The importance of being equivalent: Brexit and financial services
Scott James (King’s College London) & Lucia Quaglia (University of Bologna)
Over the summer, the impasse in the negotiations concerning a new framework agreement between the European Union (EU) and Switzerland led to the EU’s withdrawal of Switzerland’s equivalence status in finance. This move is important because, after Brexit, the EU-UK relations with reference to financial services will mainly be based on third country equivalence provisions, regardless of whether the UK leaves with or without a deal. More generally, the legal mechanism of equivalence regulates the EU’s relations with third countries in finance. So, what is equivalence and why is it so important?
Equivalence enables firms located outside the EU to conduct certain financial activities in the EU, without being subject to EU regulation and supervision in addition to those of their home country. Thus, third-country equivalence facilitates access to EU markets. Equivalence decisions are generally taken by the Commission, on the basis of the technical advice provided by European Supervisory Authorities. At times, the process of granting equivalence can be time-consuming and somewhat politicised. Furthermore, equivalence decisions are temporary, as the recent EU’s withdrawal of Switzerland’s equivalence status demonstrates.
Equivalence provisions were developed in a piecemeal manner over time. Many of the most important pieces of post-crisis financial services legislation contain equivalence clauses, notably, the Regulation on Credit Rating Agencies (2009), the Directive on Alternative Investment Fund Managers (2011), the European Market Infrastructure Regulation (EMIR) (2012), the revision of the Markets in Financial Instruments Directive (MiFID II) (2014). However, several important areas of financial services currently have no third country equivalence rules which allow for facilitated cross-border access. These include: banking (deposit-taking), lending, payment services, mortgage lending, and collective investment funds.
In the past, the UK exerted a strong influence in shaping EU’s equivalence provisions with a view to maintaining the openness of the EU single market to third-country financial entities and products, many of which were managed from London. UK regulators also viewed equivalence as essential to maintain the competitiveness of the EU financial sector. However, for France, Germany and other continental countries, equivalence provisions were, first and foremost, seen as instrumental in aligning third country rules with EU rules, thereby preventing the ‘import’ of financial instability from outside. Moreover, decisions on equivalence were a way for the EU to increase its leverage when negotiating finance-related matters with third countries, first and foremost, the US. On the one hand, it is somewhat ironic that the equivalence mechanism, which had been strongly supported by the UK in the past, will be the main way for UK’s financial firms to gain facilitated access to the single market in financial services. On the other hand, after Brexit, the EU(27)’s third-country equivalence regime is likely to become more restrictive for two reasons. To begin with, the main EU’s financial centre will be de facto located in a third country (the UK). Moreover, the main advocate of a more open interpretation of equivalence will have left the EU and will no longer have a formal say on this matter. We are already witnessing some ‘hardening’ of the EU’s equivalence regime with reference to the recent EU decision concerning Switzerland, even though this might partly be a tactical move in the context of the Brexit negotiations.
The Swiss case points to an increasingly stringent approach to third country equivalence. However, the EU’s reliance on equivalence to bind the City of London to its regulatory and supervisory framework also carries risks. As we have seen with the recent revision of the European Market Infrastructure Regulation (EMIR II), toughening equivalence provisions in anticipation of Brexit risk generating conflicts with other third countries to whom the rules apply – notably, the United States. In this case, the prospect of closer EU supervision of US-based clearing houses led to a ferocious war of words between leading US and EU financial regulators. The potential for Brexit to fuel further transatlantic regulatory disputes may, ultimately, be a reason why it is in the EU’s long-term interest to agree a ‘special’ deal for finance with the UK.
Scott James is Senior Lecturer in Political Economy at King’s College London. Lucia Quaglia is Professor of Political Science at the University of Bologna. This blog post partly draws on the forthcoming book: James, S. and Quaglia, L. (2019), The UK and Multi-Level Financial Regulation: From Post-Crisis Reform to Brexit, Oxford University Press.