Andreas Dombret of Bundesbank on Impact of Brexit on Global Finance

While examining the feasibility of the Free trade Agreement (FTA) between the UK and EU, he emphasized that “supervisors cannot allow a foreign bank to provide financial services in their market without having the possibility to curb behavior that endangers financial stability.” This is keeping in mind that the UK government has chosen to leave the single market and the customs union and withdrawn from the associated regulatory framework. Thus, “… a chapter on financial services in a free trade agreement (FTA) would be very limited … .” Next, he discussed the possibility of implementing the equivalence agreement, similar to the one with the U.S. However, the EU approach is built on a law-by-law basis, where equivalence can only be granted when the specific piece of legislation has an explicit provision. There is, for example, no basis for an equivalence decision when it comes to the licensing of banks. The European Council has, therefore, asked EC and the Brexit negotiation team to analyze whether it would be prudent to enhance this approach. In this context, he highlighted the possibility of three potential negotiation outcomes: the enhanced equivalence option, the subsidiarisation option (establishment of independent subsidiaries in each other's market), and several potential combinations of limited financial services agreements plus a less ambitious revision of the equivalence regime (that is, an extension of the law-by-law approach to encompass other regulatory areas that are currently not out of scope). “None of the remaining options for financial services are ideal. So we will have to make do with complicated, second-best solutions,” said Dr. Dombret.

If one were to follow the preferences of industry groups, a new equivalence regime would ensure a high level of liberalization for financial services; regulatory equivalence would be managed by a technical committee of EU and UK supervisors, with independent arbiters dealing with cases of conflict. He added that he is skeptical about this mutual recognition approach and about similar approaches based on regulatory harmonization through technical committees and independent arbitration mechanisms. On the other hand, the subsidiarisation option would be well-suited to preserving financial stability and democratic accountability. It might also be less costly than a full-blown mutual recognition regime. “There is no ideal option on the table, nor is any one of the three second-best solutions clearly better than the others,” said Dr. Dombret. According to him, the key takeaways are that two sovereign regulatory jurisdictions will emerge, free cross-border trade in financial services will be limited, and the remaining options all require further analysis and thought. “No matter which direction we take, our decisions will have an indirect, albeit substantial impact on other third countries to the EU.”

Brexit could affect two avenues that give financial firms access to the EU market: namely, decisions of supervisory equivalence and the licensing process. A new equivalence framework could be more systematic. For third-country CCPs, this enhanced equivalence is attractive, as it makes the decision more predictable and transparent. However, for U.S. CCPs, this approach may not be appropriate or necessary because we already have a robust equivalence decision. Given the Bundesbankk's thorough process of mutual assessment, there is a case for sustaining this outcome—for example, through a bilateral U.S.-EU agreement on CCP equivalence. The second avenue via which Brexit could affect how financial firms gain access to the EU market are higher demands for licensing foreign bank branches and subsidiaries. Take, for example, the discussion about a draft law proposing to introduce EU intermediate parent undertakings (IPUs) for short. Similar to the U.S. intermediate holding companies, or IHCs, foreign banks would have to bring their EU operations under a single holding company. He added that Bundesbank will continue to advocate fair access for foreign banks. From the perspective of U.S. banks and those from other third countries, Brexit will impact on how they can do business in the EU single market. Both the new IPU requirements and a potential enhanced equivalence approach mean a more systematic approach to ensuring fair, transparent, and stable rules for the provisioning of cross-border financial services. While this may imply some new requirements, it might end up streamlining the rules and promoting clear supervisory dialog.

Related Link: Speech

Keywords: Europe, EU, US, Banking, Securities, Brexit, Passporting Regime, Equivalence, Licensing, Bundesbank, BIS