Banks choosing Frankfurt for their licensed European Union hub after Brexit will have to set up full-scale operations in the country, not brass-plate offices with bankers commuting from London, according to German central bank Executive Board member Andreas Dombret.

“We will not accept any empty shells or ‘letterbox companies,’ where the business effectively continues to be done out of London,” Dombret said in a speech in the U.K. capital on Friday. This includes “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.”

Frankfurt is emerging as the favored destination for global banks such as Goldman Sachs Group Inc. and Citigroup Inc. that need to set up new or expanded bases within the EU to maintain their access to the single market after Britain withdraws from the bloc. Germany’s financial capital already hosts Deutsche Bank AG, the European Central Bank and part of BaFin, one of the few EU regulators with experience overseeing complicated derivatives trading.

For critical functions such as senior management and compliance, qualified staff will need to be present at the new EU subsidiary full-time, Dombret said.

Corporate Taxes

Dombret also said a “race to the bottom” on financial regulation should be avoided as the U.K. prepares to secede from the EU. His comments at a presentation organized by the consultancy zeb echoed a warning last month from German Finance Minister Wolfgang Schaeuble.

“Given how the Brexit debate developed early this year, this warning is not at all an empty one,” Dombret said. “A financial-center strategy comprised, among other ingredients, of very low corporate taxes and lax regulation has already been mentioned in the U.K. as a fall-back option for London.”

Considering the potential for political acrimony on both sides, he said people should not count on “economic sanity” being the guiding principle in the divorce negotiations between the U.K. and EU.

"That means we also have to factor in the possibility that the U.K. will leave the bloc in 2019 without an exit package, let alone the sweeping trade accord it is seeking," Dombret said.

Looking ahead to the U.K.’s future relationship with the EU after it leaves the single market, Dombret said he was “skeptical about whether equivalence decisions – may they be likely or not – offer a sound footing for long-term location decisions of banks.”

An equivalence decision is granted by the EU to countries outside the bloc when it deems their rules and supervision in particular areas to be as robust as those in the EU. This allows firms based in that non-EU country to sell services in the single market without penalty and while being supervised at home.

“There are three major drawbacks to equivalence decisions,” Dombret said. They only cover wholesale bank business, they are reversible and “given the fact that banks need time to build up a new entity elsewhere, an equivalence decision would have to be taken quite soon to actually have a bearing on the location decisions of banks,” he said.

Source:
courtesy of BLOOMBERG

by Gavin Finch , Nicholas Comfort , and John Glover

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