Dr Andreas Dombret
Member of the Executive Board
of the Deutsche Bundesbank
Speech at the 2018 Europe – US Symposium
of the Harvard Law School Program on
International Financial Systems in Armonk, New York Wednesday, 11 April 2018
Dr Andreas Dombret
Member of the Executive Board
of the Deutsche Bundesbank
Speech at the 2018 Europe – US Symposium
of the Harvard Law School Program on
International Financial Systems in Armonk, New York Wednesday, 11 April 2018
Keynote at the AIMA Global Policy and Regulatory Forum in Dublin on March 20, 2018
Ladies and gentlemen
Thank you for the kind introduction. It is a pleasure to be in Dublin and at the 2018 AIMA Forum.
“Managing a fragmented world” is, in my view, a well-chosen topic. Most economic policymakers currently have their hands full trying to escape the doom loop of a trade war and a potentially hard Brexit. At the same time, banks, investors and most other firms have to prepare for these worst-case scenarios – not least, because supervisors urge them to.
And of course such fragmentation in financial services and its regulation may cause nightmares for many in the industry as well as for policymakers. And I do understand that – because it implies a great deal of uncertainty.
But we should not, I believe, panic: greater fragmentation seems inevitable after Brexit. Though, repercussions will not be as bad, as some fear, when we succeed in managing this greater fragmentation constructively – that means without resorting to nationalism that would just be destructive for all of us.
My topic today, then, is to look at the estimated extent of fragmentation in regulation of financial services after Brexit and what we should do about it.
In Brexit negotiations common ground still seems hard to find. Even the basic principles of a new partnership remain vague. Given that and because time for preparation is running out for firms, uncertainty among businesses weighs heavier every day.
From an economic and financial market perspective, the two most important questions probably are:
In my view, there is substantial scope for a general free trade agreement. The main question to me is therefore how far-reaching can this future relationship be. For example an agreement without tariffs would be of high value and is possible. Another, less clear and highly complicated question is how to deal with non-tariff barriers like product standard regulations.
However, with a view to the financial services sector, a far-reaching free trade agreement is rather unlikely given the UK’s aspired exit from the single market and the customs union.
Likewise, I am rather sceptical about the approach via mutual recognition or about similar approaches based on regulatory harmonisation through technical committees and independent arbitration mechanisms.
Approaches of this kind could well undermine the ability of jurisdictions to set their own rules and the ability to safeguard financial stability.
The options that remain on the table are a “no deal” scenario or one with quite limited freedoms for financial services, as in the case of CETA. What would such scenarios mean to financial transactions between the UK and the EU?
First, the “no deal” scenario would mean that the EU and the UK would trade under rules set by the World Trade Organization – where services sectors are only thinly covered.
Service providers would then have to apply for comprehensive licenses in both jurisdictions and have all the necessary elements of a fully functioning bank ready in both places.
And second, even a CETA-like deal would most likely not mean far-ranging freedoms to provide financial services in the respective foreign jurisdiction.
Therefore, it is – like it or not – quite likely that we will see greater fragmentation in financial regulation and supervision in Europe. What exactly that will mean is, however, unclear up to now.
It is this uncertainty about the exact nature of fragmentation post-Brexit that makes it so hard to assess the costs and benefits of more fragmentation.
Financial firms highlight that fragmentation is likely to mean organisational inefficiencies and higher organisational costs. And there can be no doubt that at least the transition to a new regime and new organisational structure will be costly. However, these costs may be less substantial in the long term – once firms have adapted to the new regime, clever managers will find new organisational solutions that integrate new compliance realities with organisational efficiencies.
Significant as these costs may be, politicians, regulators, and supervisors nevertheless have to take a broader perspective, one that is in line with the changed democratic preferences.
Thus, from the UK perspective, a far-reaching free trade agreement for financial services – and services in general – could be considered an obstacle to taking back legal and regulatory power.
At the same time, from the EU perspective, we cannot accept a liberalised common market, without a common supervision. Otherwise, as a supervisor, I would be concerned about financial stability. It seems therefore that some degree of fragmentation is almost inevitable.
But, should we simply wait for the end of EU-UK financial relations? Should we simply hope for the best?
Of course not. We have to manage fragmentation constructively – we have to find innovative approaches for a new reality.
But let me make one thing very clear: this must not result in a race to the bottom. Fragmentation should not lead to competition through lax regulation or supervision. Such policies may seem to be in the best national interest, but ultimately they represent special interest politics. We must expose these policies for what they really are: threats to financial stability.
And that is why politicians, firms and supervisors have to deliver on three crucial points: first, a transition agreement; second, pragmatic supervisory cooperation; and third, managerial innovation.
Let me take each of these briefly, starting with the transition – or implementation phase, as it is now called.
A transitional deal between the UK and the EU was agreed yesterday on negotiators’ level. During the implementation phase, which is to last until end 2020, EU rules would continue to apply in the UK and the exact terms of the future partnership shall be worked out. It is of utmost importance in order to give firms more time to adjust to the new realities.
It furthermore can reduce the long-term costs of Brexit. Firms can weigh up their options and decide which markets they want to serve and with which organisational design. They have now time to re-arrange their organisations on the basis of an analytical and forward-looking approach, rather than an approach of simply minimising uncertainty. The inefficiencies and potentially higher costs of financial intermediation can be reduced with this agreement.
I am confident that both sides have apparently recognised the importance of a transition phase in making Brexit less abrupt and, in the long run, less painful.
Despite all this positive news, it is still too early to lay back. Many issues are still to be discussed and the transitional period is still not fully guaranteed. It remains to be subject to a successful conclusion of an Article 50-deal within the next twelve months. For instance, the Irish question – i.e. keeping the border between the Republic of Ireland and Northern Ireland invisible – needs to be resolved. Hence, the recently widely used phrase that “nothing is agreed until everything is agreed” still holds true.
But even after a transition phase, Brexit and fragmentation would mean two things. First, future access to financial services markets would be more like the access given to a third country. Second, a successful conclusion of the Brexit negotiations is not guaranteed as it depends on whether a fully-fledged long-term agreement is achieved and ratified.
This is why I see no alternative to timely preparation, and to preparing for the worst-case scenario of a hard Brexit without any free trade agreement.
Looking at banks, proper preparation would include establishing at least basic entities in the other economic area – that is, the EU27 or the UK – in order to continue doing business there. The concept of a “basic entity” is not easy to define. As far as we are concerned, I can repeat that we will certainly not accept empty shells or letterbox companies where the business effectively continues to be run from London. For critical functions such as management, controlling and compliance, qualified personnel need to be present at the EU entity at all times. We expect any branch or subsidiary to retain chief responsibility for its business.
And banks have to begin implementing their plans and submitting their license applications no later than at the end of the second quarter of 2018. Otherwise, it will be very difficult to prevent a cliff edge.
Firms have a lot to complain about with regard to Brexit, and I do not mean to play this point down. But if the UK and the EU are attractive markets, I think there is something to be said for innovative approaches to comply with this new regime. That’s why firms will have to find new, efficient organisational strategies. For example, I am convinced that profitable business models can be organised with two independently licensed entities.
But don’t get me wrong: regulators and supervisors, too, have to be pragmatic and innovative to achieve our goals of efficiency, stability, and ensuring the real economy is provided with credit.
With financial sector firms relocating their business between London on the one hand and Frankfurt, Dublin and other cities on the other hand, close supervisory cooperation becomes even more important, especially over the coming years when we have to break new ground in supervision.
The cooperation between the EU and the UK authorities will have to be put on a new foundation. We will need to ensure information exchange, and of course we will have to think about how we can reduce unnecessary burdens from double licensing.
Whatever political decision is taken, bank supervisors will not only do all they can to make the transition to a new regime as smooth as possible; they will also, in the long run, try to reduce unnecessary inefficiencies where possible.
In December last year, the PRA published a draft proposal for a post-Brexit supervisory approach. I very much appreciate the spirit behind this approach. It reflects a solution-oriented, pragmatic, yet stability-oriented stance. In the same vein, the SSM has developed quite pragmatic, cooperative policy stances on many of the relevant issues. I am confident that this cooperative style can make an important contribution towards a smooth transition.
Ladies and gentlemen, greater fragmentation will most likely be an inevitable result of Brexit.
Instead of wishing to do away with what is beyond our control, we should set about finding pragmatic and at times innovative solutions to managing Brexit and the ensuing fragmentation constructively.
However, such a constructive approach will take time, because it means many complex answers have to be developed – which is why we need a sufficiently long transition phase.
And I have to say that I was really facilitated well and truly relieved when I heard the news yesterday that a transition phase had been agreed, because this could make Brexit less abrupt and, in the long run, less painful.
During that phase, supervisors will have to find solutions that enhance financial stability without undermining economic efficiency.
And financial firms will have to find innovative and pragmatic ways to comply with the new demands while maintaining their efficiency and profitability.
For all the bullet points on our to-do list, we need an honest dialogue – if unnecessary problems and burdens arise, firms and investors should always come and talk to us. Brexit is both too complex and too important to muddle through.
Thank you for your attention.
Dombret, Dr. Andreas. “Living with Fragmentation: Post-Brexit Realities in Financial Services.” Speech, Dublin, Ireland, March 20, 2018. Deutsche Bundesbank. https://www.bundesbank.de/Redaktion/EN/Reden/2018/2018_03_20_dombret.html
“We see an unbroken interest in the German financial centre among banks that are considering relocations due to Brexit. Supervisors and politics have already done a lot over the past 18 months and are well positioned, but we must continue to work,” says Stefan Winter, Chairman of the Board of the Association of Foreign Banks in Germany (VAB) at today’s press conference. Among other things, there is a need for action to limit severance payments to high earners in the banking sector and to internationalise the law. For example, German law is often not agreed upon internationally in framework agreements, because German courts also examine these in commercial transactions as well as all general terms and conditions for consumers. “As a result of the Brexit, we expect about 20 banks to expand their presence here. This will involve up to 5,000 new jobs in the next two to three years, many of which will be hired locally. Much will of course depend on whether there will be transitional periods. In fact, everyone agrees that there must be transitional arrangements. But no one can say for sure today whether there will be any. Our members are therefore still planning to have fully operational units in Germany on 29 March 2019 so that they can continue to provide financial services for their customers,” Winter emphasises.
Silvia Schmitten-Walgenbach and Guido Zoeller, the two vice-chairmen, emphasise the stable number of employees in the member institutions, which are also attributable to the good framework conditions and the still prosperous German economy. In addition to the economically stable situation, the foreign financial industry has also benefited greatly in recent years from international harmonisation, which is also an advantage for international supervision. The ECB has taken on an important role in this respect and further developed a level-playing field in the euro zone. Schmitten-Walgenbach adds: “In the interest of international financial stability, national recentering and a softening of internationally harmonised financial market regulation should therefore be avoided.”
As the financial centre becomes more international, Zoeller points out the impact on the work of the Association: “We will provide even more information in English and set up English-speaking working groups.” As the international importance of the financial centre grows in the next few years and institutions increasingly choose the place as a starting point for their financial services in other EU states, the association must also address new issues. “So far, we have tended to have an inbound view, but this will change. We will be prepared for this and we are looking forward to it,” summarizes Winter.
The complete speech can be found in the internet at www.vab.de.
The Federal Government and the Hesse State Government are convinced that the financial hub of Frankfurt will take on a more prominent role after Brexit based on its outstanding qualities. At the same time, they emphasise that Frankfurt should be the home of the relocated European Banking Authority after the United Kingdom has left the European Union. Hesse Prime Minister Volker Bouffier joined Federal Minister of Finance Peter Altmaier, and the special representative for the EBA bid, former Federal Finance Minister Dr. Theo Waigel, in Brussels on Tuesday to present the German bid to host the European Banking Authority.
“Frankfurt is the main financial hub on the Continent and it is only logical to have the European supervision where most of the trading and exchanges actually takes place,” said the Hesse Prime Minister at the event held at the Representation of the State of Hesse. “I deeply regret Brexit, and I am convinced that it is neither a positive development for the United Kingdom nor for Europe. We are determined however to use the opportunities which do arise for the benefit of our country.”
The European financial market will be completely reshaped by Brexit, explained Peter Altmaier, Federal Minister of Finance and head of the Chancellor’s Office. For example, banks are required to have established offices in the European Union, if they want to be able to offer their products in the European Union. They are therefore currently looking for the ideal location to establish such subsidiaries. The Frankfurt bid to host the EBA signals our clear intent to other EU Member States that we are focused on planning for the future and that stability will be our watchword.
“Frankfurt offers outstanding infrastructure in the heart of Europe, an unrivalled network linking all the key players in the financial world, and an internationally-oriented environment,” stressed Bouffier. This includes international schools, 34 universities within 1 hour’s drive and 100,000 people working in the finance industry who bring a wealth of expertise to the table. “This is the ideal basis on which to relocate international authorities such as the EBA quickly and seamlessly, and to hit the ground running immediately. Any argument based on the facts and on industry requirements clearly points to Frankfurt as the ideal location,” said the Prime Minister.
“The financial markets are traditionally very sensitive to change, and Brexit is a change of quite epic proportions. It is therefore all the more important that we ensure stability and reliability for Europe in this vital sector by relocating the European Banking Authority to Frankfurt,” said former Federal Minister of Finance Dr. Theo Waigel, who is supporting the German EBA bid as a special representative. “Looking at it objectively, Frankfurt is the most suitable location for the European Banking Authority, because it links the body to the European Central Bank and the insurance regulatory authority, EIOPA, both geographically and with regard to personnel, and will therefore allow the close collaboration which will be absolutely crucial to the future of this sector.”
“In our view, Frankfurt is the logical location for the European Banking Authority,” said Hesse Minister for European Affairs, Lucia Puttrich. This opinion is often repeated in meetings with representatives of other Member States. Nevertheless, Frankfurt’s bid is by no means a foregone conclusion, as political considerations may also play a role in addition to purely technical criteria when the decision is taken on 20 November.
Alongside many other benefits however, the relocation of the EBA to Frankfurt also provides an opportunity to improve efficiency and increase political clout, since much of the EBA’s remit overlaps with that of the European Central Bank, the single EU banking supervisory mechanism SSM, the European insurance supervisory authority, EIOPA, and other European financial institutions. Deutsche Bundesbank and the Federal Financial Supervisory Authority also have their headquarters in Frankfurt.
“The State Government and all relevant partners in Frankfurt and the Rhine-Main region have a shared vision and are working together closely on the Brexit issue,” said Puttrich. Frankfurt is set to benefit from Brexit. A number of banks and other financial institutions have already announced plans to relocate there, or to expand their existing operations. Others seem sure to follow. “We are therefore planning for the future positively and with confidence.”
Following Brexit, the European Banking Authority (EBA) will have to relocate within the European Union. Alongside the Frankfurt bid, there are a further 7 bids from other EU Member States. The decision regarding the future EBA location is due on 20 November.
Ladies and Gentlemen,
It is now slightly over a year ago that the decision was made in favour of Brexit. I don’t know how you felt about it, but for me Brexit felt like a turning point, possibly the biggest setback in European integration since the European Coal and Steel Community was first founded in 1951. For a long time it looked as though Jacques Delors, former President of the European Commission, had almost set the path of politics in stone with his words “Europe is like a bicycle: you keep pedalling or you fall off.” More and more countries joined the European Union, and more and more responsibilities fell within the remit of the European Parliament and the European Commission.
And not just for the fun of it, or because the political decision-makers felt like it, but because a more connected world called for European, if not global answers. This was true in particular for financial regulation, which is now undoubtedly one of the most rigorously and thoroughly Europeanised legal fields there is. And again, not without reason. In an environment of complex and globally established markets, financial regulation depends on strong European players. The same is true for the member states of the EU, which need the maximum possible level of harmonisation and protection in a single economic area. Furthermore, Europe needs a strong, unified voice in the concert of global standard setting – just think of Basel, for example. This applies all the more if the USA really does decide to proceed down a path of more deregulation and less international cooperation.
As necessary as Europeanisation is in this matter, it also creates friction. We didn’t need Brexit to see that an increasing number of people from many different places were lamenting the apparent dominance of international bodies over national interests.
It would be wrong to look only at other countries or other continents – or only at the filter bubbles on Twitter. Similar expressions of political volition and resentment can be found in Germany, too, both online and in the real world. I don’t find that surprising, either. Concepts that in some speeches are called “an ever closer union” and “European harmonisation” simply mean loss of sovereignty in everyday life at national level.
This becomes particularly relevant when individual European regulations and the national implementation thereof lead to public debates, as we saw recently in the case of the Mortgage Credit Directive, for example. A European directive, the essential goal of which was to protect financial stability, entered into a fraught relationship with the hopes, fears and concerns of individual citizens, for example young families, who expressed these concerns to their representatives in the national parliament, which in this case was the German Bundestag.
This means that even Europe’s ever closer union calls for constant tuning between too much and too little, between bold vision, feasibility and impact analysis, taking particular account of the extent to which different interest groups are affected. And maybe the approach of seeking the greatest possible level of uniformity by trying to spell out each individual detail should give way to a new European conviction of an increased focus on principles. To say it in the language of cycling: The Tour d´Europe has to make headway. But the route and pace must be chosen carefully so that the peloton does not run the risk of failing to keep pace. Or, even worse, that some might want to fall behind.
Ladies and Gentlemen,
As much as I lament Brexit, there is little point in regretting missed opportunities or engaging in Brit bashing. We should look to the future and build a foundation for the time after the United Kingdom’s departure from the European Union. Of course, that will not be an easy task. Above all else the question looms of future reciprocal market access in the relationship between the United Kingdom and the EU27 countries. For the time being we have to assume that the UK will become a third country following Brexit. And that in itself will become an exciting challenge, both for politicians and for financial regulators and supervisors.
It is clear that the existing building blocks for market access based on equivalence, as known from the relationship with Switzerland or Bermuda, cannot be applied to the departure of the United Kingdom. The size of the financial market there and the vast level of mutual economic dependency that has built up over the last decades are alone sufficient as an argument against such an approach.
Just under half of the United Kingdom’s total exports go to the European Union, making the EU the UK’s largest market worldwide. Looking at imports shows a similar picture. The issue is even more complex in the financial sector, because economies of scale caused by historical circumstances have made London the hub for capital flows to the EU. For an industry with such cross-border interdependencies and in which trillions of euros are moved around in cyberspace, dealing appropriately with a situation such as Brexit presents a significant challenge. And there is no master plan, nor an emergency handbook that companies or regulators can simply pull out of their pockets. This is uncharted territory for all of us, and we have to pave our path as we proceed along it.
If we break the bigger regulatory picture down into its individual parts, at first glance the situation looks manageable. But, in actual fact, on many issues the devil is in the detail. Scores of banks 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 EU countries.
As the passport may only be used by banks authorised in the EU, some branches in EU27 countries will undoubtedly be converted into subsidiaries. In addition to this, there will also be newcomers. Our objective is to provide these banks with guidance for their projects in Germany, offer them legal certainty and, at the same time, ensure the stability of the German financial centre. Moreover, we must make certain that all institutions across the eurozone are supervised and regulated in accordance with the same standards. But another thing is clear: everything we do, we do as supervisors, not as agents for location policy. One thing that we definitely will not accept is the presence of empty shells containing nothing more than a letterbox and a telephone diverting calls to London.
However, there is a broad array of possibilities between letterbox companies and a wholesale move to Germany. We will therefore look closely into each business model and weigh up each legally possible option. We will also keep a close eye on the further development of the European Commission’s proposal to create “Intermediate EU Parent Undertakings (IPUs)”, i.e. single parent companies into which banks from third countries are supposed to bundle their EU subsidiaries in the future.
This discussion is still a long way from being over. First of all, the European legislator needs to introduce the necessary legal requirements during the review of the Capital Requirements Directive (CRD). In this respect, we, as supervisors, would also welcome an EU-wide harmonisation of the rules and regulations on third-country branches, which at present are regulated only at national level.
Would it help financial stability if any cliff effects that might occur in spring 2019 could be effectively minimised? I think so! We are therefore prepared, for example, to relieve banks of work that at short notice is almost unachievable. For instance, we have decided, in agreement with the ECB, to permit internal models for calculating capital in sister companies for a limited time period where these have previously been authorised by the British supervisory authority, the Prudential Regulation Authority (PRA), provided that certain conditions are met. However, the institutions must first of all submit to us the applications required for this, including an action plan. And, of course, binding agreements must be reached regarding specific further activities.
Usually, several supervisory interviews and workshops will be required, in which the models that the institutions have used previously and the structure of possible transition processes will be clarified, step by step. Only after a number of checks will the bank be able to use its internal model in practice. The bank will remain on the radar of ongoing model supervision, however, with the goal of establishing, within a predetermined period of time, a model structure which we have inspected ourselves.
We have already conducted initial workshops with some institutions, and the experiences so far have been very positive. Others are taking their time in letting us know their intentions. I’m sure that everyone in Germany knows the saying “he who comes too late is punished by life”. Supervisors are not that merciless. But I would like to point out that our resources are limited, too. Institutions would do well to submit their applications for authorisation extensions or licences sooner rather than later, and rectify any potentially missing details during a dialog-oriented application process. Otherwise they run the risk of ending up at the back of the queue.
Ladies and Gentlemen,
Another hot topic is that of back-to-back models. Back-to-back here means EU undertakings concluding a transaction in financial instruments and at the same time entering into inverse trading transactions with a company based in London in order to transfer the market price risks. In principle there is no reason to object to this. However, we expect institutions to have adequately trained employees available for such transactions who are able to assess how many risks and which risks – including market risks – are actually being passed on to the UK, or, looking at it the other way around, how many are to remain in the EU. The banks must be in a position to sensibly manage the remaining risks at all times – even if a back-to-back transaction should suddenly no longer be possible or be subject to disruptions. An out of sight, out of mind mentality would be dangerous.
Many institutions 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. The same applies here: in principle, as in many other situations, outsourcing is possible.
As is always the case, however, it comes down to finding the right balance. If an institution goes overboard in outsourcing sensitive areas, the in-house control systems might be thinned out so much that the institution becomes disproportionately dependent on partners in the UK or elsewhere. Simply latching on to group structures will therefore not be allowed. Appropriate control units must be present within the EU undertaking, and all undertakings wishing to move into the EU for the first time should therefore prepare for the fact that these functions are to be present within an institution in the EU27 countries. This corresponds to the line taken by the Single Supervisory Mechanism (SSM), which has already stated its basic position on this – and, of course, we share that view. However, there are possible exceptions to this rule for those subsidiaries which are considered immaterial from a risk point of view.
Limits are set on outsourcing in particular where the core areas of banking and control functions are concerned. And if we look closely at the core areas and control functions, we do this all the more for the management board. The duties of a management board member cannot be fulfilled by “just dropping by”.
It must be ensured that the managers are also able to complete their on-site duties in full. “Fly and drive” might be acceptable in some cases and for a transitional period, but in the long-term we also expect the top level of management to be present in the EU27 countries with more than just a nameplate.
It is not without reason that euro clearing is a hot topic at the moment. After all, more than 95% of all interest rate swaps in euros to date have been cleared through London. If something were to go wrong, a call for help could quickly be made to the central banks to provide liquidity. For this reason, a few weeks ago the European Commission published its ideas for the stricter supervision of central counterparties domiciled outside the European Union.
It is obvious that clearing activities in euros outside the European Union cannot simply be met with a shrug; instead, EU standards for financial regulation and supervision must be enforced in one way or another.
But the question gripping us all is: how, exactly? In the end, the European Commission left this unanswered, but instead suggested a staged process. In my opinion, this is the correct approach. Before making a decision, however, we should take the time to carry out a comprehensive analysis of the systemic risks and weigh up the possible reactions and consequences, including the possible reactions of third parties.
Moreover, we must not forget that nowadays almost all business processes in the financial sector depend on functioning IT infrastructures. As such, it comes with the territory that those banks that are planning a comprehensive division of work between operating units in the UK and the EU need to place a particular focus on their IT systems. These are highly complex platforms, and platforms doesn’t just mean IT. We are talking about knowledge, processes and people which have gathered together over many years, almost like a complete work of art, and now have to be split apart.
Supervisors know the significance of this issue and are prepared to allow old IT ecosystems to continue running for the time being until it is possible for completely new structures to be built and proven to be sufficiently sound. Many a time in the past we saw large IT migration projects being met with delays and unexpected problems, simply because their complexity was underestimated. In theory it would be conceivable to leave such platforms in their former locations entirely, but I have my doubts as to whether this would be of any use in practice. New offices have to be connected to the existing infrastructure in one way or another, meaning that migration processes are likely to remain unavoidable.
The institutions therefore have to carefully weigh up which strategy they wish to pursue: partial or complete relocation. Anybody who has moved house knows that while it is inconvenient, it also offers a good opportunity to declutter. Just as private individuals might get rid of Grandma Edna’s transistor radio, banks can take the chance to modernise old IT systems and processes that have diverged over time.
Yet from the point of view of a New York head office, for example, decluttering might also mean simply focussing completely on the USA or the Far East if the disputes between the UK and the EU27 countries are too drawn-out.
New jobs in the banking sector – this is the expected result of relocations from London to Frankfurt. Well-founded estimates speak of ten thousand additional jobs within the next four years. The overall increase in job growth associated with Brexit is significantly higher because multiplier effects cause growth in other industries as well, according to the findings of an academic study conducted by WHU – Otto Beisheim School of Management on behalf of Frankfurt Main Finance.
“We investigated the effects of the relocation of banking jobs as a result of Brexit on the entire labour market for the city of Frankfurt, the neighbouring cities and the Rhine-Main area,” says Prof. Dr. Lutz Johanning, one author of the study. “Our study shows that the multiplier effect is between 2.1 and 8.8, depending on the area examined. If we consider adding 10,000 new jobs in the banking industry over the next four years, then, according to our prudent estimate, an additional 21,000 jobs could be created in Frankfurt City. In the optimistic case, this could result in up to an additional 88,000 new jobs in the Rhine-Main region.”
Moritz C. Noll, co-author of the study, says, “With our models, we demonstrate that the long-term growth trajectory is changed by an initial shock, in other words, the additional jobs in the finance sector due to Brexit. Thus, we argue that the growth effects on the labour market can be significantly higher than the initial effects suggest. There’s still room for further gains.”
Hubertus Väth, Managing Director of Frankfurt Main Finance, says, “The job growth will further advance the economic strength of Frankfurt and the region. A real success story for all parties involved. Now, it is important to absorb and shape this growth positively. That is a challenge. However, the additional jobs also bring the funds to invest and master the challenge.”
Based on the assumption that 10,000 financial sector jobs will relocate to Frankfurt due to Brexit, this also results in additional tax revenues for the city of Frankfurt. In the conservative scenario, the net gain from income, value-added and local business taxes is around 136 million euros per year, while the optimistic scenario would yield nearly 192 million euros.
That also applies to the question as to where the financial centre of the European Union will in future be located. The place to be has been London up to now. The race for a successor has already started some time ago and the competition is tough: Amsterdam, Brussels, Dublin, Frankfurt, Luxembourg, Paris and Warsaw are all doing their best – each city in its own way – to become the hotspot of the international finance industry.
Long before the UK made its decision, Frankfurt made initial preparations: to have a voice and be articulate, to provide interested parties with considered answers, to seek dialogue – that is a fair description of what representatives from the Hesse state government and the Hessen Agentur /Hessen Trade & Invest as well as from Frankfurt Rhein Main and Frankfurt Main Finance have wanted to achieve from the outset. With success, as the round table discussion with their representatives shows: those taking part comprised Wolf-Dieter Adlhoch, Head of the Brexit Office in the Wiesbaden State Chancellery, Dr. Rainer Waldschmidt, Managing Director of Hessen Agentur/Hessen Trade & Invest, Eric Menges, Managing Director of Frankfurt Rhein Main GmbH, and Hubertus Väth, Managing Director of Frankfurt Main Finance.
Dr. Rainer Waldschmidt: Communication was the key from the very beginning. As early as during the discussions about the referendum, we already started to bring together important representatives from city and state institutions around the table for talks so as to agree at a very early stage about the concerted action we should take. One important point, for example, was that we don’t focus on Frankfurt as a city, but talk about the Rhine-Main region, because many aspects relating to the issues of talent, infrastructure and quality of life gain their relevance from the circumstances and realities within this larger region.
Eric Menges: It helped us considerably that we had already programmed a complete website before the Brexit decision, which we were able to set up live on the morning the results were announced. That involved a certain risk: the effort might well have been in vain. But it meant we had betted on the right horse, even though we would have preferred the vote to go a different way. There was a massive interest in receiving up-to-date information from this point onwards, as you can imagine. Our swift action received a great deal of positive feedback, especially in the social media. The nicest comment was to the effect that here’s a region that seems better prepared than the rest of England. We allowed ourselves a wry smile on reading that.
Hubertus Väth: Alongside the website, there was also a Twitter and a LinkedIn campaign with a simple, clear-cut message: welcome. As early as 6.20 in the morning, the media were already on the phone and wanted to know whether, and in what way, Frankfurt was prepared. Since then, there have been around 500 inquiries from journalists from over 40 countries. Even now, no week goes by without two to three inquiries coming in.
Wolf-Dieter Adlhoch: There are undoubtedly a lot of hard facts that speak in favour of the Rhine-Main region. Already today we are one of the most important financial centres worldwide. All the major German banks and over 150 foreign banks are present in and around Frankfurt. The most important regulatory authorities, and first and foremost the ECB, are resident here. Another merit is that the German economy is strong and robust, and – more important than ever in times like these – we enjoy a high degree of political stability. The taxes in Germany are not as high as sometimes assumed; 30 percent on average for companies, that makes us competitive. Our labour law is flexible, fair and above all efficient. As far as infrastructure is concerned, our Frankfurt Airport makes us unbeatable …
Menges: I always like to point out that it’s as close as London’s City Airport and as efficient as Heathrow.
Adlhoch: It’s important to us, however, that we don’t just beat our own drum, but that we present objective arguments.
Väth: Three messages have been clearly heard: Europe still needs the international standing of the financial centre of London, which is why we don’t want to harm London as a financial location. We want to build bridges and not tear them down. And we want to work together effectively in future as well.
Menges: Yes, that’s true: we aren’t conducting any superficial advertising campaign, as other financial centres are indeed doing. We are talking with decision-makers in the companies. And many, very concrete questions have emerged that we didn’t at first have in such clear focus. One example: international schools. You can imagine that’s an important issue for employees who are to come to Frankfurt in future with their families. So we brought all the international schools in the region – more than 30 altogether in and around Frankfurt – together around a table and discussed with them whether they are ready in their structure or in their capacity planning to accommodate a large influx of new pupils. The answer is yes. The diversity of schooling options available is also impressive. Armed with such information, we then go back to our discussion partners and can usually answer their questions in all the necessary detail.
Waldschmidt: Available office space is also a topic that comes up again and again in discussions. That’s why we have surveyed the availability and quality of sites together with the local real estate brokers. Specifically: we have 750,000 square metres of vacant office space at the necessary quality level in the preferred inner-city area. Moreover, project development plans are showing a further increase in these A-grade premises. Consequently, we can take up all the people that serious forecasts suggest for the first wave of immigration caused by the Brexit. When we talk about such changes, things don’t happen overnight. Instead, we assume that three waves will take place, each with different regional effects. The first wave will directly impact the financial centre, and therefore Frankfurt and its immediate surroundings, at the very core. The second wave will involve the relocation of European headquarters, i.e. distribution and back office as well. The radius of impact will expand to take in the belt around Frankfurt. It’s only during the third wave that industry will be affected, and that’s where the whole of Hesse is of interest.
Väth: Although we have pole position, the race isn’t over yet. It’s too early to take a breather. Exogenous factors, such as a possible US tax reform, can still change crucial parameters to our disadvantage. We must also point out that the competitors are doing a good job and are achieving some success – for instance in the domain of insurance companies and asset managers. The question of the future of euro clearing will certainly be of great importance – and area where exciting days and weeks lie ahead of us. Here, too, we’ve already done a lot of educational work. But, having said all that, it’s also time to say thank you. Whether BaFin or the Bundesbank, the state government or national government – outstanding work is has been and is being carried out when it matters, and this doesn’t go unnoticed. It has also been remarkable just how many of our members have unselfishly contacted us and asked whether they can do anything for us. Needless to say, we didn’t say no and were able to get a number of things moving. Also noticeable was how actively new members approached us and said that they now understood why we are important and why it makes good sense to participate.
Adlhoch: We take the feedback we receive from the many individual discussions we hold as representatives of state government, of Hessen Agentur, Frankfurt Rhein Main and Frankfurt Main Finance very seriously. What is well received is the confidential dialogue, and that’s why our focus will remain in this area in future. What we will do more intensively is to organise a direct exchange with experts. This region is home not only to the banks and regulators, but also to all those lawyers and consulting companies that are so necessary for the financial industry. We clarify detailed questions about labour law, tax issues and regulatory aspects by mediating contacts and networking experts. One thing we won’t be doing is to promote the location with the help of short-sighted gifts – i.e. allowances, benefits or privileges. We are firmly convinced that as a region we have what we need to make our case effectively to companies and to help them make the right decision in their strategic location. Last but not least, this also applies to the quality of life. We’ve not spoken a lot about that today, but everyone familiar with the Rhine-Main region knows all too well that the spectrum of leisure and cultural activities on offer is really quite impressive.
Just six weeks before the Brexit Referendum, in his keynote at the 2016 Frankfurt Finance Summit, Dr. Wolfgang Schäuble, German Federal Finance Minister, described this as possibly the biggest political decision in a generation. Schäuble stated that “I think both the EU and the UK are better served with Britain remaining,” and later posited that “Great Britain’s relationship with Europe should not be defined by splendid isolation, but by splendid integration.” Last year’s nightmare became this year’s reality. Article was triggered on March 29, 2017, and official negotiations are underway and on the clock. This year’s Summit, titled Europe Reloaded – Challenges for the Financial Sector, will seek to encourage productive dialogue on how Europe can move forward after Brexit.
With the formal declaration by the United Kingdom’s government to withdraw from the European Union, Brexit has now entered a new and decisive phase. Hubertus Väth, Managing Director of Frankfurt Main Finance e.V. states, “The beginning of the exit negotiations between the United Kingdom and the European Union are imminent. The negotiating parties are entering uncharted territory. Of the utmost importance, will be standing fast to the maxim that maintaining stability in the financial system must take precedence over individual interests. Both parties must strike the delicate balance between averting a cliff-edge scenario while still maintaining the recognizable appeal of membership in the EU.”
The United Kingdom’s withdraw from the EU is regrettable. The anticipated loss of rights, including passporting, will create a dramatic shift of banking and financial services out of London. While bad for London, and Europe in general, European financial centres are poised to profit from this exodus. “The Financial Centre Frankfurt is exceptionally situated to assume a position functioning as a bridge for London into the EU,” explains Väth, “As the home of the European Central Bank, the Europe’s insurance supervisory mechanism, Europe’s largest stock exchange and the largest internet hub for data traffic, Frankfurt offers best infrastructure for credit institutions and financial services providers active across Europe. Frankfurt’s TechQuartier and dynamic, growing FinTech ecosystem have been distinguished by the Federal Government with the Financial Centre Frankfurt’s appointment as Germany’s Digital Hub for the finance industry. Therefore, we still estimate that around 10,000 jobs will be relocated to Frankfurt in the coming years.”
These estimates of jobs moving to Frankfurt are not empty estimations. Just last week, Väth reported in the Financial Times that Frankfurt already has more than an indication from three of the five largest US banks, as well as a Swiss, Japanese, Korean and Indian bank that they have either decided to relocate operations to Frankfurt or are in the process of doing so. Clearly, Frankfurt is in the pole position to benefit from Brexit, but certainly not alone amongst European financial centres. Each financial centre is uniquely equipped to accept certain functions and business units. For example, Luxembourg and Dublin are ahead with asset managers. Warsaw’s affordable and well trained talent pool should result in an influx of back office functions. It seems certain that operations will move out of the City of London, but will be fragmented across European financial centres.
However, major questions still linger. What will the new financial centre landscape look like? Will Euro Clearing be forced under ECB jurisdiction? If so, who will win this 500 billion EUR market? Will the European Banking Authority join the other European regulatory functions in Frankfurt? The future of Europe and its financial centres will be the topic of the 2017 Frankfurt Finance Summit’s first keynote and panel discussion.
In its position paper “Exit negotiations between the European Union and the United Kingdom: Minimise Brexit Risks and Strengthen the European Capital Market”, Deutsches Aktieninstitut has identified the essential issues with relevance for capital markets and which deserve particular attention due to their significance for business and society in connection with the Brexit negotiations. Furthermore, it makes proposals how the negative impact of Brexit on the affected national economies can be minimised.
In particular, Deutsches Aktieninstitut makes an appeal to the negotiation leaders to enter into objective and constructive talks. The strong economic relationship between the United Kingdom and the European Union should be maintained despite the new framework conditions. It is absolutely essential not to damage the core of the European idea, which is manifested in the four fundamental freedoms of the single market.
“It is up to the negotiators to shape the future relationship between the European Union and the United Kingdom in such a way as to minimize the negative impacts of Brexit for both sides,” emphasizes Dr. Christine Bortenlänger, Executive Director of the Deutsches Aktieninstitut. “With our position paper and its recommendations, we are doing our part so that the start of negotiations can begin on a sound footing from a capital markets standpoint and ultimately to lead to favourable results.”
Luka Mucic, Chief Financial Officer of SAP SE and member of the Executive Board of the Deutsches Aktieninstitut, highlights the importance of the position paper for the forthcoming negotiations. “The paper clearly articulates the stance of the Deutsches Aktieninstitut and its member companies. Negotiators must do everything they can to prevent distortions of competition through tax dumping and a deregulation race between British and EU markets,” explains Mucic.
The central demands of the Deutsches Aktieninstitut are:
These results were developed within the framework of the Brexit project of the Deutsches Aktieninstitut. The project identified topics relevant to the comprehensive economic relations between the European Union and the United Kingdom that will play a role in the coming Brexit negotiations. The interdisciplinary project group, consisting of representatives from member companies of the Deutsches Aktieninstitut, will closely follow the content of the negotiations and as necessary, share its position on each respective negotiating stance.
In a comparison of European financial centres, Frankfurt clearly ranks in second place behind London. With numerous qualities in its favour, the German banking centre is an attractive location for domestic and international players in the financial sector and has the potential of becoming the preferred destination for Brexit-related job relocations. The following assets that Frankfurt possesses are of particular benefit: The stability and strength of the German economy, the headquarters of the ECB in its dual function, a transportation hub with a good level of infrastructure, relatively low office rents as well as a high quality of life. This is the conclusion that Helaba’s economists arrived at in their Financial Centre Study “Brexit – Let’s go Frankfurt”. But it has serious competition in the shape of Paris, Dublin, Luxemburg or even Amsterdam.
Dr. Gertrud Traud, Helaba’s Chief Economist and Head of Research, stresses: “If Frankfurt really is to become the principal winner of Brexit, it will require a concerted effort on regional, national and European levels as well as a more self-confident approach.”
In addition, a further improvement in the conditions offered by the city is essential to ensure its success. In view of Frankfurt’s excellent position in the framework of European financial centres, demonstrated by various studies, Helaba’s economists believe that it has good chances of picking up at least half the jobs in the financial sector that will be shifted from London to Frankfurt in a restructuring process lasting many years. Thus, Frankfurt now faces the task of putting the necessary prerequisites in place, e.g. in the housing market. Based on very cautious assumptions, a total of at least 8,000 employees would come to Frankfurt over a multi-year period. Since companies cannot wait for the outcome of negotiations, more than 2,000 jobs are expected to be relocated by as early as the end of 2018 already.
“This Brexit-induced effect on the labour market will act as a counterbalance to consolidation in local banks”, says the author of the study, Ulrike Bischoff. Both effects should, more or less, cancel each other out within the forecasting window. By the end of 2018, the study anticipates a total of just over 62,000 bank employees in the German financial centre.
The complete Helaba study is available for download here.