July 31, 2018
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Some have expressed concern that Brexit will reduce the use of English law derivatives documentation. Any such concern is in our view unfounded, as this note explains.
On 28 June 2018, the International Swaps and Derivatives Association, the trade body for the derivatives market, published French law and Irish law governed versions of its 2002 Master Agreement. This was done to provide optionality to market participants after Brexit in deciding the governing law of their documentation. ISDA stated their step was in response to counterparties who, once the United Kingdom leaves the European Union, may “want to retain specific benefits of EU legislation—for example, protections under certain EU national insolvency laws that require use of an EU member-state-law agreement in order to receive those protections.”
We examine here the existing popularity of the English law and New York law governed ISDA documentation and four perceived issues for English law governed ISDA documentation after Brexit that we believe have been overstated in their significance.
English and New York law governed ISDA Master Agreements have long been the preferred framework agreements for over-the-counter (OTC) derivative trades. According to ISDA, “virtually all” ISDA Master Agreements entered into between counterparties based within the EU or the European Economic Area are governed by English law.
This popularity is for good reason as English law is seen by market participants as stable, certain, predictable and sophisticated. Important features of the ISDA Master Agreement, which make the derivatives market efficient, such as close-out netting of payments owed between counterparties, are recognised by English law and have been applied by English courts for many years without the need for the statutory intervention seen in many other jurisdictions. The courts have managed to find ways to give effect to the parties’ intentions in numerous subtle and novel cases.
Market participants are therefore used to the English law governed OTC derivatives market and documentation. Indeed, many financial institutions in London employ large teams specialised in documenting trades under the English law ISDA arrangements.
English law and New York law are the preferred governing laws for many significant financing transactions globally in the derivatives and other markets.
Notwithstanding the dominance of the English law ISDA, many derivatives counterparties in the EU use the New York law ISDA Master Agreement.
In other product markets, New York law is dominant and EU corporates make frequent use of New York law governed high-yield bond documentation. Thus, EU entities and their advisers currently do not view an EU governing law as a necessity for their contracts.
EU law has sought to harmonise the law that applies upon an insolvency of a party to a contract, including under derivatives contracts.
As a general rule, credit institutions and insurers will be subject to the rules of their home Member State within the EU upon an insolvency. In respect of other companies and legal persons, the rules of the jurisdiction where the insolvency has been “opened” will apply, which is generally the insolvent party’s “centre of main interests.”
To provide parties with the certainty that their contract will govern their commercial arrangements, EU legislation provides that if a contract is subject to the laws of an EU Member State and that governing law would allow an action permitted under the contract, then the insolvency rules of the home Member State will not override the rules under the governing law of the contract.
This is pertinent to derivative contracts as it provides certainty that contractual terms, for example in relation to payments or netting, will not be overridden by a different set of laws upon the insolvency of one of the parties.
Once the U.K. leaves the EU, this protection afforded to contracts governed by EU laws might no longer apply and therefore an English law contract might be subject to the mandatory rules of an EU Member State.
However, these concerns already arise for EU entities under New York law ISDA Master Agreements as well as any other New York law governed financing arrangements. The derivatives and other product markets have not encountered material difficulties with New York law agreements and we would not expect Brexit to create any significant difficulties in relation to the use of English law ISDA Master Agreements.
The Rome I Regulation allows counterparties the freedom to choose the governing law of their contractual relationships, which choice must then be recognised by EU Member State courts even if EU-based parties choose a non-EU governing law that is entirely independent from the location of the parties.
EU Member State courts will therefore continue to recognise the choice of law governing a contract, including English law, even if that is no longer a law of a Member State. This is already the case with New York law governed ISDA Master Agreements.
Article 36 of the Brussels Regulation provides that: “A judgment given in a Member State shall be recognised in the other Member States without any special procedure being required.”
When the U.K. ceases to be a Member State then the automatic recognition of English court judgments under the Brussels Regulation will cease to apply. However, this is not the only route for recognition.
Parties will still be able to rely on the domestic private international laws of EU member states to obtain recognition. This is already the case for New York judgments and was also the position for English judgments before the U.K. joined the EU. There is no suggestion these laws are inadequate.
The Bank Resolution and Recovery Directive (BRRD) sets out a regime for EU-based financial institutions in financial difficulty and provides wide-ranging powers in relation to financial institutions allowing supervisory authorities to write down liabilities, convert debt into equity or to impose temporary stays on contractual termination rights.
Under BRRD and its local law implementation, if a contract entered into by an EU-based financial institution is not governed by EEA governing laws, it must contain a recognition by a counterparty of these recovery and resolution measures.
Assuming the U.K. does not become a member of the EEA, English law contracts, including English law governed ISDA Master Agreements, would need to include such a clause and existing English law contracts would need to be amended to reflect this once the U.K. leaves the EU. That would be the case unless and until the U.K. enters into an arrangement for mutual recognition of resolution actions and BRRD already provides that such clauses would not be required where such mutual recognition exists.
New York law governed financing agreements already include the required contractual provisions. Whilst it involves an additional administrative step to incorporate these provisions into standard forms, it is most unlikely that the need to make such minor amendments (if that is indeed required) will mean parties avoid using English law.
Indeed, standard wording to address one such power under BRRD, the so called “bail-in” power, is already seen in European Loan Market Association (LMA) and New York law governed Loan Syndications and Trading Association (LSTA) documentation, so the market has already adapted easily to the requirements of BRRD.
A number of technical consequences relating to governing law will result from the U.K. leaving the EU.
The key advantages of English law for derivatives contracts will however not change after the U.K.’s departure from the EU. Users of English law governed ISDAs will still benefit from strong contractual certainty and the deep experience and sophistication of practitioners and courts alike to help reach their intended commercial outcomes.
As we have noted, EU companies are already comfortable with and make widespread use of non-EU governing law and so there is no need, if English law becomes a non-EU governing law, for parties not to continue to benefit from it.
 Article 10 of Directive 2001/24/EC on the reorganisation and winding up of credit institutions; Article 273 of Directive 2009/138/EC of the European Parliament and of the Council of 25 November 2009 on the taking-up and pursuit of the business of Insurance and Reinsurance (Solvency II) (recast).
 Regulation (EU) 2015/848 of the European Parliament and of the Council of 20 May 2015 on insolvency proceedings (recast).
 Article 1 of Regulation (EC) No 593/2008 of the European Parliament and of the Council of 17 June 2008 on the law applicable to contractual obligations (Rome I).
 Except in limited circumstances where rules of mandatory application within a Member State apply.
 EU Directive 2014/59/EU of the European Parliament and of the Council of 15 May 2014 establishing a framework for the recovery and resolution of credit institutions and investment firms.
 For further detail on BRRD see: https://www.shearman.com/~/media/Files/NewsInsights/Publications/2016/02/BRRD-Contractual-Recognition-of-Bailin-and-Resolution-Stays-FIAFR-022216.pdf