Photographer: Martin Leissl/Bloomberg

EU Braces for Brexit by Tightening Rules for Investment Firms

  • Biggest firms would be supervised by ECB under commission plan
  • Access criteria for companies outside the EU to be toughened

The European Union plans to plug a potential Brexit loophole by bringing the biggest investment firms in the euro area under European Central Bank supervision.

Under a bill proposed on Wednesday by the European Commission, the EU’s executive arm, the ECB would assume oversight of companies classified as “systemic,” while smaller firms would become subject to a new regime that’s better tailored to their activities. The larger firms are mostly units of major investment banks.

“Smaller investment firms will benefit from simpler requirements which are more in line with their risk profile,” Valdis Dombrovskis, the EU commissioner in charge of financial-services policy, said in a statement. “At the same time, larger firms posing similar risks as banks should be regulated and supervised like banks.”

Investment firms are currently covered by parts of the EU’s prudential rules for banks as well as by securities laws, and are supervised at the national level. That’s prompted warnings from Daniele Nouy, head of supervision at the ECB, that big U.K.-based broker-dealers and other firms may choose their new EU headquarters based on the most attractive supervisory regime, creating the threat of a regulatory “race to the bottom.”

Euro Area

“In the U.K., large and systemic broker-dealers are supervised exactly like banks,” Nouy said earlier this year. “This is what we need in the euro area as well.” The European Banking Authority has also said that large investment firms in the euro area should be supervised by the ECB.

Broker-dealers trade securities for their own account or on behalf of other firms. When they trade for their own account, they act as dealers; when they trade for other customers, they act as brokers.

The EU’s biggest investment firms are concentrated in the U.K., but are in the process of shifting operations to the rest of the bloc to retain market access after Brexit, the commission said.

As of December 2016, the BOE’s Prudential Regulation Authority regulated investment firms including Morgan Stanley & Co. International Plc, Citigroup Global Markets Ltd. and Barclays Capital Securities Ltd. If these firms operate in the euro area, they could potentially come under ECB oversight if they clear an asset threshold, according to the bill. If they already have a banking license in the euro area, little would change for them.

Bonus Cap

Firms deemed systemic would continue to be governed by the banking framework that converts global standards into EU law, and also includes such contentious issues as a cap on executives’ bonuses. This classification is applied when a firm carries out bank-like activities such as underwriting and dealing on its own account, and has assets of more than 30 billion euros ($35.5 billion), according to the commission proposal. The latter is the same threshold used to identify euro-area banks that are supervised by the ECB.

The commission said it would also tighten the procedure under which rules in non-EU countries would be tested for “equivalence,” meaning the finding that oversight in a certain jurisdiction outside of the EU is robust enough to allow firms that are based there to get privileged access to EU customers. Some of the requirements for such a determination would be set out “in greater detail,” it said.

“With regard to third countries for which firms likely to use the equivalence decisions may be of systemic importance to the EU, any equivalence assessment will have to be very detailed and granular and also assess supervisory convergence with the EU,” the commission said, adding that it’s “never obliged to consider a third country’s rules and standards as equivalent.”

The proposals need approval by the European Parliament and the EU’s member states to become law.

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