JPM JP Morgan Chase and Co

By Nina Trentmann 

European companies could be forced to move financial instruments worth billions of euros as Britain prepares to leave the European Union. The process, known as repapering, might be required for syndicated loans, currency swaps and other derivatives taken out by EU-based corporates and booked through banks in the U.K.

Depending on the course of the Brexit negotiations, regulations that currently cover the City of London, the heart of the U.K.'s and Europe's financial industry, may stop applying as early as March 2019. That could make it necessary to relocate thousands of financial products used by corporates to an EU-based financial entity.

Company executives, mired in uncertainty about the final outcome of the divorce negotiations, could face significant amounts of paperwork -- and additional costs.

"CFOs and treasurers are trying to ascertain what Brexit means for their financing arrangements," said Stefan Behr, head of corporate banking for Europe, Middle East and Africa at JPMorgan Chase & Co. "There are thousands and thousands of financial contracts...which could potentially be affected."

Loans, securities and derivatives totaling approximately EUR2.4 trillion ($2.7 trillion) might have to be shifted to EU-based bank entities if Britain becomes a so-called third country after a hard Brexit, according to estimates by consulting firm Boston Consulting Group U.K. LLP. About 68% of all trading in the City of London is done on behalf of clients, including corporates, from EU-member states, BCG said.

Negotiators for the U.K. and the EU are still working on a separation agreement that would set the terms of Britain's departure from the bloc and clarify the rules for financial services in the future. Lacking that, treasurers, lawyers and advisers are struggling to come up with definitive answers about whether financial instruments will have to be altered.

A weekend summit between U.K. and EU representatives failed to resolve differences, slimming the odds of a deal later this week when EU leaders meet to discuss Brexit. The Bank of England earlier this month urged the EU to take steps to allow existing financial contracts to be honored after the U.K. leaves the bloc to avoid costs for banks and businesses.

Deutsche Bahn AG, the German rail operator, is among the companies evaluating their London-based financial instruments. The firm has interest-rate and foreign-currency swaps totaling EUR5.5 billion, some of which are booked through London.

It is unclear whether existing derivatives can be relocated from a U.K.-based bank to an EU-based bank without impacting Deutsche Bahn's hedge accounting, according to Wolfgang Bohner, head of the firm's finance and treasury department. The company is still waiting for a definitive response from its auditors, he said.

Connected to that is the question of whether existing contracts have to be rewritten or duplicated, or whether the changes will only apply to future instruments. "The conversion or renegotiation of master contracts causes a significant bureaucratic burden that can take months," Mr. Bohner said.

The company has not made any changes yet, but is considering its options, said Mr. Bohner.

This is similar to other large businesses that might be affected by the changes in regulation, according to JPMorgan's Mr. Behr. "We don't intend to execute until we know the final outcome of the negotiations," said Mr. Behr. The time for that is running out, as both the U.K. and the EU parliament need to ratify any deal before Britain's scheduled departure in the spring of 2019.

As a result, companies may remain in limbo until they know whether the U.K. will be granted equivalence status by the EU. That scenario would require less change and would likely be accompanied by a transition period to avoid disruption.

Under an EU equivalence arrangement, financial firms based outside the bloc can offer a limited range of services to European customers, provided their home country's financial regulations are broadly similar to the EU's. Compared with today, equivalence would mean less freedom for U.K.-based banks to do business on the continent, as the current passporting regime allows British banks to operate freely across all EU member states.

Keeping the passport would require the U.K. to remain part of the EU's single market. Prime Minister Theresa May said in January 2017 the U.K. would leave the single market. She has since proposed it should remain in the single market for goods, but not for services such as banking.

If the U.K. isn't granted equivalence status, making use of sterling cash pools could also become more complicated, said Stephen Baseby, technical director at the Association of Corporate Treasurers in London. Having both sterling and euros in a single pool -- a practice used by many European corporates -- might require additional short-term currency swaps, adding costs for companies and paperwork for banks, said Mr. Baseby. "The process wouldn't be as fluid any more," he said.

Further issues could arise around clearing. An acrimonious divorce between the U.K. and the EU could cut European customers off from U.K.-based clearing houses, even though certain derivatives -- for metal, for example -- only trade in London. The Bank of England last week warned that over-the-counter derivatives totaling GBP41 trillion ($53.8 trillion) at U.K. clearing houses could be at risk should negotiations between the U.K. and the EU break down.

RWE Supply & Trading GmbH, a subsidiary of German energy company RWE AG, currently relies on London-based banks to clear its trades. Changes to the current setup could cause additional costs of several hundred million euros, said Karl-Peter Horstmann, head of markets regulation at the RWE unit. Repapering some of its interest rate and currency swaps would add to the bureaucratic burden, said Mr. Horstmann. "This is presenting us with significant difficulties," he said.

Amid this uncertainty, treasurers are expanding the portfolio of banks they do business with, reinforcing an existing trend, said Michael Dakin, a partner at Clifford Chance LLC. "Most treasurers are trying to diversify the products, currencies and banks they are dealing with," he said.

Large multinationals should be able to make the required changes to their financial instruments without too much disruption, said the ACT's Mr. Baseby. "It's the smaller companies, those that have fewer banking partners and a less diversified portfolio of financial products, that we are worried about," he said.

Even for large corporates, however, risks remain. It is far from clear what it would cost companies like Deutsche Bahn to repaper a large number of financial instruments.

"You don't know whether corporates will pay for this or whether it will be the banks paying for it," said Eriola Shehu Beetz, a partner and managing director in BCG's financial institutions practice.

Write to Nina Trentmann at Nina.Trentmann@wsj.com

(END) Dow Jones Newswires

October 16, 2018 00:44 ET (04:44 GMT)

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