By Huw Jones
LONDON (Reuters) - The European Union's market watchdog is investigating ways to stop national regulators competing unfairly with each other as they try to attract firms from Britain after Brexit in a beauty parade of financial centers.
The European Securities and Markets Authority (ESMA) told Reuters it is studying the risk of "regulatory arbitrage" - where some EU states might offer financial firms lighter supervision than other member states in return for the jobs and high tax revenue they would bring.
While the issue concerns business coming from any non-EU country, ESMA's move is an early sign of how some regulators believe there may be a particular need for precautionary measures for when Britain leaves the bloc.
Regulators in a number of EU countries have made clear they will not tolerate "brass plate" arrangements, where business is officially routed through an office in a member state but senior executives and IT systems remain in London, Europe's dominant financial center.
However, the risk is that some EU states might be tempted to break ranks and allow such front operations after Brexit.
The issue is particularly likely to affect asset management; Britain is the second largest center for this after the United States, managing 5.7 trillion pounds ($7 trillion) on behalf of clients, many of them in continental Europe.
Financial firms in the UK, worried they will lose access to the bloc's capital market, are deciding whether to move some operations and staff to new bases on the continent or in Ireland.
Frankfurt, Paris, Luxembourg and Dublin are vying to attract banks, market infrastructure firms, insurers or asset managers.
A spokesman for Paris-based ESMA said its inquiries concerned issues that a national regulator in the EU may face when financial firms from another country show an interest or make an application for a license.
"It is not focused on efficiency issues of different financial centers, but rather looking at issues around outsourcing and delegation which could lead to regulatory arbitrage," an ESMA spokesman said.
Outsourcing and delegation refers to when key functions of operations in an EU state are being carried out in a country outside the bloc, such as in fund management. Worries could center around, for example, a firm being granted a license to operate a subsidiary in an EU country but being allowed to run much of unit's operations from its office in Britain.
EU rules require safeguards to ensure continuity of service and clear lines of management responsibilities.
Financial watchdogs have told banks they will have to have a certain amount of capital, senior staff on the ground and approved risk models to get a license to operate across the EU.
The European Central Bank has considerable powers to clamp down, as it must first grant the license for, say, a London-based bank that wants to move operations to Frankfurt.
This is not necessarily the case in other areas like markets, which lack such powerful pan-European regulators.
A financial industry official in London said that it made sense to have some sort of common approach among regulators across the EU for the authorization of new firms.
"But ESMA is hamstrung as they can only provide a non-legally binding recommendation, which the national regulators can freely ignore," the official said.
Discussions of Brexit-related moves are already well underway.
Hiscox <HSX.L>, an insurance underwriter in London, said on Monday it was in talks with regulators in Luxembourg and Malta about setting up a new insurance base in one of the countries.
Lloyd's of London, the insurance market that Hiscox trades on, has also looked at several locations for a new EU unit.
Andreas Dombret, a Bundesbank board member, said last week that regulators must not try to undercut each other by offering firms "discounts" or incentives to relocate operations and staff to their financial center.
"There are market participants talking about this, I don't have any direct evidence," Dombret said.
($1 = 0.8149 pounds)
(editing by David Stamp)