Preparing for Brexit: “The clock is ticking”

Sabine Lautenschläger, Member of the Executive Board of the ECB and Vice-Chair of the Supervisory Board of the ECB, talks about developments in the preparatory work of banks and supervision in light of the UK leaving the European Union, Supervision Newsletter (Summer 2017) on 16 August 2017

How far advanced are the banks in preparation for Brexit? What should they be doing more of that you are not seeing yet?

I have a very clear message to both smaller and larger banks: the clock is ticking. No one knows how Brexit will play out, and that’s why all affected banks should prepare themselves with a hard Brexit in mind. Frankly, the banks are not as far advanced as we would like them to be. Of the banks that have indicated an interest in relocating operations to the euro area, a number of the larger banks have made progress in their planning. But we have not seen many final decisions yet on how these and other banks want to organise their business. For a number of reasons, they seem to be very cautious about taking decisions. However, they must do so very soon; we only have a narrow time frame in which to assess plans and applications, following a standard process we have already communicated.

We are also striving to ensure that euro area banks are being proactive and well prepared. We are in discussions with all euro area banks under our supervision that will be affected by the UK’s withdrawal, and we are following the progress of their preparations. Not surprisingly, it is very important for us to make sure that those banks we supervise, as well as the ones looking to set up here, do not just close their eyes and wait for whatever might happen.

How are you containing the risk of national supervisors “competing” for bank business?

We will oppose any race to the bottom in supervisory standards. First, the national supervisors are an inherent part of European banking supervision, so they should have a European perspective. Second, the ECB is not just responsible for directly supervising the largest banks, but also for ensuring consistent supervision and a level playing field for all banks in the euro area – no matter which Member State they operate in. Against the backdrop of Brexit, we, together with the national supervisors, have developed and agreed upon a number of relevant policy stances. These policy stances clarify how we will treat banks in the context of Brexit without compromising our standards.

Can you talk about the policy issues ECB supervisors are currently working on?

We do not know yet for certain what the post Brexit landscape will look like. But there is already a lot we can do and indeed we have been hard at work. We have developed our approach on a number of fronts, many of which are already reflected in our “Frequently Asked Questions”. One example would be our approach to booking models, which is a complex area. We have finished a first set of concrete guidance for supervisors on what needs to be taken into account when assessing back-to-back booking.

Other issues that we have been discussing include recovery planning. Recovery plans are an essential part of being prepared for times of crisis. That’s why it is critical that they are up-to-date, and have the right scope: we will closely monitor these plans to ensure that institutions have included an assessment of the risks and consequences arising from Brexit with a view to avoiding the situation whereby the complexity of the group structure up to the ultimate parent increases unduly and complicates the recovery and resolution of the institution. Institutions that move to the euro area need to present a complete recovery plan shortly after they have established themselves here. Banks that are already here will need to update their plans to reflect the changed environment and group structure.

For banks there is also still a lot of uncertainty. When will there be more clarity?

First of all each individual case is specific; so we will not be able to answer every question abstractly or according to a set of general principles. For that reason we are open to the idea of discussing with each bank their concrete proposals and even pre-discussing applications for licences as well as giving feedback based on concrete proposals. Of course, any application needs to take into account how substantive the business being transferred is, the risk profile and complexity. Where possible, we will provide banks with more information through the FAQs on our website but this guidance cannot offer the same degree of clarity an intense pre-application phase can offer.

There is however already one thing that I can be clear about: although London will stay an important global financial hub, it will no longer be an automatic entry point to the European Union.

How will you prevent the creation of “empty shells” in the euro area?

The best way to proceed, in my view, is to counter such attempts from the outset – and by that I mean the licensing phase. We need to remember that the ECB is fully in charge when it comes to granting licences to all banks in the euro area, regardless of their size. We work closely with the national supervisors and thoroughly assess banks’ applications together with them, but to ensure consistency in the euro area the final decision rests with us. During the process we review banks’ risk management and governance frameworks, for example, and will insist that they have adequate capabilities in place.

We will also carefully review to what extent banks plan to transfer their market risks to a third-country entity via back-to-back transactions. While we do not rule out this practice per se, ultimately we expect banks to manage relevant parts of their risks locally and independently. The acceptable level of this practice, of course, depends on a number of factors, such as size, risk and complexity of business being booked back-to-back, the number of staff based in the euro area covering risk management activities and the relationship between the home supervisor and the ECB. We have learned lessons from previous experience – we cannot rule out the possibility of a parent institution suddenly finding itself in a position where it cannot fulfil its responsibilities. The local entities therefore need to be in a position to manage at least part of the risks taken – actively and on a routine basis.

European supervision is currently limited to credit institutions. Do you see a risk of banks exploiting gaps in European regulation?

I definitely see a risk here. There is indeed the danger that substantial bank-like activities will not be supervised at the European level. This might happen if banks opt to conduct such activities in the euro area through investment firms or third-country branches. Both kinds of entities would be supervised at national level, and third-country branches would not even be subject to harmonised European rules. We have achieved a lot since the start of European banking supervision, but some gaps in the legislative framework remain. In my view, it would be a huge step forward if we could close these gaps. This would ensure fair competition and contribute to a stable financial system.

How is ECB Banking Supervision preparing for Brexit in operational terms?

The ECB has set up a project to prepare for Brexit and this is a system-wide effort. Brexit has a number of implications for our operations. We are, for instance, expecting a significant increase in the number of licensing applications, qualifying holding procedures and internal model approvals – not to mention the fact that we will need to supervise the activities and banks that move to the euro area. As a result, ECB banking supervision will need to increase its staff in the coming years. And of course we are in close contact with the national supervisors to understand how they are preparing for the operational impact of Brexit. At the same time we are continuing to cooperate with the UK’s Prudential Regulation Authority. We regularly exchange information and views on issues pertaining to Brexit preparations for incoming and outgoing banks.

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