German regulator makes flexible pitch to lure banks after Brexit

Brexit is a once-in-a-lifetime opportunity for Frankfurt to try to lure global banks away from London — but do not expect Germany’s main financial regulator to be part of a heavy sales pitch.

“We are not a marketing agency and not interested in doing industrial policy,” says Felix Hufeld, the president of BaFin, which oversees 1,740 banks in the eurozone’s largest economy.

At a time when European financial centres are competing hard for business that might migrate from the UK because of its departure from the EU, the approach might seem to harm Germany’s chances. European bankers paint a stark contrast with the activism of French policymakers.

Andreas Dombret, Bundesbank board member for banking supervision, who works closely with BaFin, says German regulators have not called a single bank to try to persuade it to move to Frankfurt.

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But Mr Hufeld sets store by convincing the world that BaFin is changing, taking a more pragmatic approach to bank regulation that can reassure incoming institutions — and perhaps add to the reasons to move to Germany.

“We try to be as flexible and as pragmatic as legally possible and are willing to find bespoke solutions to make the transition easier,” he says. “If somebody tells me, ‘the legal code doesn’t say anything about a transition period’, my answer is, ‘well, it does not say anything about Brexit either’.”

So far Frankfurt, with or without help from BaFin, is emerging as a likely winner from Brexit. Seven of 15 global lenders have decided to make Frankfurt their post-Brexit EU headquarters — among them Citi, Goldman Sachsand Morgan Stanley — a Financial Times survey in December showed. The EU’s four other big financial centres — Paris, Dublin, Luxembourg and Amsterdam — have attracted the same number of banks between them.

Abstaining from an aggressive marketing campaign may actually be one contributing factor. “If you promise me something, you can take it away from me again,” said a senior US banker who is moving operations to Frankfurt.

Another senior manager of an American investment bank that has chosen Frankfurt as its new EU hub praises the “very constructive dialogue” with BaFin.

That was not always so. One former banker says the agency — created in 2002 when Germany’s supervisors for banks, insurers and capital markets were merged — “always treated us with the attitude of criminal prosecutors”. Another lawyer describes a “parochial organisation that was not really up to its job”. BaFin was scolded by parliamentarians for its tardy response to the financial crisis of 2007 and 2008, when German lenders IKB, Hypo Real Estate and Commerzbank needed taxpayer-funded rescues.

The regulator’s internal culture started to change when Mr Hufeld joined in 2013 after having worked at Boston Consulting Group, Dresdner Bank and other private sector employers.

The start of the eurozone's banking union, put in place after the financial crisis, also helped change: the German regulator now collaborates more closely with the European Central Bank, which pushes for a less legalistic approach to supervision. Since 2014, the currency area's biggest banks are mainly supervised by the ECB, rather than national watchdogs, which reduces the options for regulatory arbitrage.

But Andreas Krautscheid, managing director of the Association of German Banks, still says “a good regulator is a competitive advantage” for Germany’s financial centre. He says BaFin is “handling all issues around Brexit extremely well and in a flexible manner”.

BaFin is trying “to be very engaging on the individual level, and [WE]are trying to make sure that the dialogue with the banks is smooth”, Mr Hufeld says.

His view on Brexit is coloured by the worst-case scenario of a very hard Brexit without any transition period, which Mr Hufeld says could be “a threat to financial stability”. The complex issues and short timeframe means BaFin has focused on what may be best described as a triage approach of prioritising the most important questions.

Lenders’ internal risk models, used to calculate the default probability of loans and key in determining how much equity banks need, are an example: BaFin and the Bundesbank will have to evaluate hundreds of complex models.

“The lack of time makes it just impossible to review every single one before March 29 2019,” says Mr Dombret. The pragmatic answer is that models approved by the UK’s Prudential Regulation Authority will be temporarily accepted.

Yet German regulatory flexibility has limits. “One fundamental principle is that we won’t accept a pure ‘letterbox’ approach, with banks setting up a token presence in Germany,” says Mr Hufeld. Another issue is a limited willingness to put up with “back-to-back accounting”, in which a lender duplicates a Frankfurt-based transaction in London and moves the risk out of the country.

Another thing Mr Hufeld insists is that from day one after Brexit, BaFin will insist banks have “a proper risk management function in Frankfurt”. Otherwise, the German regulator would have very limited control. “If push comes to shove, in a financial crisis, we need legally be able to focus on the underlying assets,” says Mr Hufeld.

He says his pragmatic approach required “some persuasion internally”, as a departure from a legalistic and formalist tradition that haunts the corridors in BaFin’s Bonn headquarters. But he insists Brexit is an exceptional historical situation that puts bankers, regulators and lawmakers into uncharted territory — and says his key concern is to avoid decisions that would make matters worse.

“We don’t have any interest in escalating such a situation even further by regulatory actions,” says Mr Hufeld. “You have to be careful as a regulator not to build the wall everybody would drive into.”- Copyright The Financial Times Limited 2018.