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LONDON, Oct 24 (Reuters) - European Union regulators need temporary fixes in place to prevent market distortions in case banks based in Britain face a Brexit without a deal, Germany's financial watchdog said.
Britain's EU departure in 2019 "certainly won't be a piece of cake" and given that five rounds of divorce talks have not made enough progress, regulators must assume a "cliff edge situation", Felix Hufeld, president of BaFin, said.
Regulators will need temporary solutions to avoid dangerous "distortions" in markets while entering the post-Brexit world, Hufeld said at an event in London.
Frankfurt is emerging among the winners in a battle between EU financial centres to attract banks in London who want to open new hubs in the bloc to continue serving customers there.
Goldman Sachs Chief Executive Lloyd Blankfein said last week that he will be spending "a lot more time" in Germany's financial centre.
New hubs being set up by UK-based lenders must not be empty shells, Hufeld said.
"Banks that are planning a comprehensive division of work between offices in London and the EU need to transplant and split up their entire ecosystem established over the years that means IT infrastructures, knowledge, processes and people."
But they will be allowed to continue using capital models approved by UK regulators "for a limited time period".
Banks that want to save costs by managing in London risks from trades undertaken at new EU hubs, known as back-to-back, must have "adequately" trained risk management staff in case this model is no longer possible.
There was also a need to find the right balance for outsourcing hub activities to London, he added.
"What is not allowed is for the subsidiary in the EU not to have an adequate control system on-site, and to therefore be dependent on the sister or parent company in London in order to fulfil the necessary control functions," Hufeld said.
Over 95 percent of euro denominated interest rate swaps, widely used by companies to insure themselves against adverse moves in borrowing costs, are cleared by the London Stock Exchange's LCH arm.
The EU has proposed a law that would, as a last resort, force a UK clearing house handled large amounts of euro swaps, to move to the EU if it still wanted to serve customers based there after Brexit.
EU standards should be enforced for clearing euro contracts outside the EU in one way or another, Hufeld said. (Reporting by Huw Jones; editing by Jason Neely and Alexander Smith)