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* HQ move to Frankfurt would 'kill' deal in current form - source

* UK less likely post-Brexit to accept Frankfurt HQ - banker

* Brexit deemed worsening factor on existing Hessen deal concerns

London Stock Exchange’s (LSE) [LON:LSE] and Deutsche Boerse’s [ETR:DB1] planned merger could face regulatory opposition over the London location of the combined company’s planned headquarters, a source close to the situation and a sector banker said.

Any move to shift the HQ to Frankfurt would “kill the deal” in its current form, the source said.

German regulators and politicians had voiced concerns over the planned “HoldCo” HQ location in London rather than Frankfurt already before last week’s UK vote to leave the European Union (EU), the sector banker said, adding that Brexit may turn this into an even bigger stumbling block. Meanwhile, UK policy makers are now less likely to accept a HQ location in Frankfurt as they will want to retain clearing and exchange infrastructure in the UK, he argued.

This impasse could potentially be resolved if UK companies were granted passporting rights to run operations in the EU, the banker said. But this would require lengthy negotiations over “a whole host of specific areas”, he argued.

It would have been easier to finalize the merger without Brexit, the source said. But even before last week’s referendum outcome, the Hessian Exchange Supervisory Authority, which needs to clear the deal, had signalled that it would need to scrutinize several aspects of the transaction, he added.

The deal parties need to engage in a long-term dialogue with Hessen to understand the regulator’s concerns and whether these primarily relate to jobs, Frankfurt’s position as a financial hub, or other matters, the source said. However, any relocation of the HQ to Frankfurt would mean the parties would need to “start again”, the source said. This could be possible if LSE or Deutsche Boerse shareholders vote down or do not tender into the deal, but would then result in a different combined company, he added.

LSE and Deutsche Boerse’s shareholders would likely have to vote on a HQ relocation from London to Frankfurt, a person familiar with the German company said. It would not be an option to adjust the deal terms or to change the deal structure from a merger to a takeover, this person said.

For now, the parties need to focus on LSE’s shareholder vote on the merger on 4 July and Deutsche Boerse shareholders’ tender process, which ends on 12 July, the source said. Regulators including Hessen will be in focus after that, he added.

A person familiar with LSE declined to comment on specific shareholder feedback ahead of the vote, but noted there have been no signs that would give cause for concern. Market participants have been positive about the deal rationale so far. And with the UK outside the EU, the logic for a company with one foot in both regions would be even stronger, he argued.

LSE shareholders will be in dialogue with the deal parties up until the 4 July meeting, the person familiar with the UK company said.

As of 22 June, Deutsche Boerse shareholders representing 0.66% of the votes had approved the merger, the person familiar with that company noted. Large investors are likely to make up their minds right before the 12 July deadline, this person added without speculating about the outcome.

But LSE and Deutsche Boerse’s share prices indicate that the deal may not happen, the sector banker said. As of today (27 June) LSE stock is down 16% and Deutsche Boerse 14% since 23 June, before the UK referendum outcome was announced. This may be due to likely regulatory hurdles, the first and a second sector banker said. This, rather than any shareholder opposition, is the most plausible reason for the price reaction, the first banker added

The parties on 24 June said they remained committed to the deal and would continue the process of obtaining necessary approvals.

Their Referendum Committee will in coming days convene and discuss the priorities, the person familiar with Deutsche Boerse said, adding that preparations are currently being made for the meeting. Ways to alleviate any concerns at the Hessen regulator will likely be part of the discussion. But because so much uncertainty remains over the form of Brexit, it is largely impossible to say much about the agenda, this person added. The Committee will assess the situation continuously, but at this early stage it “does not have much to talk about”, the source argued.

It will not be possible to extend the deal timeline beyond the 13 June 2017 long-stop date, the source and person familiar with Deutsche Boerse noted. The deal should be possible to close before that date, the person argued. In any case, Brexit per se is unlikely to hit the deal or the timeline, the source argued, adding that regulation will probably determine the outcome.

Spokespersons for LSE and Deutsche Boerse declined to comment on the matter.