Brexit – what might it mean for Australian vanilla debt capital markets trades and Kangaroo bonds?

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Publication May 2016


Introduction

If, on 23 June, the British public decide to make “Brexit” (British exit from the European Union) a reality, there may be consequences for Australian issuers in the eurobonds market and UK or European issuers accessing Australian domestic capital markets (“Kangaroo” issuers).

What are the potential legal and commercial impacts of a Brexit on these issuers and the broader Australian debt capital markets? The answer at this stage is, at best, a “guesstimate”. Following a vote to leave, the UK will enter into a two-year period of negotiations that will determine what form Brexit will, in fact, take.

During that two-year period, it is unlikely that Brexit would have a marked legal impact on existing or new Australian-issuer medium term note (MTN), commercial paper (CP) or Kangaroo bond programmes.  During that period, EU law will continue to apply unaffected in the UK.

Potential scenarios under which the UK leaves the EU range from the UK relying solely on existing World Trade Organization rules without any new agreements with the EU, to the UK re-joining the European Economic Area (EEA) and European Free Trade Area (EFTA). In the former scenario, the UK would gain autonomy over its trade policy but have limited or no access to the single market. In the latter scenario, UK capital markets would largely remain integrated with EU’s, but the UK would continue to follow EU rules without having a say in how they are drafted and implemented (see the London knowledge team’s Brexit technical resource).

Brexit may, however, affect some aspects of MTN and CP disclosure documents, and the regulation of EU and UK issuers in sectors such as banking and financial services.  For example, under the current rules if an Australian issuer selects the UK as its home member state for disclosure purposes and offers debt securities to the public and/or lists them on a regulated market in the UK, then the approved prospectus can be passported into the other 27 EU Member States. This significantly increases the size of the investor pool as the issuer can issue to investors across the EU.

While scenarios that involve re-applying for EEA and EFTA membership or agreeing bilateral agreements with EU member states would mean that a degree of access to EU capital markets would be maintained, they would differ in one aspect.  So long as the UK is a member of the EEA, the application of existing EU legislation could provide a comprehensive market architecture and regulatory framework.  Issuers in the UK would continue to enjoy the ability to passport a prospectus into the EU.

A bilateral scenario would require the UK to voluntarily apply capital market rules to UK firms (including UK affiliates of Australian companies) and to Australian firms listing on British regulated markets. This would likely need to be complemented by ‘indigenous’ UK-specific market architecture and regulation for those firms not operating in Europe. As a result, a bilateral scenario (and to some extent where UK-listed firms fall outside the EU framework) would likely result in such firms needing to comply with overlapping UK and EU requirements. Such requirements might not always be consistent.

If UK and UK-listed firms were excluded from the EU capital markets framework, they would likely seek to participate as third country participants (similar to the access by US firms). This would require compliance with both EU and UK rules.  From an Australian perspective, the result could be a trend towards listing in EU Member States such as Ireland or Luxembourg that have a developed market ecosystem and access to the entire EU investor base.

Possible legal implications

The table below considers some of the potential legal implications of Brexit for existing and future Australian-issuer MTN and CP programmes and Kangaroo bond programmes, and their respective trades.

 

Issue MTN/CP programmes (Australian issuer) Kangaroo bond programmes
Disclosure in Offering Documents/IMs Specific Brexit-related disclosure is not currently required but may be prudent, depending upon the nature of the issuer’s business.

If an issuer considers that Brexit may have a material effect on its business or the regulatory environment in which it operates (which, for example, might result in a higher risk of default in discharging payment obligations under the notes or the market value of notes) additional Brexit risk factors may be appropriate.

The forms of UK, EU and/or EEA selling restrictions may require changing. There may be UK disclosure requirements that mirror or diverge from the EU prospectus and transparency rules that currently to existing MTN/CP programmes.

Without the ability to automatically passport disclosure documents from the UK to the EU and vice versa, issuers may need to either prepare two sets of disclosure in order to access both markets, or list in an EU Member State such as Ireland or Luxembourg.
Given the very limited disclosure - and the limited risk factors (if any) - included in most Kangaroo bond programmes, unless Brexit will have a material effect on an issuer’s business or the regulatory environment in which it operates, it is unlikely that  specific Brexit-related disclosure would need to be included.  

The forms of UK, EU and/or EEA selling restrictions may also require certain changes.  There may be UK disclosure requirements that mirror or diverge from the existing EU Transparency and Prospectus Directives, as may currently be applicable to existing MTN/CP programmes.
Choice of law  Currently, English courts determine the governing law of a contract in accordance with the Rome I Regulation. In the event of Brexit, the Rome I Regulation ceases to apply. In the absence of the enactment of a replacement regime, English courts would revert to common law rules, which are similar to the provisions of Rome I Regulation.

The position is less clear with regard to non-contractual liability, as the Rome II Regulation (which allows commercial parties to stipulate the governing law of non-contractual liability) does not reflect as closely the previous position under English common law.  Provisions relating to the governing law of non-contractual obligations might no longer be effective in proceedings in the English courts.
Brexit is unlikely to affect many programmes.

For those programmes where English law or the law of an EU member country is relevant (for example, where English law governs subordination and/or guarantee clauses where the issuer or a guarantor is an English company), an Australian court would recognise and uphold English-law governing law clauses and English jurisdiction clauses, subject to the usual exceptions under Australian law.
Enforceability Following Brexit, the Brussels I Regulation on jurisdiction and enforcement of judgments would no longer apply. In the absence of a new arrangement, the jurisdiction of the courts and the mutual enforcements of judgments between the UK and the EU could be affected.

It is possible that a party may claim that, as a result of Brexit, their contract is incapable of being performed and is therefore frustrated.  The success of such a claim would depend on the individual facts.
The effect of Brexit on the enforceability of programme and/or trade documents is likely to be limited to subordination and/or guarantee clauses that are governed by English law, because the programme and trade documents are otherwise governed by Australian law.  Enforceability risk is likely to be addressed, where relevant, through UK or EU legislation or amendments to applicable treaties.
Default events - generally It is unlikely that Brexit, of itself, would trigger an event of default under the terms and conditions of notes issued under most programmes. This assumes that those programmes are subject to a market standard set of general terms and conditions.

Similarly, it is unlikely that Brexit would give rise to a misrepresentation based on the unenforceability of transaction documents, on the basis (as noted above) that Brexit should not, subject to changes in UK law, affect enforceability.
Unlikely that Brexit, of itself, will affect many programmes.  

This is because Kangaroo programmes typically only include events of default triggered by non-payment or insolvency.
Clearing and settlement There is a strong chance that euro-denominated securities will need to be cleared via a central counterparty located in the euro zone. The European Central Bank’s policy of requiring clearing houses handling euro-denominated securities to be located inside the euro zone was successfully challenged in 2015 by the UK at the European Court of Justice. Following a Brexit, the UK would lose these protections. There is a strong chance that euro-denominated securities will need to be cleared via a central counterparty located in the euro zone. The European Central Bank’s policy of requiring clearing houses handling euro-denominated securities to be located inside the euro zone was successfully challenged in 2015 by the UK at the European Court of Justice. Following a Brexit, the UK would lose these protections.

Possible market implications

The commercial impact of Brexit on the debt capital markets more generally may be of most significance; however, it is difficult to speculate with detail what these might entail. Our “guestimate” is that potential impacts could include execution risk, increased financing costs, and an uptick in issuances of Kangaroo bonds.

Execution risk

It is currently unclear what effect Brexit may in terms of pricing and demand for securities in an environment of potentially increased market volatility and reduced liquidity.  For this reason, participants may want to tread carefully (in both the primary and secondary markets) immediately before, during and after the Brexit referendum.

Increased financing costs

The cost and complexity of establishing debt issuance programmes and effecting trades are likely to increase, at least in the short term post-Brexit, leading to increased economic costs to businesses and the potential of slowing the progress of economic development more generally.  In particular, legal costs for participants are likely to rise as a result of any changes to UK and EU regulation.

More Kangaroos

Conversely, for the Australian domestic market (including the Kangaroo bond market), it is possible that Brexit might (at least in the short term) lead to an increased demand for Australian dollar denominated and Australian law governed bonds, as investors look for markets with less volatility and risk around currency and political (and regulatory) stability.  This could lead to further deepening and efficiency in the Australian bond markets.


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