- Following the end of the Brexit transition period, the EU and UK regulatory frameworks impacting debt capital markets are now two separate but parallel regimes, with certain differences in some areas.
- Whilst the pan-European wholesale debt capital markets continue, the impact of the parallel regulatory regimes in the EU and UK is particularly felt when drafting transaction documentation.
- This article highlights some practical points to consider when documenting debt capital markets transactions in the EU and UK.
At the end of the Brexit transition period on 31 December 2020, existing EU law was onshored and formed part of retained EU law in the UK through the EU Withdrawal Act (EUWA), as amended. Although the UK rules broadly follow the EU rules in many areas, care is needed as there are certain differences between the rules and there will be instances where market participants will now need to comply with two regulatory frameworks. The UK is now considered a third country for the purposes of EU law and vice versa and this will impact how transactions are documented going forward. Although EU directives are not directly effective into the national law of member states, care should be taken to ensure that references to EU directives that were implemented by UK legislation prior to Brexit should refer not just to the UK implementing legislation so as to ensure any non-implemented rights are also caught.
Points to consider in documentation
Market participants will need to consider references to legislation more generally and decide if they need to refer to one or both of EU and UK law and, in the case of UK law, if references need to be updated from the EU versions in existing documents. UK law will depend on the context and location of the investors and transaction parties. Similarly, references to EU Member States or the European Economic Area (EEA) may need to be clarified as they will no longer include the UK.
Retail offers: From 31 December 2020, issuers with a prospectus approved by the Financial Conducts Authority (FCA) can no longer passport it into the EU. Such issuers that would like to trade securities on an EU regulated market or make a retail offer in the EU will need approval from an EU27 competent authority.
Similarly, it is no longer possible to passport prospectuses that have been approved by an EEA competent authority into the UK for a regulated market listing or retail offer of securities and the approval of the FCA will be required.
Any prospectuses that were approved by an EU27 competent authority and passported into the UK before 31 December 2020 will be grandfathered until the end of their 12 month validity period and can, therefore, continue to be used for an offer of securities during that time.
Supplements: As many of the changes are technical in nature, such as updating legislative and regulatory measures, market participants may conclude that a supplement is not required for prospectuses that were approved prior to the end of the Brexit transition period, particularly in the case of wholesale programmes. However, this would need to be considered on each particular transaction on a case by case basis. It could be that in some cases changes to the base prospectus might be material in the context of a particular issuer and, therefore, a supplement would be required.
There is still some lack of clarity around how prospectuses that are valid in both the UK and the EU should be supplemented. It is not clear whether one supplement that fulfils the requirements of both the EU and UK prospectus regimes would suffice or whether the relevant competent authorities will require two separate supplements.
Selling Restrictions: The International Capital Market Association (ICMA) has updated its selling restrictions for use on transactions, including draft UK selling restrictions that the market is already starting to implement. Market participants will need to consider whether they need to update the selling restrictions in programmes now or can wait until their annual update of their base prospectus if there is already a generic selling restriction.
Home Member State: An issuer with the UK as its home Member State for the purposes of the EU Transparency Directive1 that has debt securities listed in the EU will now need to elect another home Member State in the EU to satisfy the relevant requirements. The host Member State also needs to be informed of the new election, although there does not appear to be a specific process to do this, so market participants should always check with the relevant competent authority. The EU Transparency Directive requires filing, publication and dissemination of regulated information in an issuer’s home Member State.
Wholesale exempt offers: Issuers can continue to use a wholesale prospectus that has been approved by a competent authority in the EEA to make exempt offers in the UK, without the need for it to be approved by the FCA, if one of the exemptions under the UK Prospectus Regulation applies.2. This includes debt securities with a denomination of at least EUR 100,000 (or equivalent in another currency) and offers made to a small number of potential investors. Similarly, issuers can continue to use a wholesale prospectus for offerings of exempt securities in the EEA, by using the public offer exemptions from the requirement to publish a prospectus under the EU Prospectus Regulation3.
Issuers that rely on the wholesale EUR100,000 denomination regime in either jurisdiction should check the exchange rate when issuing to ensure that the denomination of their securities, if not euros, is equivalent to or greater than EUR100,000.
In addition, issuers should ensure that any prospectus approval language in documentation correctly refers to the law and competent authority in the jurisdiction where the approval is sought.
Market participants will need to consider carefully whether they need to comply with the EU product governance rules or the equivalent UK product governance rules or if they need to comply with both sets of rules. This will depend on various factors, not only the location of the issuer, but also the location of the respective product manufacturer and the location of the investors.
ICMA has produced UK product governance and PRIIPs (Packaged Retail and Insurance-based Investment Products) language for use on transactions. Market participants will need to consider whether the UK product governance rules apply in respect of any issuance, which could be the case where one of the joint lead managers is located in the UK or if the securities are likely to be sold to UK investors.
Market abuse regime
Although the UK onshored Market Abuse Regulation (MAR)4 will mirror the EU MAR5 rules and the rules in respect of stabilisation, market soundings and inside information will continue to apply, the reach of the UK Market Abuse regime is much wider and extends to the EU in some circumstances.
The UK rules on market abuse will apply to conduct related to securities admitted to trading on a regulated market, multilateral trading facility or organised trading facility situated or operating in the UK and any EEA member state. This may therefore mean that market participants may need to comply with both the EU and UK rules. With regards to stabilisation, ICMA has updated its stabilisation wording to reflect the UK MAR regime and any entities that are acting as stabilising manager should consider whether they can rely on relevant safe harbours and the relevant notification requirements.
Credit rating agencies
If transactions are being marketed in both the UK and the EU, market participants will need to ensure that the credit ratings can be used in both the UK and the EU. The UK has incorporated Regulation (EC) No 1060/2009 on credit rating agencies (as amended) (the EU CRA Regulation) into UK domestic law via the EUWA and amended it to operate in the UK context (the UK CRA Regulation).
Transactions listed on a UK regulated market or transactions listed in the EU where UK credit institutions (and certain other firms) are targeted as investors will need to comply with UK CRA Regulation and include a UK CRA statement in the prospectus. The credit rating agency (CRA) will need to be registered with or certified by the FCA or the rating should be endorsed by a UK CRA. There is also a temporary 1 year regime for ratings from EU CRAs in certain circumstances.
Where transactions are being listed on an EU regulated market or if EU credit institutions (and certain other firms) are targeted as investors, issuers will also need to include a statement in the prospectus in accordance with Article 4 (1) of the EU CRA Regulation. Any ratings from UK CRAs will need to be endorsed by an EU CRA for use in the EU.
Issuers should, therefore, ensure that prospectus disclosure reflects the EU and/or UK rules as relevant.
Although under the EU Benchmarks Regulation (EU BMR)6, EU supervised entities can only use a benchmark in the EU where the benchmark or its administrator is registered with European Securities and Markets Authority (ESMA). ESMA announced its intention to remove UK administrators from the ESMA register; any UK administrators have been deleted as they will now qualify as third country administrators. There are, though, transitional provisions which mean that third country benchmarks, including UK benchmarks, can still be used until the end of 2023 if the benchmark is already being used in the EU.
In the UK, there is a transitional provision under the UK onshored version of the Benchmarks Regulation (UK BMR)7 so that UK supervised entities can continue to use existing benchmarks that are provided by a third country administrator if those benchmarks have been used in relevant contracts before the end of 2022.. The FCA has indicated that information from the ESMA register has been copied onto the UK benchmarks register.
Under the EU Prospectus Regulation, a description of an index must be included where the index does not appear in the ESMA benchmarks register. Similarly, the UK Prospectus Regulation requires a description of any index to be included in the prospectus if it does not appear in the FCA Benchmarks Register. Market participants should ensure that any prospectus disclosure correctly reflects the status of any benchmark in both the EU and UK and ICMA has prepared suggested language. In particular, market participants should consider whether a prospectus supplement describing an index is required where securities referencing an index are being issued in the EU if the index is no longer on the ESMA benchmarks register and the prospectus does not already contain a description of the index. Likewise, in order to offer securities linked to an index which is not on the FCA benchmarks register in the UK, market participants will need to ensure that the prospectus includes a description of that index.
We are already seeing divergence in the EU and UK rules on benchmarks in the context of changes to address the discontinuation of the London Inter-bank Offered Rate (LIBOR). The revisions to the EU BMR which give the European Commission new powers to replace certain critical benchmarks which have no fallbacks or insufficient fallbacks, including third country benchmarks, where their cessation would significantly disrupt the functioning of financial markets or pose a systemic risk in the EU came into force on 13 February 2021 and, therefore, do not form part of EU retained law and will not apply in the UK. This new power apples, broadly, to any contract or financial instrument governed by an EU Member State law that references a benchmark and certain third country law contracts between EU parties where the third country law does not provide for an orderly wind down of a benchmark.
In the UK, the FCA is expected to consult further on its new powers under the Financial Services Bill in relation to synthetic LIBOR. It is still unclear how this new power will interact with the FCA’s synthetic LIBOR plans or even the US’s legislative plans such as the New York state legislation.
Contractual recognition of bail-in
As English law is now third country law with regards Article 55 of the EU Bank Recovery and Resolution Directive (EU BRRD as amended by EU BRRD II)8, EU banks shall ensure that a contractual recognition of bail-in clause is included in the terms and conditions of any in-scope liabilities governed by English law in order for such liabilities to be eligible for ‘Minimum Requirement for own funds and Eligible Liabilities’ (MREL) purposes. It is worth noting that resolution authorities may request legal opinions on the effectiveness and enforceability of such clauses, which need to meet certain specific requirements set out by the Single Resolution Board.
Under the UK contractual recognition of bail-in regime, UK financial institutions will need to include a contractual recognition of bail-in clause in contracts governed by a third country law, including EU law. The UK bail-in clause will differ from the EU bail-in clause as it will need to refer to the standalone UK regime. UK financial institutions should also continue to include such a clause in relevant contracts governed by non-EU law (such as New York law) and from 31 December 2020 any new or materially amended contracts should include the new form of the clause, which will need to refer to the UK bail-in regime, rather than the EU bail-in regime and there may be a requirement for a legal opinion as to the effectiveness and enforceability of such a clause.
Debt issuances that are governed by an EU law with a UK joint lead manager will, therefore, need to include a UK contractual recognition of bail-in clause. ICMA and AFME (Association for Financial Markets in Europe) have recently updated the BRRD other liabilities clause to include a separate version for liabilities subject to UK bail-in, which has been widely adopted on transactions. Market participants will want to consider whether they need to include this clause in their documentation.
Sanctions and the Blocking Regulation
Market participants should review any provisions that require compliance with sanctions and ensure that sanctions that need to reflect UK law are updated accordingly. The UK has onshored the EU Blocking Regulation9 in the form of The Protecting against the Effects of Extraterritorial Application of Third Country Legislation (Amendment) (EU Exit) Regulations 2019, which means that broadly a UK person - both companies and individuals – will be in breach of English law if they comply with certain US sanctions, as is currently the case for EU entities under the EU Blocking Regulation.
Where EU and UK entities understand that they will not be obliged to comply with sanctions that would put them in breach of the EU Blocking Regulation or its UK equivalent and consequently include a carve out in the transaction documents, this carve out should be reviewed to ensure it refers to the UK onshored legislation.
What to look out for next
Although the UK and the EU started with very similar rules in the debt capital markets space, divergence is already occurring and this is only likely to increase over time.
As mentioned above, in relation to LIBOR, the UK has proposed giving certain new powers to the FCA under the UK Financial Services Bill to assist with the orderly wind down of LIBOR and the creation of “synthetic LIBOR”.
Meanwhile, the revisions to the EU BMR came into force on 13 February 2021, which give new powers to the EU Commission in certain circumstances to deal with the wind down of critical benchmarks as discussed in the “LIBOR” section above.
Issuers will want to review the fallbacks in their debt issuance programmes to establish whether they would fall within scope of the EU statutory override and this may lead to provisions diverging over time.
In addition, Europe has introduced its Capital Recovery Package, a set of targeted changes including amendments to the product governance rules and the EU Prospectus Regulation to facilitate the recapitalisation of EU companies on financial markets in the wake of the Covid-19 pandemic. The changes to the EU Prospectus Regulation in the form of the introduction of a new EU Recovery Prospectus for secondary issuances of shares are not expected to impact the debt capital markets, although they provide an indication of the divergence which may come over time.
The UK is also looking at its rules and on 3 March published the UK Listing Review, which is part of a plan to attract high-quality innovative companies to list in the UK. Although the Review will primarily focus on equity capital markets, there also may be some impact on debt capital markets, particularly given that one of the recommendations is a complete redesign of the UK prospectus rules. Specifically, the UK Listing Review proposes that there should be a return to the kind of system that the UK had in place before the introduction of the Prospectus Directive and Prospectus Regulation in the EU. It calls for fundamental reforms including separating the requirements for admission to a regulated market from offers to the public and changes to the prospectus exemptions.
Market participants may want to monitor closely the FCA consultations that will follow on some of the recommendations in the UK Listing Review, as well as any action taken by HM Treasury, which will hopefully provide more clarity.
Although some of regulatory changes following the end of the Brexit transition period may be technical in nature, other changes may be more far-reaching and need closer consideration. Market participants who are active in the EU and UK capital markets will need to stay abreast of regulatory developments affecting debt capital markets in both the EU and UK and monitor any divergence going forward.
1. Directive 2004/109/EC on the harmonisation of transparency requirements in relation to information about issuers whose securities are admitted to trading on a regulated market and amending Directive 2001/34/E
2. Regulation (EU) 2017/1129 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/EC as onshored by the EUWA
3. Regulation (EU) 2017/1129 on the prospectus to be published when securities are offered to the public or admitted to trading on a regulated market, and repealing Directive 2003/71/EC
4. Regulation (EU) No 596/2014 on market abuse and repealing Directive 2003/6/EC and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC as onshored by the EUWA
5. Regulation (EU) No 596/2014 on market abuse and repealing Directive 2003/6/EC and Commission Directives 2003/124/EC, 2003/125/EC and 2004/72/EC
6. Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014
7. Regulation (EU) 2016/1011 on indices used as benchmarks in financial instruments and financial contracts or to measure the performance of investment funds and amending Directives 2008/48/EC and 2014/17/EU and Regulation (EU) No 596/2014 as onshored by the EUWA
8. Directive 2014/59/EU establishing a framework for the recovery and resolution of credit institutions and investment firms and amending Council Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC, 2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010 and (EU) No 648/2012
9. Council Regulation (EC) No 2271/96 protecting against the effects of the extra-territorial application of legislation adopted by a third country, and actions based thereon or resulting therefrom