Differing approaches can also be seen as regards the supervisory approach to cross-border booking arrangements with the UK authorities opting for a more open internationalist approach in contrast with the EU again taking a more local approach.
In its August 2018 Dear CEO letter concerning cross-border booking arrangements the FCA said that it was open to a broad range of legal entity structures or booking models. These include the use of back-to-back and remote booking, provided their associated conduct risks were effectively controlled and managed. The FCA’s starting point is not to restrict business models but to understand the principles and practice involved and how the conduct risks that arise from them are managed. As such the FCA stated that booking models should comply with the following principles
- Firms should set out a clear rationale for their booking arrangements, document them and have them approved by the board.
- Risk management should be appropriate for the firm’s booking activities including hedging arrangements.
- There should be a broad alignment of risk and returns at the entity level.
- Firms should have adequate systems and controls in place to ensure that booking arrangements are followed.
- Firms should consider whether responsibility for oversight of booking arrangements should be explicit in statements of responsibilities.
- Booking arrangements should not be an impediment to the firm’s recovery and resolution.
The FCA added that it expected UK boards and senior managers to ensure that effective governance was in place to identify and mitigate the potential harm which could arise from modified booking arrangements.
In contrast the ECB has taken a fairly conservative approach to booking models and empty shells. Essentially its position is that banks in the EU27 should be capable of managing all material risks potentially affecting them independently at the local level, and should have control over the balance sheet and all exposures. The bank must be in a position to be able to respond directly and independently to enquiries by the ECB and relevant EU27 national supervisors on all activities affecting the bank and provide information swiftly. In addition, governance and risk management mechanisms must be commensurate with the nature, scale and complexity of the business and fully comply with EU legislation. Establishing an “empty shell” entity is not acceptable to the ECB.
The ECB’s FAQs on Brexit specifically mentions the back-to-book booking model. It states that the ECB and EU27 national supervisors would expect that part of the risk generated by all material product lines should be managed and controlled locally. For market risk, this might mean eventually establishing permanent local trading capabilities and local risk committees, as well as trading and hedging risks with a diversified set of external counterparties.
The ECB adds that supervisory expectations vis-à-vis booking models will be applied proportionately according to the materiality and complexity of each individual institution’s activities. This means that large banks, with a high level of interconnectedness and complex capital market operations, will be subject to higher supervisory expectations and assessments.