Financial Services post-Brexit: “Equivalence” does not mean “equal to”

The financial services sector accounts for around 12% of Britain’s economic output and generates greater tax revenues than any other industry. If the UK withdraws from the Single Market, its banks and financial firms will lose their current high degree of access. HSBC among others has signalled its intention, following a Parisian charm offensive, to move some of its operations abroad. Evidently, there are compelling incentives to maintain as much openness as possible. Recently, Michel Barnier, the EU’s Chief Negotiator, rejected the possibility of a “bespoke agreement” that provides UK financial services with continued unconstrained access. This is unsurprising: the EU has already signalled that there would be no common regulatory framework in a future EU-UK FTA (discussed previously in Services in an EU-UK FTA: what’s on the horizon?). However, it has been suggested that an equivalence regime could replace the existing arrangements for UK financial services. Could this work?

An equivalence regime is a unilateral mechanism where one trading partner A recognises as equivalent the standards (and their enforcement) of trading partner B. Both parties remain free to set their own standards and market access to A is provided so long as regulatory  outcomes in B are at least broadly the same as those in A. The EU has developed an equivalence approach for financial services that has been used widely for third-countries outside of the Single Market (in particular Japan, the USA and Canada). However, there are a number of limitations.

Firstly, the scope of EU equivalence is limited and patchy. Rather than cover all types of financial services, equivalence is available only in the 15 EU acts that contain “third-country provisions”. It is in these instances that the EU can decide on equivalence (although not all of the provisions have been used yet). Significantly, there is no equivalence regime for a number of important financial services. These include: deposit taking, lending, payment services, mortgage lending and insurance mediation and distribution. Secondly, the conditions for equivalency depend on the particular EU act. This means there is no uniform process of assessment and what constitutes equivalence varies. Thirdly, the process for designation is a slow, one-sided system where the Commission determines whether a country’s rules and supervisory mechanisms are equivalent. Not only does this process lack transparency, it has become politicised. Finally, and perhaps most importantly, equivalency may be altered or withdrawn. Changes can be at short notice which underlines that there is little security against a policy change in Brussels, making it a comparatively unattractive basis on which to do business. An example of this precariousness is the EU’s decision that ongoing equivalence recognition of the Swiss stock market will be conditional on progress towards a new institutional framework.

The EU position that the UK should simply rely on existing equivalence regimes is based on a mixture of its unease at the prospect of having little influence over a large financial centre on which it would continue to rely, together with the opportunity to lure financial services away from the City. Clearly, some member states, France being the prime example, sense that offering nothing beyond the current equivalence regime may aid their efforts to gain business while protecting their domestic financial sectors.

Going forward, the UK has several options for retaining some form of enhanced market access beyond what the current equivalence framework makes possible.

One would be to join the European Economic Agreement (along with Iceland, Liechtenstein and Norway) – that is, stay in the Single Market. The passporting rights of financial institutions would be maintained but would come at the cost of accepting all relevant EU rules and regulations (including free movement and the jurisdiction of the European Court of Justice). Politically, despite the recent House of Lords amendment encouraging this approach, this seems an unlikely way forward, especially as it has been ruled out by the leaderships of both major political parties.
Alternatively, the UK could persuade the EU that both sides should develop a more comprehensive equivalence approach that addresses some of its stated limitations. This is a significant challenge, but not impossible. Given British regulation and supervision is currently compatible with (and partially constituted by) EU law, it is arguable that, on Brexit day, they should be considered equivalent where an equivalence regime is available. The challenges would be to broaden the range of financial services for which equivalency can be agreed, to establish a uniform and transparent process for determining equivalence and to obtain commitments on how and in which circumstances such determinations could be withdrawn. Appropriate cooperation, oversight and dispute settlement mechanisms would of course be needed but these are already envisaged as part of a future EU-UK FTA. To go beyond the EU’s current equivalence regimes and provide comparable (but still not equal) terms of trade in financial services will require goodwill on both sides and dynamic thinking. Time will tell how easy this path might be.

Written by Luigi Pedreschi, PhD candidate at the European University Institute in Florence.

Edited by the Linklaters Trade Practice. The views and opinions expressed here are the personal opinions of the author(s) and do not necessarily represent the views and opinions of Linklaters.