With Brexit complete, UK negotiators are now striving to reclaim selected access to EU financial markets. The benefits may be overstated, according to critics.
On December 24, the UK and EU announced a trade agreement predominantly focused on physical goods, which came into force after the former ended economic transition arrangements with the bloc at the end of 2020.
A notable highlight is a lack of detail on managing cross-border financial services, something many professionals have branded as a ‘no deal’ for the industry.
The new agreement states that the UK and EU will agree a memorandum of understanding by March 31 establishing a framework for regulatory co-operation on financial services. It aims to bring transparency and dialogue on the adoption, suspension and withdrawal of equivalence decisions. It also commits both parties to tackling international financial crime and tax evasion.
However, it is not entirely clear how equivalence will work, spawning several theories. Some industry sources believe equivalence will happen: after all, the two parties separated on good terms, equivalence is mentioned as an objective and they have common regulatory regimes. The opposing view is that any EU equivalence decision will boil down to political and economic considerations, which could result in much more limited access to EU financial markets.
Glass half-full…
The EU has only granted temporary equivalence to UK clearing houses for financial stability reasons due to the sheer volume of euro-denominated instruments cleared in London. A mammoth effort will be required to bring this activity into the EU fold.
“The fact that we got a deal creates an enormously positive environment for progress, making equivalence more likely. It puts us in a much better place,” says Ben Blackett-Ord, managing partner at consultancy Bovill.
The fact that we got a deal creates an enormously positive environment for progress, making equivalence more likely
The optimists fall into two camps: The ‘visionaries’ are calling for the UK and EU to forge an ambitious equivalence agreement covering all wholesale financial services and to extend the current 30-day notice period the EU gives to a third country to terminate access.
Currently, equivalence-style measures are embedded in the Markets in Financial Instruments Directive II (MiFID II), the European Market Infrastructure Regulation (EMIR) and the Alternative Investment Fund Managers Directive. This covers activities such as clearing, alternative investment funds and trading venues, leaving a swathe of other financial services outside the equivalence parameters. Without equivalence, it is a case of tackling individual member states’ national regimes, which differ greatly.
In a note, law firm Macfarlanes stated that equivalence will not give the UK the same level of access to the single market it enjoyed as a member state, and there are 59 possible equivalence decisions, subject to administrative processes.
The ‘pragmatists’ argue that the UK should only look to secure equivalence rulings within the EU’s existing frameworks, making it more likely they will be granted.
…or half-empty
However, the EU recognising the UK as equivalent is far from certain. “I think it is unlikely that financial services equivalence is about to be granted,” says Rob Moulton, a partner at law firm Latham & Watkins. He explains that under the UK’s overseas persons exclusions and temporary permissions regimes (TPR), EU entities can in any case come to the UK to access the City of London’s financial services, so why would the bloc reciprocate with direct access to its markets any time soon?
Also, it might be in the EU’s interests to drag out the process given that Brexit is a unique opportunity to grab business from London. This would dovetail with the European Commission’s ambition to build up EU capital markets like in the US, for example.
As of the first week of January, the omens for the UK were not good. On January 4, the European Securities and Markets Authority (Esma) withdrew EU registrations for UK-located credit rating agencies and trade repositories, for which the industry was well prepared. That means activities, such as trade processing and reporting, are now divided between the two jurisdictions.
“We’ve seen hardly any issues from a derivatives and a Securities Financing Transactions Regulation reporting perspective,” says Val Wotton, managing director of product development and strategy, repository and derivatives services at DTCC, a global post-trade market infrastructure firm. “The industry was well prepared on day one. Early indications are really positive across all client segments, including broker dealers and the buy side, as well as firms leveraging delegated reporting.”
However, since Brexit some depositories and custodians have stopped offering services in both the UK and EU due to the complexity of doing so.
On the same day as the Esma announcement, data firm Refinitiv reported that €6bn of euro-denominated share trading had shifted out of the UK to exchanges and trading venues within the bloc. This is because the EU no longer recognises UK trading venues as equivalent.
Not surprisingly the UK is looking to overhaul its listings regime to attract more companies to float in London. There are already demands to relax rules requiring start-ups to sell at least 25% of their equity in an initial public offering and to allow dual-class share structures.
Consultancy EY calculated that more than £1tn in assets has left London for the EU since 2016, mainly relating to banks having to set up separately capitalised subsidiaries within the bloc.
Drawn-out process
“The UK granted equivalence in a number of areas [to the EU], but it has been vocal in saying it will be doing things differently,” says Chris Biggs, a partner at accounting firm Theta Global Services. He adds this may influence the EU to take a ‘wait and see’ approach before reciprocating.
Probably with the talks in mind, UK City minister John Glen recently stressed that the UK will not deregulate its financial services and does not intend to diverge meaningfully from the EU.
“I don’t think there will be broad-based equivalence given to the UK in short order [by March 31],” says Adrian Whelan, a senior vice president and head of regulatory intelligence for investor services at investment bank Brown Brothers Harriman. “I think we will be talking about this issue right the way through this year and into subsequent years, because I think what will happen is you won’t get a broad blanket equivalence. I think it will be looked at in specific detail for each and every area.”
Mr Whelan thinks equivalence is most likely to be granted where there is no natural eurozone substitute, although some of that trade could simply migrate to Hong Kong and New York.
The UK granted equivalence in a number of areas [to the EU], but it has been vocal in saying it will be doing things differently
He believes the most likely areas to be granted equivalence are the more complex over-the-counter products, such as derivatives and possibly repos. This would come under Emir and possibly MiFID II, such as for the derivatives trading obligation (DTO). The UK’s Financial Conduct Authority, under TPR, is giving relief on DTOs to EU-located firms using these products, most likely to help preserve London’s leading position. Much of that specific expertise does not exist elsewhere and would take a long time to replicate in the EU.
The value of equivalence?
For all the fuss about equivalence, its value might be limited. “Equivalence is highly uncertain, highly politicised and is open to avenues of protectionism,” says Mr Whelan.
David Biggin, a financial services expert at PA Consulting, adds: “My view is that, if you are an international business, you almost always have to have a substantial presence in that country to service clients and you need a local presence to be competitive. Once you have that presence, you have local authorisation anyway.”
Mr Biggin believes passporting is probably more useful to growing businesses such as payment firms. Also, he explains that firms that had to move assets because of Brexit have already done so. “Equivalence decisions for the future are less crucial because we prepared for the worse, but it would be a nice bonus and a good footing for financial services in London if we do get it,” he adds.
Besides, there is recognition within the EU that passporting does not work to the extent that it should, meaning a lot of financial products have to be country-specific for various cultural and national regulatory reasons.
“Even if you have equivalence, the EU does not really have a single financial services market. There are a lot of country-specific rules,” says Mr Whelan.
And there are reservations over the value of equivalence among UK officials. On January 6, Bank of England governor Andrew Bailey warned against blindly following EU rules to access its financial markets as too high a price, adding that the UK should not be a rule-taker.
Whether or not equivalence is granted could yet have some bearing on how the two regulatory regimes evolve in the future.
“It will be very interesting to see what the UK does and if it follows the approach taken by Europe under regulatory fitness and performance or opts for a different model,” says DTCC’s Mr Wotton.
The EU is currently reviewing a number of its regulatory texts such as MiFID II, the results of which could be implemented around the third quarter of 2021. Meanwhile, the UK is also rethinking its own regulatory regime, and although no major deviations are expected, there is nonetheless scope for the two to diverge substantially over time.
This article first appeared in The Banker’s sister publication Global Risk Regulator.
