Over to EU: ISDA publishes template amendment to convert legacy English law governed agreements to French or Irish law

• United Kingdom

• Financial services and markets regulation - Derivatives
• The future of funds - Derivatives
• Financial services - Asset managers and funds

16-03-2020

On 12 March 2020, the International Swaps and Derivatives Association, Inc (“ISDA”) published a template amendment agreement which allows the parties to an English law governed ISDA Master Agreement to convert that agreement to an equivalent Irish or French law version (the “Amendment”).

Background

The UK politically and legally withdrew from the EU on 31 January 2020 but has entered into a transitional or implementation period (the “TIP”). During the TIP, the UK is treated as if it is still an EU Member State for the purposes of trade (including trade in financial services). Following the expiry of the TIP, from the perspective of EU Member States, English law will become the law of a ‘third country’. 

The Irish and French law governed versions of the ISDA Master Agreement were published by ISDA on 3 July 2018 in response to market demand (predominantly from EU firms) for the continued availability of an ISDA Master Agreement governed by the laws of an EU Member State following the UK’s departure from the EU.

• Read the French law ISDA Master Agreement
• Read the Irish law governed ISDA Master Agreement

Following their publication, ISDA has taken steps to support the use of the French and Irish ISDA Master Agreements, including commissioning new legal opinions to confirm the enforceability of the netting and collateral provisions of French and Irish law governed ISDA documentation. Despite these steps, however, there has been reluctance from some EU market participants to switch from the use of the English law governed ISDA Master Agreement to its Irish and/or French law equivalent either in respect of new or legacy agreements.

Possible reasons for low take-up

The reluctance by firms to adopt the French and/or Irish law versions of the ISDA Master Agreement  may be caused by a number of underlying concerns. For example:

Updates to policies and procedures

Some market participants may have long established policies and procedures which provide for the use of English law governed documentation. The exercise of establishing new policies regarding the governing law of contracts will, for many firms, be extremely challenging and will require a complex comparative exercise of the different options available.

Repapering

In relation to legacy agreements, parties may have taken a view that the advantages presented by a change in governing law do not outweigh the disadvantages of a lengthy repapering exercise across multiple counterparties (which might involve reopening unrelated settled negotiation points). Firms may also face a number of other significant repapering exercises in relation to their derivatives transactions (for example in relation to new initial margin requirements and the cessation of interbank offered rates) and an additional project might prove an unattractive proposition.

Basis risk

Greater diversity in relation to choice of law and jurisdiction may bring with it increased basis risk (i.e. the risk associated with imperfect hedging arrangements). This basis risk might arise if a firm documents a derivatives transaction under an ISDA Master Agreement governed by the laws of a particular jurisdiction with one counterparty and then hedges its risk under that transaction with another counterparty under an ISDA Master Agreement governed by the laws of another jurisdiction. This basis risk does not arise if the European market shuns diversity and continues use English law.

Continued recognition of choice of English law

As well as practical and commercial considerations, there are also a number of legal reasons why the continued use of the English law governed ISDA Master Agreement is likely to remain attractive, particularly until the future relationship between the UK and EU the becomes clear.  For example, in the EU, the Rome I Regulation (“Rome I”) lays down the rules in relation to applicable law for contractual obligations and the Rome II Regulation (“Rome II”) lays down the rules in relation to applicable law for non-contractual obligations. In general terms, both Rome I and Rome II will give effect to the choice of governing law made by an EU counterparty and so the choice of English law by EU counterparties will continue to be recognised by the courts of EU Member States.

Factors that might encourage switch to French or Irish ISDA Master Agreements

The publication of the Amendment might prompt more widespread adoption of the Irish and French law governed ISDA Master Agreements, in particular by banks and counterparties established in the EU. Factors that might be considered by EU counterparties when deciding whether to use the French or Irish law version of the ISDA Master Agreement include:

Cross-border enforceability of judgments

If English legal proceedings are commenced before the end of the TIP, a judgment obtained pursuant to those proceedings would be recognised and enforceable in any EU Member State under the Brussels I Recast Regulation (“Brussels I”). 

Following the expiry of the TIP however, the position is less clear and it is possible that judgments of an English court made in respect of an English ISDA Master Agreement may no longer be recognised and enforceable in some EU Member States. Even if the judgment is recognised and enforceable, the procedures involved may be more expensive and time consuming.

English court judgments will only be recognised in EU Member States if either: (i) 2005 Hague Convention on Choice of Court Agreements (“Hague Convention”) is applicable; or (ii) the local position of an individual EU Member State is such that foreign judgments are respected and enforced. Some EU Member States currently do not recognise judgments from third countries, meaning enforcement may not be possible in these jurisdictions if the Hague Convention does not apply.

Selection of jurisdiction

Under Brussels I, the selection of the jurisdiction of the courts of one EU Member State is respected across all EU Member States. The Withdrawal Agreement provides that Brussels I will continue to apply to UK and EU courts during the TIP. Following the expiry of the TIP however, the continued application of the principles laid out in Brussels I will depend upon reciprocity. The UK has indicated previously that it will seek to replicate the existing EU judicial cooperation framework and parties may therefore wait to see the shape of the future trade arrangements before taking a decision based on a potential issue with the recognition of jurisdiction clauses.

The Lugano Convention 2007 (the “Lugano Convention”) applies between the EU, Iceland, Norway and Switzerland. During the TIP, the Lugano Convention will also continue to apply to and in the UK. In its negotiation position paper “Our approach to the Future Relationship with the EU” the UK stated that it intends to accede as an independent contracting party to the Lugano Convention. If the UK accedes to the Lugano Convention, then issues with jurisdiction and enforceability would be resolved. Accession to the Lugano Convention requires the agreement of the existing adhering states. The UK government has announced that Iceland, Norway and Switzerland support the UK’s accession. The UK’s accessions will however require the agreement of the EU and will form part of wider trade discussions. 

The UK government has declared previously that it would adhere to the Hague Convention in the event it withdrew from the EU without a deal. As a deal was reached, the UK withdrew its declaration. At present, the Hague Convention is in force between the EU, Mexico, Montenegro and Singapore. During the TIP, the Hague Convention will also continue to apply to and in the UK. The UK will adhere following the expiry of the TIP. Adherence to the Hague Convention has the advantage that the approval of existing adhering states is not needed.

The Hague Convention applies only to fully exclusive jurisdiction clauses. This might not, therefore offer a complete solution for counterparties as the jurisdiction clauses in both the 1992 and 2002 versions of the English law ISDA Master Agreements respectively are not fully exclusive jurisdiction clauses. It is also not clear whether signatories to the Hague Convention will recognise exclusive jurisdiction clauses that are entered into before the UK joins the Hague Convention in its own right following the end of the TIP. Firms might consider applying exclusive jurisdiction in their English law ISDA Master Agreements. A model clause published by ISDA can be found here.

If the UK does not adhere to the Lugano Convention and the Hague Convention does not apply to the English law governed ISDA Master Agreement, then the jurisdiction of the English courts will depend upon the laws of the relevant Member State.

Regulatory amendments

An EU bank counterparty that enters into an English law governed ISDA Master Agreement with a counterparty that is established in a third country may be required to include certain provisions in that ISDA Master Agreement in order to satisfy requirements under the EU Bank Recovery and Resolution Directive (the “BRRD”). These requirements include the incorporation of ‘bail-in’ clauses and terms recognising stays. If the governing law of the ISDA Master Agreement is amended to the laws of an EU Member State, BRRD will apply absent contractual recognition of the requirements and the new provisions will therefore not be needed. 

Safe harbour protections

Insolvency law benefits in certain EU Member States whose EU national insolvency laws require contracts to be subject to EU/EEA law in order to qualify for safe harbour protections following bankruptcy may cease to be available to EU counterparties if the English law ISDA Master Agreement is used.

French vs Irish ISDA Master Agreement

If parties have decided to update the governing law of an English law ISDA Master Agreement to the laws of an EU member state, a decision must then be reached as to whether the Irish or French law version should be used.

Civil law vs common law

French and Irish law were selected as representatives of civil law and common law systems respectively. All Member States other than Ireland and, to some extent, Cyprus and Malta operate under civil law systems. The prevalence of civil law systems across EU Member States might mean that contracting parties operating in these jurisdictions prefer to adopt the French law ISDA Master Agreement.

Decisions of the courts of England are commonly used as persuasive authority in Irish courts. This is particularly the case in deliberations in respect of new issues that have not previously been considered by the Irish courts. Parties that are familiar with the English law system but wish to benefit from the advantages of EU Member State recognition. might therefore select the Irish law version.  

Amendments to familiar English law version

The Irish law version of the ISDA Master Agreement is the most similar to the English law ISDA Master Agreement of the two new ISDA Master Agreements. 

The differences between the English and Irish ISDA Master Agreements are minimal as the English and Irish law legal systems are much more closely aligned than the English and French.

Given the number of differences between the common law and code-based civil law systems, the French law ISDA Agreement deviates from the English version in a number of respects. These changes are necessary to transpose into French law certain common law provisions and concepts of the English ISDA Agreement that cannot function either at all or in the same way under French law. 

Section 2(a)(iii): The flawed asset and conditionality provision has been amended because the concept of “flawed assets” has no equivalent under civil law. The changes made in drafting the French version preserve the benefit of conditionality and allow the suspension of performance obligations, but also ensure compliance with French law by imposing a defined time limit on the operation of this section. 

Section 2(c): An amendment has been made to prevent payment netting being classified as a novation.

Section 3: The caveat that references equitable principles of general application has been removed as they are not applicable under civil law. 

Section 9(f): A five-year contractual limitation period has been included in the ‘no waiver of rights’ provision.

Practical considerations

The choice between the French and Irish law agreements might depend upon the policy choice of a counterparty. If one party has a particularly strong negotiating position, the other party might have little choice but to yield to the other parties preference. It might also be the case that counterparties located outside of either France or Ireland but dealing with a French or Irish counterparty might prefer to select a neutral jurisdiction.

Potential use of the French or Irish law versions of the ISDA Master Agreement by non-EU counterparties

This briefing generally considers the potential use of the Amendment by EU firms. It is possible that UK firms might be required to use the Irish or French law versions of the ISDA Master Agreement when offering to provide investment services or perform investment activities to clients located in the EU.

Article 46(6) of the Regulation on Markets in Financial Instruments (“MiFIR”) requires firms located in a third country providing investment services or performing investment activities under an equivalence decision to “offer to submit any disputes relating to those services to or activities to the jurisdiction of a court or arbitral tribunal in a Member State”. It may therefore be that, if operating under an equivalency regime, UK firms offer the choice of a French law or Irish law ISDA Master Agreement in order to satisfy this requirement.

How can we help?

Our global derivatives practice supports clients across all major financial markets. We advise clients in relation to the English law, French law and Irish law governed ISDA Master Agreements and can offer advice to clients in relation to their strategies for dealing with Brexit, including migration to the French or Irish law governed ISDA Master Agreements.