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BREXIT for French counterparts: Update and commentaries as of Brexit Day minus 80 days

Jean-François Adelle

Brexit impact on financial dealings between UK financial services entities and French counterparts

The withdrawal of the UK from the EU will end the direct effect of EU law in the UK and accordingly the effectiveness of freedom of establishment and freedom of services benefiting UK entities in financial services, subject to any transition period and other modalities of the draft withdrawal agreement. Accordingly, regulated United Kingdom financial institutions located in the United Kingdom or their branches in the EU will be prohibited from providing regulated services in the EU27 Member States.

It brings about legal issues across the impact of Brexit on contracts as well as strategies deployed to circumvent those effects. They can be summarized as follows:

1- Structural: Where UK entities affected by the loss of the freedom of services and passport rights (Brexited Entities) set up branches and subsidiaries or transfer portfolio of activities or contracts to duly licensed institutions in the EU.

2- Operational: Where Brexited Entities pursue their activities under exemptions from relevant monopolies attached to regulated activities: reverse solicitation etc.

3- Contractual: To which extent can executory contracts entered into before Brexit effective date between Brexited Entities and counterparts in France be continued?

4- Insolvency: How does the loss of EU insolvency schemes affect financial arrangements?

5- Disputes: How does the UK’s exit from Brussels Recast and Rome I, Rome II affect the handling of disputes arising out of financial agreements?

6- Regulatory: How does supervision adapt to Brexit related challenges, whether to accompany structural changes, monitor operational and contractual challenges or and avoiding regulatory arbitrage among EU 27 countries?


Preparing for a Hard Brexit scenario:

This update considers the respective scope of the French and the EU contingency action plan in preparation for the possibility of a failure of negotiations between the European Union and the United Kingdom, known as a hard Brexit scenario.

 

I) French bill

On October 3, 2018, the French government presented a bill (the Bill) to the Senate aimed at granting legislative authorizations to the government to issue ordinances, in preparation for the possibility of hard Brexit scenario. Such initiative was taken in accordance with the European Council of 29 June 2018 decision asking the Member States to prepare for the eventuality of a failure of negotiations between the European Union and the United Kingdom.

The Bill addresses a wide range of issues, from rights of entry and residence of UK citizens to the continuity of freight transport flows, aims at removing uncertainties and facilitating an orderly transition.

1. The Bill is accompanied by an explanatory memorandum and an impact report. Those documents enlighten potential areas of uncertainties affecting the continuity of contacts upon loss of passport rights of UK institutions. In financial services, they largely embody analyses and recommendations in the reports of the Paris market place Haut Comité Juridique de la Place financière de Paris on the impact of Brexit published on 12 September 2018[1] and 15 October 2018[2].

2. The Bill pursues two objectives:

→ Providing legal certainty to the performance of executory contracts entered into before the loss of recognition of UK licenses and passports in France;

→ Securing access by French entities to interbank settlement and settlement delivery systems of the UK.

– Providing legal certainty to pre – Brexit executory contracts

The principle is that regulated new services can no longer be provided after Brexit effective date. In EU law, it is generally accepted that the notion of services provision is defined by reference to the characteristic performance of the service, but such is not specified by EU law, whether in credit, payment services, investment services or those of derivative instruments.

Legal certainty is essential considering the public policy nature of the requirement of a license to perform regulated services, the sanctions attached to a breach, the fact that EU law is tainted by contract law solutions.

a) According to the impact assessment, renewing contracts or changing an essential obligation to a contract concluded prior to the withdrawal of the United Kingdom would be prohibited. As regards a public policy effect of the loss of the right to provide services under the freedom of services or establishment in France, it would be irrelevant that such new services, renewal or changes had been contractually contemplated.

In all other cases, the contracts concluded prior to the withdrawal of the United Kingdom with French contractors located in the territory of the Union, would not see their continuity questioned, even though putting new funds at the disposal of the borrower qualifies as the characteristic performance of a lending contract.

The impact assessment provides examples of life-cycle events in both cases:

. In financing and collateral arrangements, material lifecycle events would include new funding under uncommitted facilities, adding a new French borrower, changing the maturity date or the financing amount. Life cycle events that would not be deemed to bring about the provision of a new service would include further drawdowns under committed credit facilities, payment of a guarantee extended prior to Brexit after Brexit.

. In derivative agreements, that are materialized by a master agreement, material lifecycle events they would include the modification of the notional amount or the maturity date.

. In insurance matters, including credit insurance, although the performance of new services could be seen as not including the performance of pre-Brexit indemnification commitments, the payment of premiums and indemnities post Brexit could also be held as qualifying as a characteristic performance and therefore a new service.

b) The Bill seeks to create a new legal regime whereby UK firms would, under certain limited circumstances and for a limited period of time, be authorized to continue to perform all their commitments including those which would not otherwise be authorized without a passport within the framework of an ad hoc regime known as “extinctive management” (gestion extinctive). Such regime would be based upon the regime applicable to banks or investment firms whose licenses are withdrawn toward extinction for their existing contracts, to safeguard clients’ interest.

c) It also contemplates the creation of a new legal regime allowing the transfer, in a simplified form, of existing agreements originally entered into by the UK entities of international groups to one of this group’s regulated entities established in the EU 27. Simplified procedures for obtaining counterparties’/clients’ deemed or express consent to such transfers are believed to be key to this regime.

d) The impact assessment stresses that the loss of the passport would not entail, in French law, the nullity (ab initio) of contracts validly concluded before the withdrawal of the United Kingdom, in the event the UK institution wrongfully provides services. However, the contract could be terminated.

– Securing access by French entities to interbank settlement and clearing systems in the UK

The Bill also seeks to permit credit institutions and investment firms in France that are participants of interbank (Target2) or clearing system (CLS, CHAPS, CREST, LCH Clearnet) in the UK to continue to avail of clearing houses and central depositories in the UK and continue to benefit from the bankruptcy remote netting normally reserved to intra- EU entities (Close out netting). It also aims at securing the continuation of master agreements entered into before the withdrawal.

That proposal is inspired both by contracts continuity and markets stability goals during a transition period.

 

II) EU Commission contingency plan

The Commission contingency plan of 18 December 2018 is motivated by the Commission’s concern that the uncertainties surrounding the future relationship between the United

Kingdom and the Union may adversely impact the financial stability of the Union and its Member States and on the integrity of the Single Market.

Accordingly, its delegated decisions focus on securing continued access by EU 27 counterparts to central clearing of derivatives and central depositaries services in the UK that are widely used by such counterparts. It provides:

– A temporary and conditional equivalence decision for a fixed, limited period of 12 months to ensure that there will be no immediate disruption in the central clearing of derivatives;

– A temporary and conditional equivalence decision for a fixed, limited period of 24 months for central depositaries’ services by UK operators currently used by EU 27 operators; and

– A mechanism facilitating transfer from a UK to an EU27 counterparty novation, for a fixed period of 12 months, of certain over-the-counter derivatives contracts.

 

III) How do the Bill and the contingency plan combine?

The Commission contingency plan renders the part of the Bill relating to clearing of derivatives needless.

Other aspects of the plan and the Bill respectively address separate issues and should be implemented concurrently.

 

IV) Setting forth a French legislative frame to ensure legal certainty in executory contracts is likely to be relevant even if there is no Hard Brexit

The draft withdrawal agreement agreed upon by the EU Commission and the UK government on 14 November 2018 does not provide for any specific accord in financial services.

It sets forth a general 3-year transition period which can be extended for one or two years, during which substantive EU law will continue to apply, and the UK will remain subject to the jurisdiction of the EU 27 Court of justice. Its goal is help administrations and businesses to adapt to the withdrawal.

The declaration includes a statement that both parties will work to assess their equivalence frameworks (that allow them to declare a third country’s regulatory and supervisory regimes equivalent for purposes of providing regulated services) by the end of June 2020. However, this works as a best endeavor, both sides would have the ability to decide unilaterally what kind of market access to provide to firms of the other party. Furthermore, it would produce effect only in those regulated services in which there is a concept of equivalence, i.e. investment services under MiFID and AIFM, but not under credit and payment services.

Therefore, at the end of the transition period, the withdrawal agreement would work as a hard Brexit scenario, with a cliff, subject to available equivalence regimes.

While parties shall have time to prepare before, the solutions in the Bill would bring about useful guidance.

 

[1] Rapport sur le Brexit et gestion d’actifs :

https://www.banque-france.fr/sites/default/files/rapport_22_f.pdf

Rapports sur les impacts du Brexit en matière d’activités d’assurance :

https://www.banque-france.fr/sites/default/files/rapport_21_f.pdf

[2] Rapport sur le Brexit, activités bancaires et de services d’investissement :

https://www.banque-france.fr/sites/default/files/rapport_20_f.pdf

 

Jean-François Adelle – Partner

jfadelle@jeantet.fr

+33 1 45 05 82 80