By Carolyn Cohn and Maiya Keidan
LONDON (Reuters) - Regulators should prevent investment firms from setting up shop in one jurisdiction to avoid stricter controls in their home state, the European Union's markets watchdog said, as centers such as Dublin, Frankfurt and Paris vie for business.
EU authorities are concerned about a "race to the bottom" as financial services firms shift operations after Britain leaves the bloc in 2019, amid reports businesses are being set up that are effectively no more than postal addresses to take advantage of more lenient rules in some countries.
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Ireland has complained to the European Commission that it is being undercut by rival centers, Reuters reported in March.
National securities regulators should "mitigate the risk of letter-box entities and ensure that any relocation is effective", the European Securities and Markets Authority (ESMA) said in an 'opinion', or formal guidance, on Thursday.
Regulators should ensure senior management are based in the home jurisdiction of the firm and that "board members and senior managers in the EU27 have effective decision-making powers, even where the investment firm is part of a group", ESMA said.
If regulators believe that investment firms, such as broker-dealers including the trading arms of banks, are not genuinely operating in their home jurisdiction, "this may provide grounds for not granting or withdrawing authorization", ESMA said.
ESMA also said regulators should not design "fast-track" authorization processes.
Financial professionals have said the speed with which they can set up in various jurisdictions has contributed to their decision-making on EU operations after Brexit.
"I think that the fast-track prohibition is targeted at the French – the AMF have offered UK-based fund managers a quick authorization process if they move from London to Paris," said Neil Robson, a partner at law firm Katten Muchin Rosenman.
France's AMF regulator has launched the "2WeekTicket" (TWT), a fast-track pre-approval process for firms already authorized by Britain's Financial Conduct Authority.
"ESMA is saying that a quick authorization to leave the UK cannot be acceptable and that there are formal mandated authorization processes that have to be followed," Robson said.
The AMF said the TWT was "not a license or an authorization" but a first-review service aimed at identifying whether there was any major obstacle to doing business in France.
"It does not substitute the normal complete authorization process for asset managers willing to establish in France, whether they were previously located in the UK or not," a spokeswoman said. "To our knowledge, there is no specific concern from ESMA regarding the TWT."
Lawyers also said the guidance risked a lessening of national regulators' powers.
"Is there some form of disintegration of the (regulators') ability to make rules in relation to their own jurisdiction, and govern their own authorization process?” said Monica Gogna, funds lawyer at Ropes & Gray.
In a separate opinion on secondary trading, ESMA said decision-making for designing, controlling and monitoring trading systems' operations should not be outsourced outside the EU.
The broker-dealer trading arms of banks in Britain have previously asked EU regulators whether their entities in the other 27 EU states will still be allowed to outsource operations to London once Britain leaves the bloc.
"ESMA considers it necessary that conditions for outsourcing activities to UK-based entities do not generate regulatory and supervisory arbitrage risks," the watchdog said.
In a third opinion, ESMA said regulators should also prevent asset managers from setting up letter-box operations, bringing them into line with rules applying to hedge funds.
"It is a big development because the ‘letter-box’ concept is only a ... hedge fund idea," said Leonard Ng, co-head of the EU financial services regulatory group at law firm Sidley Austin, adding legislation for other asset managers "has not previously been as prescriptive".
ESMA said regulators should keep a close eye on investment managers who set up operations with fewer than three full-time staff.
"Granting authorizations to relocating entities should not result in a situation in which these entities could continue to perform substantially more portfolio management and/or risk management functions for the relevant funds in their original member state," it said.
Chris Cummings, chief executive of Britain's Investment Association, said he supported ESMA's setting of "robust standards" for UK investment management firms doing business with the EU after Brexit.
(Additional reporting by Simon Jessop; Editing by Keith Weir and Mark Potter)