Financial services after Brexit – can regulatory equivalence be achieved?

Now that the UK has left the EU and entered into the transition period, work has begun in earnest on reaching an agreement on the future relationship between the UK and EU. For financial services, the key component of the negotiations is one word: equivalence.

Asking the experts

The House of Lords EU Financial Affairs Sub-Committee (the Committee) is taking evidence on the future of financial services after Brexit. Over the past month, it has held sessions with academics (29 January), City experts (5 February), and senior regulators (12 February).

The sessions have covered topics including:

how important the EU is for the UK financial services sector
the current state of the UK's onshored framework for financial services
how the regulators envisage the future relationship between the UK and EU in financial services
where the opportunities lie for divergence in financial regulation after Brexit.

However, the running theme throughout all of these discussions has been equivalence.

What is equivalence?

Equivalence is a concept that the regulatory or supervisory regime of a third country – which, for the purposes of EU legislation, means a jurisdiction that is not part of the EEA – relating to a particular sector is of an equivalent standard to those standards set by EU law.

Effectively, the equivalence regime allows firms that are not based in one of the EU Member States to access the single market, provided that the rules and regulations applying in their jurisdiction are similar enough to those in the EU.

Equivalence is governed by individual pieces of legislation, and according to the European Commission (the Commission) there are around 40 equivalence provisions throughout different EU financial regulations, including MiFID II, AIFMD, Solvency II and CRD.

How is equivalence assessed?

The question concerning how equivalence will be assessed was a hot topic in all three Committee sessions, and the responses received demonstrate that there is not one standard approach.

It is unclear what approach the respective authorities are likely to take. In particular, the type of assessment could be rules-based, in which there is a line-by-line assessment of the relevant rules, or outcomes-based, where what matters is whether the overall goals are the same, rather than whether the rules are identical.

The UK's preference is for an outcomes-based approach, however it is unclear whether the EU will agree to this. Speaking in the 29 January session, Professor David Miles of Imperial College London said that he "would not be terribly optimistic that the Commission's position is anything other than pretty rigid and hard line".

In a presentation to the Council Working Party on 10 January, the Commission set out the overarching principles which the EU will take into consideration when assessing equivalence:

equivalence decisions are unilateral and discretionary
the EU is to make a decision on the basis of an assessment which protects its own interests
there will be questionnaires and meetings with UK authorities
the assessment of UK legislation and supervision will take a risk-based and proportional approach
the higher the possible impact on EU markets and interests, the more granular the assessment will be.

Regarding the UK's position, in a speech delivered on 11 February, Bank of England Deputy Governor for Financial Stability Sir John Cunlife highlighted the importance of the following considerations:

the relationship should be built on the assessment of similar outcomes in a non-discriminatory way, paying due respect to the home country regimes
future regulatory and supervisory arrangements need to be stable and built on good faith
it must be possible for these arrangements to change over time
in the end, both sides will need to make a balanced assessment.

What are the potential problems with equivalence?

Patchwork

In the 12 February session, Andrew Bailey, Chief Executive Officer of the FCA, described the equivalence regime as a "patchwork", because it does not apply to all sectors. Significantly, equivalence does not exist for a number of important financial services such as payment services, insurance distribution and lending. This could leave the UK in a difficult position in the event of a "hard Brexit". However, there is currently no commitment by the UK or EU to plug these gaps.

Withdrawal

Even for those areas where an equivalence regime does exist, there are concerns over whether equivalence can be withdrawn (by either party) on 30 days' notice. Speaking to the Committee in the 5 February session, Miles Celic, Chief Executive Officer of TheCityUK, shared concerns that "a 30-day basis for withdrawing your business is not sustainable".

Politicisation

These worries are exacerbated by the row in Switzerland last August, which culminated in the EU withdrawing Switzerland's status of financial equivalence for arguably political reasons. A running theme throughout the three Committee sessions was the concern that any decisions around equivalence could be politicised (by both sides).

Evolution

The equivalence process does not typically look beyond whether regimes are equivalent on day one. However, equivalence assessments should also consider whether there is scope for sensible divergence thereafter. It is essential that the UK has the capacity to review and adapt its rulebook, and if there is the threat of equivalence discussions each time a rule is adjusted, this could hinder regulatory reform within the UK.

Dialogue

In all three sessions, the Committee considered whether certain disclosures by the UK would help or hinder the EU's equivalence assessment. In particular, if the UK already knows that it wants to diverge from certain EU rules on day one, should it declare this to the EU from the outset, and is there scope to have an open dialogue about how this will affect equivalence in the future? The consensus from the experts seems to be that the UK should set out its stall sooner rather than later.

What are the next steps?

In the Political Declaration setting out the framework for the future relationship between the EU and the UK, both parties committed to start assessing equivalence as soon as possible after the UK's withdrawal from the EU. In a letter sent to the Chair of the EU Committee, HM Treasury confirmed that the priority for the UK Government is to obtain equivalence from the EU (and grant equivalence to the EU) by 30 June 2020.

In the 12 February session, Deputy Governor of the Bank of England and head of the PRA Sam Woods told the Committee that he expects that the equivalence assessments will land in the form of an extremely long questionnaire, but "this ought not to be tremendously demanding".

In addition to the equivalence assessments, the FCA's next steps include supporting the government on free trade negotiations and continuing to look at how the industry is evolving.

Finally, the UK Treasury has said that it will set out its vision for the future of financial services – including an outline of its preferred system of outcomes-based equivalence – in a White Paper, which is expected to be published in Spring.