Speech by Andrea Enria, Chair of the Supervisory Board of the ECB, at the 20th LSE German Symposium
Frankfurt am Main, 5 February 2021
Thank you for your invitation to the German Symposium. Even though the United Kingdom and the European Union might have come to a fork in the road institutionally, we continue to be bound together by countless economic, cultural and personal ties. This event is testament to that.
In any other year, Brexit’s final form and its potential repercussions would probably have been the most discussed topic in the hallways of European parliaments and government buildings. But unfortunately, as we all know this was not the case for the year 2020.
One year ago, Europe recorded its first cases of the coronavirus (COVID-19), and we remain very much in the grip of the pandemic today. Thankfully, banks absorbed the first economic shock of the pandemic much better than they did the hit of the great financial crisis. The regulatory overhaul carried out by the international community following the last crisis significantly increased the resilience of the banking sector and enabled public authorities to launch a decidedly countercyclical response to the financial fallout of the pandemic. It is too early to pass a final judgement, but the efforts to strengthen the capital and liquidity position of banks, improve their measurement and management of risks, and establish buffers in good times – to be used in stressed conditions – paid off in this first phase of the COVID-19 crisis.
The policy response in the wake of the great financial crisis brought with it a resurgence of a territorial approach to financial regulation and supervision. Mervyn King, then Governor of the Bank of England, famously bemoaned the fact that global financial players were international in life, but national in death. Theoretically, this tension could have been resolved in one of two ways – either via international treaties providing robust legal underpinnings to international crisis management, or by segmenting the business of global institutions along national lines. In other words, by making global banks international also in death, or by making them more national in life and driving cross-border groups towards looser combinations of local establishments. In the aftermath of the great financial crisis, the first option never gained much traction, aside from a few proposals from legal scholars and (even fewer) policymakers. International standards on crisis management were developed by the Financial Stability Board, based on best practices; additional requirements on loss-absorbing capacity were also agreed to make large global players resolvable too. But, at the same time, it was made clear that this loss-absorbing capacity had to be localised to a significant extent at each subsidiary and that crisis management procedures would need to take place within the boundaries defined by local legislation. We gradually moved into the world of intermediate holding companies or parent undertakings – a de facto request for global players to have self-contained subgroups or subsidiaries in each relevant jurisdiction, subject to all relevant local requirements and intensified supervisory scrutiny. The concepts of equivalence and alternative compliance, which retain an important role in securities regulation and provision of financial market services, were not applied to a significant extent in the prudential sphere: local supervisors tended to rely less and less on the assessment of the home authorities, which resulted in material duplication of supervisory and reporting requirements.
The ring-fencing that dominated the response to the great financial crisis happened also within the European Single Market. But the post-crisis financial reforms provided an opportunity to strengthen the regulatory and supervisory underpinnings of the Single Market. The European Supervisory Authorities were established, with a mandate to pursue maximum harmonisation (the single rulebook) and supervisory convergence. A legal basis was provided for national competent authorities to take joint prudential decisions on cross-border groups, thus establishing joint responsibility between national authorities in a number of key prudential matters, including preparing for and managing crises. Finally, the banking union delivered the much needed institutional set-up for greater market integration, with the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) providing full alignment between supervision in going concern situations and the management of banking crises. The Single Resolution Fund, with a common backstop, now also provides a common safety net for banks that are a cause for system-wide concern at the European level.
While the international framework focused on stronger international standards but moved to more territorial approaches to prudential supervision and crisis management, the European framework coupled a fully unified set of prudential rules with a single institutional framework for supervision and crisis management. This different trajectory of the integration of regulation and supervision of banking activities has relevant implications for Brexit.
From the European perspective, after Brexit the United Kingdom has become a third country. In other words, Brexit has itself been a fragmenting force. The equivalence framework that governs the relationship with third countries in the area of banking services does not foresee to grant market access similar to the freedom to provide services within the Single Market. For banks providing banking services to EU customers from the United Kingdom, as well as for European banks servicing UK customers from the EU, this has meant a significant effort to relocate business.
Over the past few years the ECB has been continuously engaging with banks and urging those relocating to the euro area and also our banks operating in the UK to prepare for Brexit. Most banks have understood that empty shell institutions are not acceptable in the euro area, and that they must allocate capital, liquidity, top management with effective responsibility to steer European business, and an appropriate quality and quantity of resources in charge of risk management to establishments within the banking union. This must be done in a way that is commensurate with the activities and risks undertaken with European customers and counterparts. We continue to stress this message in our conversations with banks and we will closely monitor how they implement their plans and build up their capabilities within the EU.
As a result of the preparations requested and monitored by the ECB, the transition to the new regime went smoothly, without banks suffering from market or liquidity disruptions related to Brexit. Likewise, thanks to banks progressively building up their capabilities, there have so far been no major disruptions to the servicing of EU clients.
According to their Brexit plans, incoming international banks intended to move a total of around €1.2 trillion worth of assets to institutions supervised at the European level. Banks headquartered in the banking union also planned to move a substantial amount of their capital market business from the United Kingdom to the EU. Many significant banks have made considerable progress towards achieving their post-Brexit target operating models agreed with ECB Banking Supervision. As at September 2020, around €810 billion worth of capital market assets still needed to be moved by significant institutions. The ECB continues to monitor banks’ progress towards these models in terms of assets, staff and booking practices.
We have expressed some concerns about the possible fragmentation of international banks’ presence in the euro area. Several incoming banks plan to conduct business in the EU via investment firms, which, under the current regime, are solely supervised at the national level and as such are out of the scope of the ECB’s direct supervision. The new legislation on investment firms that will come into force in June this year will significantly improve this set-up and ECB Banking Supervision, following the PRA’s model, will soon assume direct responsibility for the prudential supervision of systemically relevant investment firms in the area. However, some banks also plan to access EU markets through channels that are enshrined in national law, such as third-country branches in EU countries and direct cross-border access for the provision of investment services to retail clients. Such a fragmented structure limits the integrity of supervision and may even be used to avoid direct supervision by the ECB, but we know that this is due to some regulatory loopholes in our own European framework.
This focus on the relocation of activities and on the effectiveness of prudential controls on financial services provided to EU customers would, however, be short-sighted if we didn’t acknowledge the close connections that will remain between the banking sectors in the EU and the United Kingdom for years to come. To a very large extent, European corporate issuers of equity, debt securities and syndicated loans continue to directly rely on banks headquartered outside the EU, particularly in London. Even after full migration of assets to the EU according to the agreed target operating models, the safe and prudent management of global banking groups will remain an essential ingredient of financial stability in any jurisdiction in which they have a significant presence. Moreover, the provision of financial services is becoming increasingly mobile, also thanks to the trend towards digitalisation that the pandemic has further accelerated. Regulators and supervisors would be facing a rude awakening if they thought that their more territorial approach could succeed in neatly boxing in financial activities and containing risks in their domestic jurisdictions. Due to financial markets innovating constantly, interconnections and channels of contagion will always take new forms and the only possible remedy is strengthening supervisory cooperation across borders.
The ECB is committed to cooperating closely with the UK supervisory authorities. The infrastructure for such cooperation has been put in place. In April 2019, the ECB agreed a comprehensive post-Brexit cooperation framework with the UK authorities in the form of a Memorandum of Understanding, which came into effect on 1 January 2021. The Memorandum of Understanding, which is based on a template prepared and negotiated by the EBA, covers the prudential supervision of entities other than insurance undertakings and pension schemes. It provides for the exchange of information as well as the reciprocal treatment of cross-border banking groups. The ECB and the Prudential Regulation Authority (PRA) have also agreed on how to share responsibilities relating to the supervision of branches. We have signed a statement of intent on the exchange of benchmarking information and analyses of relevant entities of groups headquartered in other third-country jurisdictions, as far as allowed by applicable law. Last but not least, the European Commission and the UK government have stated their intention to negotiate a Memorandum of Understanding on regulatory cooperation in the area of financial services by March 2021. The ECB will be involved in this cooperation as appropriate, in line with its central banking and supervisory competences.
Formal agreements and structures for cooperation aside, we all know that regular, open and frank discussion, at all levels of our organisations, is the most important ingredient for tackling issues in a coordinated fashion, especially in times of crisis, when tensions may well arise and objectives may become misaligned. I am glad to say that ECB banking supervision and the PRA have built very solid foundations for supervisory cooperation and I am sure this will help address the challenges that are certain to arise in the post-Brexit world.
I now look forward to our discussion.