The European Central Bank (ECB) has warned that too many international investment banks continue to serve euro zone clients out of London and that the ECB plans to force them to relocate trading activity to the EU.
Some major banks have been reluctant to relocate activities to the EU after Brexit, despite demands by the ECB, which supervises the EU’s biggest financial groups.
ECB Supervisory Board chair Andrea Enria wrote in a blog post that “… empty shell structures … are a very real concern.”
Enria said: “As the supervisor for the euro area, it is our duty to protect the depositors and other creditors of the local legal entity, prevent the disruption of banking services and safeguard broader financial stability in our area of jurisdiction.
“In this context, empty shell structures – legal entities located in the euro area that book exposures remotely with their parent company or book them locally but rely fully on risk management hubs and financial infrastructures located in third countries, often by means of back-to-back mirror transactions and hedges transferring the risk to their parent entity – are a very real concern.”
Enria added: “For the desks identified as material, we will issue individual binding decisions to the incoming banks.
“These decisions may require the bank to (i) appoint a head of desk within the euro area legal entity with clearly defined reporting lines and a compensation structure linked to the performance of that entity; (ii) ensure the desk has the adequate infrastructure and number and seniority of traders to manage risk locally; (iii) establish a solid governance and internal control framework of remote booking practices with parent affiliates; and (iv) ensure limited reliance on intragroup hedging.
“The ECB is navigating uncharted waters. No major supervisor has ever had to assume, over a short period of time, the integration of a significant number of incoming institutions with global market activities belonging to groups headquartered in third countries in its supervisory remit.
“The ECB is not setting specific targets for the relocation of banking business to the euro area.
“Instead, we want to ensure that incoming legal entities have onshore governance and risk management arrangements that are commensurate, from a prudential perspective, with the risk they originate.
“The extent of the actual relocation and specific booking configuration will depend on the current set-up of each bank and how it decides to implement the supervisory expectations.
“The ECB is mindful that its expectations may lead to changes to the current set-up of some banking groups and intends to apply its policy in a proportionate manner.
“For instance, we are aware that the risk arising from some foreign exchange products may be more efficiently managed in accordance with a centralised group-wide set-up.
“Furthermore, the ECB is also taking into account in its assessment the complexity of some products, for which the convenience of having a centralised management could be considered.
“The review of trading desks and their associated risks does not mark the end of the ECB’s supervisory scrutiny of incoming banks’ post-Brexit operating models.
“Investigations into credit risk-shifting techniques, the reliance on parent entities for liquidity and funding, and internal model approvals are still ongoing.
“This work has a key overarching objective: to ensure that all SSM entities have prudentially sound risk management arrangements and a local presence which enables effective supervision and is commensurate with the risks they originate.”