Britain and Germany are inching towards a common understanding on financial market co-operation after the UK leaves the European Union, but the journey could be a bumpy ride.
Representatives of the German Bundesbank and the Bank of England, in separate speeches in London in the past few days, have waded into the debate over clearing of euro-denominated currency and derivatives.
Andreas Dombret, the Bundesbank board member responsible for financial market regulation, said on 24 February in London that the City would be able to continue its leading role in euro clearing only if the UK fully respected the European Market Infrastructure Regulation. This refers to European legislation for regulating over-the-counter derivatives, establishing common rules for central counterparties and trade repositories.
Sir Jon Cunliffe, deputy Bank of England governor responsible for financial stability, said at an OMFIF City Lecture two days earlier that ‘currency nationalism’ in policies over euro clearing would not help financial monetary stability. It could open ‘further fragmentation of the global capital market – rather than the route to the sound and efficient management of risk.’
Dombret said on Friday that the Bundesbank was taking a rigorously neutral line in not favouring one financial location over another in terms of the post-Brexit financial landscape. He said that, after EU withdrawal, London would probably remain ‘an eminent – even the eminent – global financial centre’.
However, he warned that economic rationality would not necessarily guide policy-making during a politically fraught period. If negotiations broke down, the UK could leave the EU absent either a worked-out settlement or an accord on a new framework for links with the 27 remaining members. This would be major handicap to financial services firms in the City and in Europe.
‘While economic policy will of course be an important topic during negotiations, we should not count on economic sanity being the main guiding principle. And that means we also have to factor in the possibility that the UK will leave the bloc in 2019 without an exit package, let alone the sweeping trade accord it is seeking.’
Dombret said such a scenario would hurt economic activity on both sides of the Channel – but that would not necessarily prevent it from happening.
Dombret supported the idea of a transitional deal to allow UK-based financial services firms to access the continent’s internal market after Britain’s planned EU departure. Yet he doubted whether so-called ‘equivalence’ measures would provide a secure basis and a reliable substitute for ‘passporting’ at the heart of a new UK-EU relationship in financial services.
Dombret said ‘numerous major market participants’ had contacted the German Federal Financial Supervisory Authority (BaFin) and the Bundesbank about relocating activities to Germany, though he added, ‘I will not promote any financial centre.’
He warned against financial centres that tried to apply ‘discounts’ to European regulation. He added that the German authorities would not accept ‘empty shells’ or ‘letterbox companies’ effectively run out of London.
‘For critical functions such as management, controlling and compliance, qualified personnel need to be present at the non-UK EU subsidiary at all times.’
He made clear that the Bundesbank and BaFin would not accept ‘seemingly creative solutions’ such as ‘fly-and-drive’ banking, where bankers fly in daily from London, or ‘dual hatting’, where transactions are booked on the EU subsidiary but in fact executed in London.
In the absence of a new deal, Dombret warned financial services firms would have to prepare for operating in ‘two separate jurisdictions’ after the Brexit process. ‘These jurisdictions might diverge over time – or instantly, once the divorce has gone through.’
David Marsh is Managing Director of OMFIF.