The UK leaving the EU would raise the prospect that resolution measures for non-UK European covered bonds governed by English law could be challenged, Moody’s said today (Thursday), adding that an expected recognition framework may provide less certainty than the established system.

In a report published today, Moody’s noted that European covered bond programmes with no UK assets or counterparties still have “a UK dimension”, with bonds, swaps and other structural features sometimes governed by English law.

“In the normal course of events, changes to parts of a covered bond programme that are governed by English law would need to be made in accordance with English law,” said the rating agency. “However, in a bank resolution, the authorities in an EU member country have the power to take resolution measures that ordinarily might not be effective under English law.

“UK courts currently recognise such measures under the Bank Recovery & Resolution Directive (BRRD) framework. However, after Brexit, the UK will potentially no longer be part of this system.”

Moody’s said that, as a result, UK courts may not recognise resolution measures taken in the post-Brexit EU and allow challenges to resolution measures on the basis that such measures are not effective under English law.

“A lack of legal certainty undermines resolution and that is credit negative for covered bonds,” said John Hogan, assistant vice president and analyst at Moody’s. “The risk that the courts might not recognise resolution measures could prevent resolution from working efficiently to benefit covered bonds as intended by the BRRD.

“Resolution relies on legal certainty and on resolution authorities’ ability to act quickly and decisively and on the basis that their decision will be effective.”

Contractual terms and conditions contained in prospectuses and swap agreements of non-UK European covered bonds are the types of contracts most likely to be governed by English law, according to Moody’s, and therefore the most likely to be open to challenges.

It said that a resolution measure that could be open to challenge, for example, would be the transfer of assets and liabilities of a covered bond programme to a new issuer without consents that would be required under English law.

“Whether or not any challenge would be successful is highly uncertain,” said the rating agency.

Moody’s said it is likely that a new reciprocal recognition framework would eventually be implemented to make resolution measures taken in EU member states effective in the UK post-Brexit.

“However, uncertainty will persist until a new framework is implemented and, even when that happens, the new framework may not offer the same level of certainty as the current system,” said Jane Soldera, vice president and senior credit officer at Moody’s.

Photo: UK prime minister Theresa May and German chancellor Angela Merkel; Credit: Tom Evans/Crown Copyright