British banks may have to set up subsidiaries in EU countries to trade default swaps with counterparties in the European Economic Area, Ashurst lawyers led by Haines wrote in a note to clients. 

Brexit raises "immediate issues for participants in the derivatives market" and the impact "will be substantial," they wrote in the note.

The ability for U.K. clearinghouses to process euro-denominated trades may also be in jeopardy. The European Central Bank has previously tried to prevent trades in the currency from being cleared in the U.K., with a failed court case last year.

Linklaters LLP has advised clients to check for references to the EU in ISDA master agreements, which govern over-the-counter derivative transactions, according to Deepak Sitlani, a partner specializing in derivatives. The Credit Support Annex to the master agreement, for example, may only allow collateral originating from EU nations.

Collateral Checks

The contracts are expected to continue to be governed by New York or English law, according to Sitlani.

"In a slightly worried state, people are asking what they can do," said Sitlani. "One thing is to look at your existing contracts and assess whether references to the EU will continue to be appropriate or whether they should specifically refer to the U.K. as well, for example in reference to eligible collateral."

Still, the effect of Brexit on the global market for credit derivatives will be limited by the fact that many traders are based outside of Europe and so are less affected by changes within the EU. Furthermore, only a portion of contracts are in euros.

Lawyers at Allen & Overy LLP said that while they're receiving "many queries" about whether Brexit warrants changes to documentation governing derivative trades, it's difficult to make alterations before a deal is made.

"Until the terms and timing of the U.K.'s exit from the EU are clearer, there is not a great deal that can be done from a documentation perspective," A&O said in a note to clients. "Any changes could conflict with any legislation designed to ensure continuity of contracts."

HSBC Holdings Plc has told clients that sterling bonds can be delivered into settlement auctions for euro-denominated credit-default swaps and index trades, according to Michael Hampden-Turner, a default swaps specialist on the credit trading desk in London. The bank has received an increase in "general questions" from investors since the referendum, he said.

"People are concerned about the impact of Brexit on the U.K. credit derivative market," Hampden-Turner said. "Investors are beginning to wonder what will happen if we start to see some U.K. distress and even defaults. We're still in that phase where we're getting overreactions to headlines, and that will probably last for another month at least."

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