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[...] many are now hoping for an equivalence decision to fill the gap left by passporting rights. If the European Commission deems the regulatory and supervisory regime in the UK to be equivalent to that in the EU, market access would be partly retained. However, I am rather sceptical about whether equivalence decisions – may they be likely or not – offer a sound footing for long-term location decisions of banks. Equivalence is truly different from single market access.
There are three major drawbacks to equivalence decisions. First, they only cover the wholesale business of banks. Second, given the fact that banks need time to build up a new entity elsewhere, an equivalence decision would have to be taken quite soon to actually have a bearing on the location decisions of banks. Third, equivalence decisions are reversible, so banks would be forced to adjust to a new environment in the event that supervisory frameworks are no longer deemed equivalent. These drawbacks lead me to the overall conclusion that equivalence decisions are not a reliable substitute for passporting.
So it seems that the prospects for EU market access through the UK look rather dim. To ease the pressure on financial institutions, a transition period could help. It would reduce risks and increase planning security for banks, which would be economically beneficial. Furthermore, it could support a smooth relocation process by taking pressure off both supervisors and banks, for example by making "first mover advantages" less important. This being said, transition periods would be a politically sensitive topic in the negotiations, and it is unclear how likely such an agreement might be.
As mentioned earlier, we should not forget about the access of European banks to the UK, which is also an important issue. For German banks, for example, the UK is the second-most important foreign market, right after the US. It will be up to the UK Prudential Regulation Authority to decide under what circumstances European banks can retain access to the UK. Whether the UK would be prepared to unilaterally grant access for EU financial institutions in order to retain the attractiveness of London as a financial centre, remains an open question. And let me add that it is of course not regulation alone that plays a role when European banks decide on opening a branch or a subsidiary in the UK. It is also a question of what kind of entity their counterparties and clients want to do business with.
Let me summarise the prospects for market access, at least from my point of view. Continued passporting rights are rather unlikely, and an equivalence decision would be a somewhat imperfect substitute. A transition period could ease some of the pressure, but it clearly is a sensitive issue.
Could a free trade agreement be the solution? According to their Brexit white paper, the UK government will strive for an ambitious free trade agreement with the EU as a long-term solution. But regardless of the fact that negotiating comprehensive free trade agreements is an arduous and time-consuming task, financial services are an especially tricky area. So far, the EU has never fully integrated finance in its free trade agreements with third countries.
Where does this lead us? So far, while acknowledging and accepting the divorce, policymakers are trying to find ways to hold the UK and EU economic areas and jurisdictions together. And they will continue trying so. The reason is that most of us are convinced that harmonised rules eliminate unnecessary frictions and act as a powerful catalyst for business across national borders – for the real economy as well as the financial sector. However, looking at the facts that I’ve just laid out we also have to acknowledge that it is at least questionable whether this undertaking will be easily achieved. Financial institutions should take into consideration that, in the end, there might well be two separate jurisdictions in which they operate, and that these jurisdictions might diverge over time – or instantly, once the divorce has gone through.
3 Whether and where to move
As a consequence, many banks are now considering moving some of their activities to the EU. First, let me say that I expect London to remain an eminent global financial centre. Nevertheless, I also expect a number of UK-based market participants to move at least some business units in order to hedge against all possible outcomes of the negotiations.
The question that is causing some excitement is: Where will banks go? As a supervisor, my main concern is that banks are supervised according to standards that are both high and consistent. This is best ensured within the SSM area. This also means that I will not promote any particular financial centre. That said, I am open to dialogue with financial institutions in assessing the conditions for moving business units to Germany. And I go as far as to say that – in many respects – these conditions are attractive. [...]
Numerous major market participants have already contacted the German Federal Financial Supervisory Authority BaFin and Bundesbank. We respond to such requests pragmatically. That is, we provide financial institutions with quick and reliable guidance and aid a smooth transition if one of them decides to move business units to the continent. Three weeks ago, BaFin has hosted a workshop for representatives of foreign banks covering all questions surrounding Brexit. And just this Wednesday, Bundesbank has launched a website on the topic, providing information as well as contact details for banks assessing to move part of their business to Germany.
Of course, we also emphasise the requirements for establishing a licensed entity there. For example, this means that we will not accept any empty shells or "letterbox companies" where the business effectively continues to be done out of London. For critical functions such as management, controlling and compliance, qualified personnel need to be present at the non-UKEU subsidiary at all times. And I urge banks not to spend their time inventing strategies to circumvent these requirements. This includes seemingly creative solutions such as "fly-and-drive" banking, where bankers fly in daily from London, or "dual hatting", where transactions are booked on the EU subsidiary but in fact executed in London.
To summarise: As important as outsourcing strategies will understandably be when banks restructure their business to adjust to the new environment, it has its limits, and we expect any branch or subsidiary to retain chief responsibility for its business. [...]
5 Regulation and supervision
My main message here is that we must avoid a regulatory race to the bottom at all costs. Given how the Brexit debate developed early this year, this warning is not at all an empty one. A financial centre strategy comprised, among other ingredients, of very low corporate taxes and lax regulation has already been mentioned in the UK as a fall back option for London. And in January, Chancellor of the Exchequer Philip Hammond made it clear that the UK would "do whatever [it has] to do" to regain competitiveness.
Regulation and supervision in the UK have been both highly professional and stability-oriented in the past. I strongly hope that supervisors here will be able to keep up this good work and turn a blind eye to demands for deregulation and lax supervision. The current regulatory and supervisory standards we have set together are an important lesson from the financial crisis and it would be a mistake to roll them back. I am convinced that in the long run, well-capitalised and strictly supervised financial systems are the most successful ones.
To be clear, my call to refrain from using regulation or supervision for the sake of increasing one’s competitiveness is equally addressed to the EU. There might be a certain temptation to use Brexit as a chance to strengthen financial centres across the rest of Europe, for example by offering discounts with respect to licensing procedures. This is not a route we should take, and I am confident that the strong role and far-reaching competences of the SSM, including the ECB’s responsibility in licensing, will forestall such ideas becoming reality.
While I am serious about my warning of lax rules and supervision, I am cautiously optimistic that we can prevent this scenario from materialising. And this is because I know my colleagues in London very well, and I know that they share my views on this issue. Our cooperation with the UK Prudential Regulation Authority has been exemplary in the past, and we will invest all our efforts in continuing this partnership in the future.
Now, more than ever, we should also harness our relationship to work together closely during Brexit. Information sharing needs to be an important part of this. For example, when European authorities examine the risk models of banks wishing to establish a subsidiary on the continent, we would benefit from knowing what the PRA found in their previous assessment. This includes at what time the PRA last examined the model, under what assumptions, and to what verdict it came. Conversely, we are open to sharing all necessary information that the PRA might need to process applications by EU banks to operate in the UK.
The guiding principle of our cooperation should be to ensure a smooth transition to a post-Brexit world. As supervisors with the necessary distance from political haggling, we can make a substantial contribution by providing pragmatic and efficient solutions. In parallel, I believe that European and UK supervisors should fathom out how we can put our future cooperation on a more formal footing. [...]