As far as Brexit headaches go, Barclays' John McFarlane saysthat while his bank is on top of job relocations, he's moreconcerned about rewriting “hundreds of thousands” of contracts.

He's not alone. Andrew Bailey, head of the U.K. FinancialConduct Authority, said “contract continuity” is among thebiggest potential disruptions in a no-deal, no-transition Brexit.Both Bailey and McFarlane, who also chairs London's banking lobby,testified before lawmakers Wednesday. Bank of England Governor MarkCarney and European Central Bank President Mario Draghi have alsoexpressed concern about the issue and the lack of time left for afix.

A week ago, data from the European Banking Authority showed thescope of the issue, and that money is already on the move for thatreason. European banks have slashed their U.K. assets by $425billion, driven by a 35% drop in derivatives exposures. Insurancepolicies are affected too, with Carney saying that about 20 billionpounds ($26.9 billion) of insurance liabilities in Britain could beaffected without swift action.

The issue arises because one side or the other of a contract canmeet its obligations only thanks to an authorization that's set todisappear once the U.K. leaves the European Union in 2019. That mayresult in a firm being obliged by contract to do something thatregulation forbids. Impossibility generally doesn't work as adefense against nonfulfillment of a contract, said Simon Gleeson, aregulatory partner at Clifford Chance in London.

“A bank which enters into a contract which becomes illegal toperform by reason of Brexit may well be liable in damages for itsnonperformance to the counterparty,” said Gleeson. “Dealing withthis is so much in everyone's interest that I'm amazed it hasn'tbeen addressed.”

McFarlane's testimony on Barclays's Brexit planning ranged fromwell-trodden ground on derivatives clearing to the details ofshifting operations abroad. “The jobs lost are—in a tradescenario—they're insignificant,” McFarlane said. “They're not themost important thing. The most important thing is that we may haveto repaper hundreds of thousands of contracts into the EU.”

An aggregate 1.28 trillion euros ($1.52 trillion) of bankassets, including loans, securities and derivatives, may need to bere-booked from the U.K. to the EU following a hard Brexit, unlessalternative arrangements can be reached, according to a studycarried out for the Association for Financial Markets in Europe,the lobby group for Europe's wholesale financial markets.

Cross-border revolving credits—credit lines that can be drawndown, repaid, then tapped again—are among such contracts. Many areissued to EU companies by syndicates with members based in the U.K.For example, lenders to Volkswagen Financial Services' 2.5billion-euro line include London-based entities for Bank of Americaand Citigroup, as well as the U.K. units of the major Britishbanks, data compiled by Bloomberg show.

Lifecycle Events

A lender that lost its authorization but made an advance to thecompany under the revolver might find itself in breach of local lawin jurisdictions including Germany and France, according toClifford Chance. On the other hand, it might be in breach ofcontract if it fails to make the loan.

Andreas Hoffbauer, a spokesman for the carmaker, declined tocomment on the company's preparations, calling the Brexitdiscussion “a hypothetical question.”

Derivatives present a different problem. Carney estimates 26trillion pounds of uncleared, over-the-counter derivative contractscould be affected. Banks that lose authorizations may not be ableto deal with “life-cycle events” affecting derivative contracts,such as rolling open positions, exercising options and compressingtrades, according to the BOE.

Adding to the difficulties, regulators may require lenders tocarry out actions—such as so-called trade compression, which netsout offsetting positions—that they are forbidden to do. Moving thecontracts to unaffected entities requires time, consent fromdifferent parties and involves the courts.

Potential Solutions

As for insurance, when presenting the BOE's Financial StabilityReport on Tuesday, Carney estimated 6 million U.K. policyholderscould be affected—as well as 30 million European policyholders,with a separate 40 billion pounds of liabilities. Absent someagreement, insurers may be unable to collect premiums or pay out onliabilities, with contracts such as life insurance and employers'liability that extend far into the future “particularlyvulnerable,” according to the BOE.

“This is of particular concern to us,” said Malcolm Tarling, aspokesman for the Association of British Insurers in London.

Quizzed by lawmakers, Bailey laid out three possible ways ofdealing with the continuity issue. One would be to write somearrangement preserving authorizations into the U.K.'s final exitagreement, he said. Another possibility would be for U.K. and EUlegislators to act separately, but in parallel, the same coursesuggested by Carney.

The final option “which we would strongly advise not to follow,”is to leave firms to deal with it themselves, he said. “The problemwith leaving firms to sort it out is that it is extremelydisruptive, and there isn't enough time to do it.”

From: Bloomberg News

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