When reading the news, one cannot deny that a hard Brexit may well be looming. While we all hope that a political solution will be agreed upon in the end, it still makes sense to discuss legal possibilities that might soften the impact if no agreement can be reached.
When it comes to the UK’s loss of access to the European single market, the „equivalence solution“ is almost automatically mentioned as a solution for the financial market. But what exactly does equivalence entail? And does it really represent a viable way for the UK and the EU in case of a hard Brexit? In this post we will provide an overview of the current equivalence regime within the European regulation.
In the event of a hard Brexit, the UK will lose access to the European single market overnight and will become a third country under European law. The solution for maintaining access to the European single market could be the so-called equivalence solution. This would allow companies established in third countries to gain access to the European single market, even if no bilateral agreement is concluded in time between the UK and the EU, which seems likely at the moment. The prerequisite is that the third country’s legal and supervisory standards would need to be recognised by the EU as equivalent to the European regulations. UK banking and financial services providers and fund managers would thus continue to have access to the European single market if the EU recognises the British legal and supervisory standard in the financial sector as equivalent to that of the EU. Since the UK currently applies EU regulations, this should at a first glance be a no-brainer.
However, the European legislator does not provide market access for third countries in all areas of banking and financial services easily through regulation. Specific third country rules are contained, for example, in:
- the European Financial Markets Regulation (MiFIR);
- the Second Financial Instruments Directive (MiFID II);
- the Regulation on OTC derivatives, central counterparties and trade repositories (EMIR); and
- the Directive on Alternative Investment Fund Managers (AIFMD).
In the Fourth Capital Requirements Directive (CRD IV), the Second Payment Services Directive (PSD II) and the UCITS Directive, the European legislator has not stipulated third country rules. In these contexts, access to the European single market through recognition of the equivalence of the supervisory regime is not currently possible. In the areas of the concerned financial services sectors (i.e. credit institutions, payment institutions and the management of UCITS), the UK would therefore be dependent on a bilateral agreement with the EU in any case in order to keep (or regain) access to the European single market.
In those areas where third country rules are provided for, the recognition procedure and the number of third countries recognised as equivalent differ.
For example, under EMIR, the following applies: If a Central Counterparty (CCP) established in a third country wishes to provide clearing services to clearing members or trading venues established in the EU, it may do so only if it has previously been recognised by the European Securities and Markets Authority (ESMA). For this purpose, the CCP must submit an application to ESMA. The latter may only recognise a CCP from a third country if the EU Commission has recognised the legal and supervisory mechanism of the third country as equivalent to that of the EU, and provided that the CCP is authorised in its home country and is subject to effective supervision and enforcement in that country. Moreover, it is required that ESMA has concluded a cooperation agreement with the local supervisory authorities which, for example, simplifies the exchange of information and the home country of the CCP must have an equivalent system for combating money laundering and terrorist financing. If these conditions are no longer met, ESMA may withdraw recognition from the CCP.
CCPs currently recognised by ESMA are located in Australia, Hong Kong, Japan, Singapore, South Africa, Canada, Mexico, Switzerland, South Korea, USA, UAE, India, Dubai International Financial Centre, Brazil and New Zealand.
The recognition procedure for trading venues under MiFIR is slightly different. It is not the trading venue for derivatives itself that can apply for equivalence. Rather, the EU may, at its own discretion and in cooperation with ESMA and the member states, issue a resolution recognising the legal and supervisory framework of a third country as equivalent to that of the EU. Before issuing a resolution, the member states must approve equivalence. The recognition of the equivalence of a third country in the area of MiFIR requires that: (i) the trading venues are admitted in their home country and are subject to effective and continuous supervision and enforcement; (ii) the trading venue has transparent admission rules; (iii) the issuers are subject to regular information obligations which guarantee a high level of investor protection and (iv) rules against market abuse in the form of insider dealing and market manipulation are in place.
So far, the EU has only recognised the USA as an equivalent third country under MiFIR. Under MiFID II, however, the EU has recognised four countries providing trading venues for other financial products (such as listed shares) as equivalent to EU venues: USA, Australia, Hong Kong and Switzerland (the recognition of Switzerland is limited to one year until 31 December 2018 but may be extended if there is sufficient progress on a common institutional framework).
This shows that even if the UK is recognised by the EU as a third country with equivalent regulatory standards, this is far from resolving all the difficulties.
On the one hand, the UK would actually have to maintain its current regulatory and supervisory standards and adapt to those of the EU in the future; a substantial deregulation is thus ruled out. A comparatively minor problem, on the other hand, is that the recognition of equivalence by the EU may well take some time. The UK’s supervisory standard currently corresponds to that of the EU, so if it were to be maintained after Brexit, there would at least be no legal grounds against swift recognition. However, much more serious for the UK, would be that as a third country they would no longer be able to influence the European legal and supervisory standards for lack of voting rights; they would be referred to the role of a „rule-taker“.
Therefore, it remains questionable whether recognition as an equivalent third country is really a good solution for the UK. The alternative would be one or more bilateral agreement(s) with a dispute settlement mechanism. In any event, the advantage of such an agreement would be that it would be negotiated by both sides and would not refer the UK to the passive role of an equivalent third country.