Although financial institutions have yet to publicly acknowledge their relocation to EU states, the migration is on and finer details are being worked out quietly.
In what is forming out to be a strategic development, a gap in the financial rules governing EU states is allowing members to compete with each other to host investment banks relocating from London following its historic decision to divorce the bloc.
The competing EU states are offering looser regulatory standards as incentives to London-based financial institutions who are looking to relocate.
Although the European Central Bank is the Eurozone’s central bank, however under EU law it does not have direct responsibility for the divisions of the banks that form part of the bloc which conduct most of their market trade, including brokerage deals. Typically operations such as these are considered some of the riskiest in their portfolios.
This situation is such because ever since the ECB took charge of the Eurozone in 2014, the bulk of the brokerage deals happened in London, and thus were outside of its purview.
Now with these financial institutions moving away from London to greener pastures in the EU they will now come under the ECB’s jurisdiction and supervision.
Countries within the bloc are luring these financial institutions with differing regulatory standards, thus raising the fear in the ECB that they could be subject to loosened supervisions and thus undermine the consistent financial regulation existing within the bloc.
“Regardless of balance sheet size, it’s currently the national regulators who will have the authority to approve and regulate the broker-dealers. That is raising concerns of inconsistencies emerging,” said Vishal Vedi a partner at Deloitte who is advising banks on how they will need to reorganize as a result of Brexit.
Countries across the Eurozone, including Luxembourg, Frankfurt, Madrid and Dublin are vying to lure banks in the hope that they would bring in tax revenues and jobs.
One of the areas which are in focus is, to what extent will national regulators allow brokers and dealers to conduct “back-to-back” trading.
CNMV, Spain’s markets regulator is aiming to make Madrid “the most appealing option for investment firms considering a move from the UK to another EU country”.
As per the people advising investment banks on where to relocate, CNMV has stated it would consider allowing broker-dealers to go back-to-back 100% of their trades. Similarly, regulators in other countries have also allowed back-to-back trading although their come with a condition which state that a portion of such trade will have to be managed locally.
“We can look into it, but we will see how this plays out and what the regulatory framework will look like in two years’ time,” said CNMV’s spokesman.
Earlier in December, CNMV had said it wanted to be the most welcoming place in Europe for UK financial firms and that it would not accept “totally empty shells” or breaches to EU securities rules.
London-based banks are, as yet, not biting the bait citing factors such as Spain’s relatively low sovereign credit rating.
Bafin, Germany’s regulator has also stated it would consider the limited and temporary use of back-back arrangements, as per an official at Bafin. It has however emphasized that eventually it expects these relocating institutions to establish a substantial operation in Germany.
“Regulators differ in their approach to risk models – particularly around the level of reliance that they will be prepared to place on models which have already been approved in the existing UK entity and the amount of pre-assessment they will do themselves,” said Deloitte’s Vedi.
Despite talks of exodus from London, most banks have publicly not acknowledged their relocation move with executives saying they are skeptical as to whether they will be allowed to use workarounds like back-to-back in the long term.
“We do suspect that following Brexit, there will be constant pressure by the EU not to ‘outsource’ services to the United Kingdom but to continue to move people and capabilities into EU subsidiaries,” said Jamie Dimon, JPMorgan’s Chief Executive in his annual letter to shareholders.
On its part the ECB has made it clear, cutting corners will not be allowed. Those asking for back-to-back deals will be disappointed.
However, currently the ECB does not have the legal authority to oversee these broker-dealers, although as per sources familiar with the matter at hand, the ECB is quietly trying to apply pressure on countries where they think standards are being lowered.
“Needless to say that I would certainly not accept banks booking all exposures with the euro area entity while having their risk management and internal control systems outside the euro area,” said Sabine Lautenschlaeger, an executive board member of the ECB.