Brexit, the Leopard, and Financial Institutions

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Sound and Prudent

5 min readApr 6, 2019

“Di una volta romana o romantica” (Massimo Catalani)

A new expression has just entered — through the main door(1) — the financial regulation parlance as a result of Brexit: Relocation supervision.

Will we hear a lot of that?

Before attempting an answer, we must take a step back. This is a story that starts in 1989 (no worries, I will fast forward to Brexit soon), when EU banks — and eventually, over the decades, all financial institutions — were granted the “passport”: EU financial institutions have a right to do business in the rest of the EU.

The passport rapidly became one of the cornerstones of London’s role as the global groups’ gateway to Europe. Donald Duck Inc., a major US bank, would establish DD Plc, a wholly owned UK bank, which would “activate” its passport and start doing business throughout Europe (no need to establish a bank in each jurisdiction!). Over time DD Plc may have grown to hundreds of people in Canary Warf (although back in the days DD was probably in the City or around Berkeley Square). DD Plc’s employees can travel across the Channel as they wish. Maybe DD Plc has over time also established a branch on the continent.

Yet, the core of its staff and operations remains in London.

Comes Brexit and DD Plc’s passport vanishes, but the solution is readily available: Relocate the European hub, by establishing DD S.p.A., a wholly owned Italian bank which benefits from the passport.

Most likely, however, DD would prefer to follow the steps of the Leopard.

No, not the animal, the character in Tomasi di Lampedusa masterpiece, who claims that “if we want that everything remains as it is, everything must change”. In more mundane terms, DD would like to relocate its licence to Italy only (formally), while leaving the current structure unchanged (lest employees must all move to Milan with their families).

Things thus start becoming more complex, because in order for DD S.p.A. to obtain its passport, it must have enough substance in Italy.

Is it sufficient to move 1 employee out of, say, 100, from London to Milan? That’s a fairly easy “no”. Do I necessarily have to move 99 employees? That’s another fairly easy “no”.

Unfortunately, life is rarely black or white: Grey, in all its innumerable shades, dominates (no innuendos intended). Moving 5 or 10 employees is still most likely an easy “no”. But what if I relocate to Italy 50 employees? What if I relocate permanently 40 but I add 15 employees travelling twice a month for a couple of days? What if I relocate 45 and add 1 senior manager hired in Italy supervising the work of the offices remained in London? What if I add to any of the options above that DD S.p.A. is fully entitled to use the IT platform of the DD group?

These solutions all sound more promising, it is fair to assume.

Finding the right balance (limiting the impact on the current structure and yet ensuring compliance with the law) will thus be a matter of mixing various solutions, involving personnel, IT, outsourcing, intragroup arrangements, etc.

This is where “relocation supervision” triumphantly enters the stage. Regulators will have to assess whether DD S.p.A. has enough substance, in the face of the predictable tendency of financial institutions to limit to the minimum any changes to their current organization.

I can now endeavour answering the initial question: Will we observe frequent challenges to the relocation strategies adopted by financial institutions?

My (professionally educated) guess is that we might actually see less than one might expect (blatant breaches of the law aside). Here are a few reasons for that.

Firstly, whether DD S.p.A. has “enough substance” is an utterly factual question, concerning a fairly hazy concept (“substance”, although that is not the actual word used by the law). The implications are relevant: Factual assessments of immaterial concepts are by their very nature very difficult, in the absence of hard metrics. Take this example from a different area of financial regulations: In the 12 years since the implementation of MiFID in Italy I met only one case where sanctions have been issued for breaches of the rules on “inducements” (compared to scores of sanctions for breaches of, say, rules on “suitability”). Why is that? I think that has to do also with the fact that claiming that an inducement structure is in breach of MiFID requires assessing a factual question, about an immaterial concept: Regulators must prove that the inducement does not enhance the quality of the service.

Secondly, in a world where technology is the true governing force behind financial institutions, any discussion on where “substance” is located may prove futile. Consider a fully digitized bank whose IT infrastructure sits on a public Cloud. Where would you consider that infrastructure based?

Thirdly, Brexit affects innumerable financial institution. The whole “too big to fail” idea has been questioned (ask Lehman) and yet, if I can borrow from that concept, I think we are facing a sort of “too big a market structure to fail” dynamic. Even leaving aside the possible effects of the lobbying actions by financial institutions (do not underestimate the power of the Force of banks, Darth Vader would warn), the mere idea that all major financial institutions must radically alter their entire organization in a short time sounds unrealistic and policy makers are acknowledging that. Consider the recent Press Release by the Italian Ministry of Finance: In case of a hard Brexit, a transitional period will commence during which “banking, financial and insurance intermediaries […] will be able to continue to operate according to existing laws and regulations”(2). This sounds as a textbook much ado about nothing, at least in the short term, doesn’t it?

(1) The expression is by Steven Maijor, Chair of ESMA, “Brexit — the Regulatory Challenges” — speech at the European Financial Forum, held in Dublin on February 13, 2019. At least I have not heard that expression before (and Google seems to confirm that this is a new expression). Readers familiar with the topic at hand will however know a number of instances in which “relocation” is being addressed by Regulators (see, among the others, ESMA’s “MiFID II Supervisory briefing on the supervision of non-EU branches of EU firms providing investment services and activities” of February 6, 2019).

(2) Italian Treasury, Press Release of January 24, 2019, no. 15.