Understanding the EU’s equivalence framework for FS

01 August 2019

The European Commission (EC) released its Communication document on the equivalence framework for financial services (FS) on Monday, 29 July 2019, updating an earlier Staff Working Document. It sets out the Commission’s equivalence policy priorities, and puts the EU’s recent legislative efforts into that context. It also seeks to build consistency into the assessment and the decision making processes around equivalence.

In context of Brexit, the paper is important because regulatory equivalence is suggested as the framework which will govern access to EU markets for UK firms after Brexit, including regulating the ability of EU businesses and individuals to do business with UK-based FS firms. For Financial Services, the UK’s largest export sector, which contributes over £90bn in tax revenue to the UK Exchequer and employs a million people, this framework matters.

In the paper, the EC notes that equivalence provisions had been written into 17 pieces of EU law. But they were not written in the expectation of a large, international financial centre being located so close to the EU, conducting a large share of the EU’s FS activities independent from the EU. So since the referendum in 2016, new EU FS legislation has “emphasised that equivalence and ensuing supervisory decisions need to be risk sensitive, reflect closely the regulatory and supervisory regime of the third country under assessment and take into consideration the impact of the third country activities on EU markets.”

Both the UK and the EU expect that during any negotiation of future trading arrangements, the EU’s existing equivalence will need some “enhancements.” To the UK, desirable enhancements would include: greater transparency about how equivalence decisions are made, greater predictability about the process and its timings, and the potential to broaden or add equivalence in some areas, for example to facilitate pan-European competitiveness in global capital markets.

This new Commission paper nods in the direction of these enhancements - setting out the role of European Supervisory Authorities (ESAs) and technical criteria in how decisions should be made, and acknowledging that “equivalence decisions can bring benefits in terms of improving cross-border business conditions and creating new opportunities, thus contributing to fair and open trade between the EU and third countries.”

But fundamentally, the EC interprets “enhancement” quite differently from the UK. One might say it sends several warning shots towards the UK’s Brexit presumed position (not all of which are new, but reinforced here), noting that it sees equivalence fundamentally as a risk management exercise:

  1. There is no “right to equivalence;” the EU does not need to provide an assessment of equivalence, even if the third country’s regulatory regime meets all the technical criteria (i.e. so equivalence is, ultimately, a political decision for the EU).
  2. The Commission may decide to adopt, suspend or withdraw an equivalence decision, as it finds necessary (and has done so with this Communication … see final point).
  3. Equivalence needs to be assessed in proportion to the financial stability risk posed to the EU (i.e. size and degree of reliance by EU firms on operators regulated in the third country) with the complexity of the assessment, supervisory cooperation and other arrangements commensurate to the risks, and with ongoing monitoring of adherence to the conditions by which equivalence was decided.
  4. Financial stability should be interpreted widely, so equivalence decisions are compatible with other EU policy priorities: “sanctions, the fight against money laundering and terrorist financing, tax good governance … to ensure the consistency of the EU’s action on the international stage.” This gives the EU a very big basket of options on which to negotiate equivalence with third countries, including potentially making the use of “competitive” tax policies a reason to withhold equivalence.
  5. Third country regimes do not need to be identical to the EU framework, but they do need to “ensure in full the outcomes” as set out in that framework.
  6. Monitoring means “technical work” to examine the effects of existing equivalence decisions - which seems positive. But based on the technical work, the Commission will decide if equivalence continues to fulfil the EU’s objectives, and whether new risks to financial stability, market integrity, investor protection or a “level playing field” with the EU have arisen. As we have seen from the Switzerland decisions, technical monitoring is only part of a wider decision.
  7. The Commission announces, for the first time, that it is revoking equivalences previously agreed - eg for equivalence of credit rating agencies in: Argentina, Australia, Brazil, Canada and Singapore. The EC is signalling a move away from passive management of equivalence, once a finding occurs; equivalence is not permanent.

The EC’s overall positioning on equivalence in the Communication is not a surprise, given the recent legislative changes for Brexit incorporated in recent EU legislation: the recently-concluded “banking package” (which includes the requirement for certain non-EU firms to establish an EU27 intermediate parent undertaking (IPU)); the Investment Firm Review (which centralises supervision of large investment firms in the Euro area by the ECB, rather than by country-level authorities); and the European Market Infrastructure Regulation 2.2 (which establishes a new “tiering” structure of stability risk to the EU posed by third country market infrastructure providers - along with supervisory cooperation requirements).

Rather, the Communication aims to establish a consistent approach - both for third countries to understand, and for Member States to comprehend, as the EU puts the groundwork in place for its negotiations with the UK on the post-Brexit framework for the FS industry. For the FS industry, the Commission’s paper will (intentionally) reinforce the prevalent industry view that UK Brexit negotiators will have a lot to do, to achieve equivalence enhancements capable of providing a stable, predictable basis for doing Europe-wide post-Brexit business from a UK-based hub.

Brian Polk

Brian Polk | Director
Profile | Email | +44 (0)7711 898535

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