In Brussels, political negotiations started for the period after the United Kingdom leaves the European Union (EU). The negotiations did not produce any concrete results in 2017. An issue of huge importance for companies, financial regulators and policymakers is what shape the United Kingdom's access to the single market of the EU 27 countries, and vice versa, will take in the period after Brexit. Just under half of the UK’s total exports go to the EU, making it the UK’s largest export market worldwide. Looking at imports shows a similar picture. The issue is even more complex in the financial sector, because London is currently still the central hub for capital flows within the EU.

As things stand at present¹, the UK is expected to become a third country following Brexit, i.e. it will not be granted special status. Companies as well as national and European supervisory authorities are currently working flat out to prepare for adequately dealing with this challenge.

BaFin continued its dialogue with interested companies in the past year and again organised workshops. Scores of banks and financial services institutions are intending to move their offices to Germany and other countries because Brexit will mean that they will lose their European passporting rights that allow them to conduct business in the member states of the European Economic Area (EEA). BaFin and policymakers aim to provide these institutions with guidance for their projects in Germany, offer them legal certainty and, at the same time, ensure the stability of the German financial market.

Internal models during the transitional period

In total, BaFin has held over 100 consultations with interested companies to date. In this process, it has also made clear the importance it attaches to ensuring that all companies across the eurozone are supervised and regulated in accordance with the same standards. This principle of equal treatment also applies to internal models, which BaFin has to review and approve before institutions are allowed to use them to calculate capital requirements.

Currently, both Germany's BaFin and the Single Supervisory Mechanism (SSM) under the leadership of the European Central Bank (ECB) recognise internal models, if they have already been approved by the UK's Prudential Regulation Authority (PRA). When reviewing internal models, the PRA applies, until Brexit at least, the same benchmark as BaFin and the ECB: the European Capital Requirements Regulation (CRR). This will allow BaFin and the ECB to tolerate the use of internal models approved by the PRA for a transitional period, initially without conducting comprehensive and time-consuming reviews.

To this end, the German model supervisors at BaFin and the Deutsche Bundesbank – in accordance with European regulations – have specified a multi-stage process for interested institutions, during which they closely partner with the companies in workshops and supervisory interviews.

BaFin wants to achieve two objectives with this approach: undertakings relocating their operations from London to Germany in response to Brexit can use their internal models approved by the PRA without wasting time. Together with BaFin’s or the SSM’s model supervisors, they will at the same time embark on a process that ensures that the stringent German and European requirements to which internal models are subject are met on a permanent basis.

For a limited period – and in agreement with the ECB – BaFin is also prepared to permit the internal models already approved by the PRA for calculating capital in sister institutions, if certain conditions are met. First of all, the institutions must submit to BaFin the applications required for this purpose, including an action plan. Binding arrangements for further action can only be made once this has been done.

Back-to-back models

Back-to-back models, for example, must not be rejected as a matter of principle. Back-to-back trades occur when EU undertakings conclude transactions in financial instruments and at the same time enter into opposing trades with a company based in London in order to transfer the market price risk. The banks must, however, be able to manage the remaining risk expediently at any time by deploying adequately trained personnel.

Many undertakings also find it convenient for their back office and internal control functions, such as risk control, compliance or internal auditing, to be carried out largely by a company based in London. In these, as in many other cases, outsourcing is possible in principle. Striking the right balance is key. BaFin will not allow undertakings to simply latch on to corporate group structures. The undertakings domiciled in the EU must have appropriate control units. Limits are set on outsourcing, in particular where core areas of the business operation and the control functions are concerned.

Moreover, BaFin surveyed banks and insurance undertakings that operate in Germany under the European Passport. It is currently analysing the undertakings' responses on business and emergency planning for the exit scenarios.

Euro clearing

Since 2017, euro clearing has been a hot topic. More than 95 percent of all interest rate swaps in euros to date have been cleared through London. On 13 June 2017, the European Commission published its ideas for the stricter supervision of central counterparties domiciled outside the EU (see info box "Central counterparties domiciled outside the EU").