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Brexit, the City and the EU: no sudden break

25 October, 2017Ouida Taaffe

EuroAs the clock ticks down towards Britain's exit from the EU in March 2019, the debate on what Brexit will mean for financial services in Europe and the UK is picking up. 

Felix Hufeld, president of the German Federal Financial Supervisory Authority (BaFin), speaking in London on 24 October at an event held by the consultancy zeb, pointed out the “vast economic interdependency between the UK and the EU” and the dangers inherent in any abrupt rupture in the current ecosystem.

“Brexit negotiators have not made sufficient progress on the designated key separation issues, we [regulators] have to think in terms of scenarios and hope for the best and prepare for the worst.”

Hufeld argued that regulators will find work arounds to “avoid dangerous distortions” immediately after Brexit but that “things that can be tolerated at the start – for instance to avoid ‘cliff effects’ – must be brought into an appropriate balance in the medium term.”

Just how interconnected financial services are was made clear last year by the EC’s proposal that systemically-important, non-EU banks should be required to set up an ‘intermediate parent undertaking’ (IPU) in the EU. (At that time, it was estimated that around 19 large banks would be affected.) This was widely seen as a response to US regulation requiring large non-US banks to set up intermediate holding companies.

Lawyers have suggested that such a regime is not needed in the EU because each local regulator decides whether the prudential supervision of any non-domestic bank is equivalent or not. What will actually happen is still up in the air. “The debate [on the IPU question] is far from over,” Hufeld said when asked about the issue. “European legislators first need to set up the necessary legal basis.”

Clearing and capital

Other systemically-important institutions in the eye of a potential Brexit storm are the central counter-party clearers. The EC estimates that UK-based CCPs clear around 90 per cent of the euro-denominated interest rate swaps of euro area banks, and 40 per cent of their euro-denominated credit default swaps. Where such CCPs should be domiciled – at one point the ECB wanted to insist that clearing of euro-denominated instruments should be carried out in the Eurozone – remains a thorny question.

In a speech in June 2017, Benoît Coeuré, member of the Executive Board of the ECB, noted:

quote - brexit“What concerns us today in the context of Brexit is that the current EU regime regarding third-country CCPs was never designed to cope with major systemic CCPs operating from outside the EU. Indeed, this regime relies to a large extent on local supervision, and provides EU authorities with very limited tools for obtaining information and taking action in the event of a crisis.”

When asked about the CCP issue, Hufeld said: “There is a need for comprehensive analysis of clearing risk. It is a political as well as a technical question…People should not jump to easy solutions. There is a danger of fragmenting liquidity.”

Liquidity is closely intertwined with capital and ten years after the financial crisis, the amount of equity funding that banks are required to hold is still a hot button topic. It has been argued that some European countries would not want to domicile large banks because of the systemic risk they can represent in the event of a bailout. “Financial services are so interconnected that Frankfurt would be hurt by a [bank meltdown] in London in any case,” said Hufeld. The question of – appropriately managed – risk-weighted assets versus overall GDP “is not a particular headache [for Germany].”

As for ‘Basel IV’ – the discussions about enhanced capital requirements for European banks, including a minimum ‘floor’, rather than relying on banks’ internal models – Hufeld said that “the Basel committee has not yet managed to find a compromise…[it is] still designing the output floor [and] working hard to reach an agreement.” (It is expected that a ‘floor’ would hit some German banks, in particular Deutsche Bank, hard.)

europe-1456246_1280Where the jobs will be

Many commentators in the UK have been concerned that the City of London could haemorrhage jobs – and talent – to the continent as a result of Brexit. Hufeld said that over twenty financial services institutions have approached the German regulator with a view to operating out of Frankfurt. Hufeld did “not have” any details of the assets that might be involved, as that would involve decisions that “are moving targets for the banks themselves”. He stressed that BaFin was a supervisor “and not a marketing agency…there will be no empty shells.”

When it comes to challengers to the big banks, Hufeld said that Germany does not want to set up a regulatory “sandbox” for fintech challengers in the way that the UK’s FCA has. He pointed out that BaFIN does not have a competition mandate – “we don’t have that and don’t want it” – and said that they could support fintech and innovation through “many ways and means”.


The UK is, of course, not the only country facing difficult political choices and some potentially bitter pills regulatory pills in the near-term. The EU has just finished consulting on how to deal with the problem of non-performing loans at EU banks and will make its recommendations in Q1 2018. What steps should be taken is highly politicised and the ‘peripheral’ EU counties, in particular Italy, will have the most to do.

“Not tackling the issue would be crime,” said Hufeld. “There is not the slightest doubt that the ECB has the legal authority to address such issues and, I would add, the duty…The one thing [the ECB] is not going to do is do nothing because [the issue] is politically contentious.”

Ouida Taaffe is the Editor for Financial World, the official journal for The London Institute of Banking & Finance.