The European Securities and Markets Authority (ESMA) said it was vital investment firms did not select a location “just for reasons of regulatory or supervisory arbitrage” in guidance published on Thursday.
The warning comes as Dublin, Frankfurt and Paris battle to attract financial firms moving operations out of London in the wake of the Brexit referendum.
The UK’s decision to withdraw from the union had created a “unique situation”, ESMA said, which required a common effort across the EU to ensure supervision of firms was consistent.
Regulators should therefore “scrutinise applications in order to ensure that the choice of the member state for relocation is driven by objective factors and not be regulatory arbitrage”, the watchdog said.
It added: “National competent authorities (NCAs) should mitigate the risk of letter box entities and ensure that any relocation is effective and investment firms comply with the Mifid framework from day one and on an on-going basis.”
The watchdog added that the UK would be considered a ‘third country’ once the withdrawal from the EU complete and that regulators will need to reassess current outsourcing arrangements.
It raised fears outsourcing to service providers outside the EU would make oversight and supervision more difficult, particularly if there was a “high concentration of outsourced activities” in a third country.
“Such developments may increase the likelihood of materialisation of risks to investor protection, orderly markets and financial stability, something which may expose the EU’s 27 countries to high risks in case of sudden and unexpected developments in that third country jurisdiction,” ESMA said.