its express rights under a finance agreement. In addition, a lender could be prevented from making new loans under an existing facility agreement or from amending existing finance documents if these actions require a country-specific licence post-Brexit. These invalidity and illegality issues have significant implications and, in my experience, create dangers for both lenders and borrowers particularly if cross-default or payment obligations are triggered.
Brexit could lead to ratings downgrades and resultant higher financing costs and difficulties in raising new finance for corporate loans. If ratings are downgraded as a result of Brexit, which is a possibility in my opinion, this could give rise to associated rights of termination, creating further pressure on corporate loan providers.
Many factors will determine the impact of Brexit on existing corporate lending, including market forces and circumstances such as lender and borrower location; group structure across jurisdictions; tax regimes; and accounting frameworks. If passporting rights are lost and no mechanism is put in place to reduce the impact in relation to existing transactions by either grandfathering arrangements (to exempt existing financing arrangements from new laws or regulations) or an agreed run-off period for existing financing arrangements the lenders who may be impacted by new licensing requirements will be forced to consider the restructuring options including:-
1. the use of alternative entities and arrangements to continue existing corporate lending – as this type of arrangement will not be revealed by public submissions to court or applications for banking licences the prevalence of these arrangements are harder to track;
2. whether to terminate individual corporate loans and seek pre-payment and cancellation – these rights will typically result from a breach of invalidity or illegality clauses;
3. the transfer of corporate loans and other rights or obligations to a third party operating in the jurisdiction in question – evidence suggests that this is one of the more popular restructuring options chosen and it is likely to be the most significant in terms of future impact on the corporate lending market; or
4. whether to cease to act in various capacities (such as security trustee) in relation to corporate loans – as these are private contractual arrangements it is hard to assess the extent that resignations will be prompted by a no-deal Brexit.
Cross-Border Due Diligence
It is anticipated that Brexit will necessitate greater in-depth due diligence particularly where there is a cross-border element. This is likely to increase the cost of borrowing and the time it takes to complete a financing transaction.
Foreign Lawyer Input
Legal opinions from foreign lawyers are likely to become compulsory on all corporate lending involving a cross-border element, however insignificant the cross-border aspect may be. Again, this is likely to increase the cost of borrowing and potentially the time it takes to put a corporate loan in place. We may see borrowers restructuring their corporate finances, however, I have seen a reluctance to implement significant restructuring plans while Brexit implications remain so uncertain.
Industry bodies such as the Loan Market Association have highlighted the need for transition arrangements not only in the UK but across the EU to preserve liquidity, avoid economic instability and protect existing financing arrangements. Transition arrangements would allow lenders and borrowers time to adjust to the legal and regulatory changes resulting from Brexit and help avoid the negative impact of uncertainty in the corporate loan market and are needed from my perspective as a lawyer involved in corporate lending.
I think it is too late to unravel plans by UK-based lenders to move assets, businesses and staff to European bases to protect against the impact of a no deal Brexit. However, these contingency plans create an opportunity to consider measures to protect or even improve the availability and affordability of corporate lending in Northern Ireland.
By Naomi Gaston