70% of post Brexit trading desks are operated on a back-to-back structure - Results of the ECB Desk Mapping Review expose risk management weaknesses within EU subsidiaries

In 2021, the ECB started the “Desk Mapping Review”, an exercise evaluating how international banks manage their capital markets trading business in the EU two years post Brexit.

The main purpose of the DMR was to assess the progress banks have achieved in establishing an EU-based trading presence and ensuring financial stability within the EU.

For banks outside the EU, the relocation of senior staff to financial hubs such as Frankfurt, Dublin and Paris, plays a decisive role besides transferring assets to their EU subsidiaries for doing trading business in the EU economic area. Due to challenging staffing requirements and the reluctance of employees to relocate from parent entities, EU subsidiaries of international banks transfer risks of their trading activity to their parent entities by using back-to-back transactions and use split desks to reduce organizational and monetary costs. Thereby, these subsidiaries can accumulate high counterparty credit risks by back-to-back transactions and lack essential risk management capabilities due to insufficient senior staff for identifying, measuring, and monitoring risks adequately.

As a result, the ECB suspected that these subsidiaries might not be in full control of their balance sheet risks as crucial infrastructure, business and risk management functions are understaffed, resulting in financial risks for the euro area, and led the ECB to scrutiny.

The ECB review was based on a risk-based approach focusing on the booking model structures and risk management concerning all trading desks to assess its risk management capabilities and governance adequacy. To judge the trading desk’s materiality in regard to business relevance and financial risks, the assessment was based on several risk key indicators such as (i) total capital market risk-weighted exposure amount (RWEA), (ii) total net trading income, (iii) traded notional amount and (iv) ticket count.

As a result, 264 trading desks of seven international banks were scrutinized, whereby 70% of all trading desks were still using a back-to-back booking structure and 20% using a split desk approach. For 21% of these trading desks, combining in total 46% of the risk-weighted exposure amount (RWEA) of the scrutinized banks, supervisory actions are warranted. Consequently, the ECB will issue individual binding decisions for banks with material trading desks. For trading desks considered material, banks must appoint a head of desk within the European subsidiary, establish clear reporting lines and a compensation structure based solely on the entity’s performance. Moreover, adequate staffing of senior employees based in the local subsidiary is required. To reduce risks due to necessary remote bookings and intragroup hedging activities to a minimum, banks must establish a solid governance and internal control framework.

The ECB desk mapping review can be considered a first step in assessing the operational model of foreign banks outside the EU after Brexit and might be followed by further scrutiny by the ECB in the future.

It will be interesting to see how banks react to the results and establish their long-term Day 2 Operating Model in the EU. It can definitely be said that the results themselves do not come by surprise – it is a result of an assessment based on expectations set out in 2018 by the ECB. Although the direction is clear for local players here in the EU – challenges will arise on how global headquarters will see the results.

Nevertheless – ECB and EU have now taken the next step to develop the EU capital markets footprint and banks now have to react.

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