- City of London is keen to maintain full single-market access
- EU Commission issues, and can withdraw, equivalence decisions
For bankers in the U.K., a lot of money and a lot of jobs hang on the terms of their continued access to the European Union’s single market after Brexit. Yet those terms -- such as “passporting” and “equivalence” -- aren’t exactly household names.
Of the two, “passporting” might get the City of London closer to its goal of maintaining full access to the single market. It refers to the right of companies authorized in one country of the European Economic Area -- currently comprising the EU plus Iceland, Liechtenstein and Norway -- to carry out a range of permitted business activities throughout the bloc. It’s a major attraction for the big foreign banks, such as JPMorgan Chase & Co. and Citigroup Inc., that base their European operations in London.
Yet EEA membership comes at a price Prime Minister Theresa May may not be prepared to pay: contributing to the EU budget and following its rules, including the free movement of workers, while having no voice in making them. If passporting’s off the table, the U.K. may have to fall back on “equivalence,” which can give companies based outside the EU privileged, if targeted, market access.
What’s the difference?
The main difference between passporting and equivalence is that one is a right, the other a privilege.
“There’s only one thing about equivalence that really matters and that is that it can be withdrawn at any time,” said Simon Gleeson, regulatory partner at Clifford Chance LLP in London. “The one-line summary is that passports are permanent, equivalence is precarious. It’s nice to have, you’d encourage the government to get it sorted out, but equivalence is no basis for long-term planning.”
What’s involved in an equivalence decision?
Equivalence refers to the European Commission’s recognition that a country’s rules and oversight of specific business lines are as tough as its own. This allows the EU to rely on firms’ compliance with those frameworks, reducing overlaps on both sides as well as reducing capital costs for EU companies exposed to equivalent third countries.
Most EU financial-services acts contain provisions for equivalence, including the updated markets rules known as MiFID II, which come into effect in 2018. Equivalence is also possible for some purposes in the EU’s bank capital rules and in Solvency II, which governs the insurance industry.
How does it work?
To see how equivalence works, take the recent agreement the commission struck with the U.S. Commodity Futures Trading Commission on central counterparties.
EU law, in this case the European Market Infrastructure Regulation, allows companies based outside the bloc to “provide clearing services to clearing members or trading venues” set up in the EU on two main conditions. First, the commission has to determine that the country’s legal and supervisory systems are an “effective equivalent” to those in the EU; second, the company must be recognized by the bloc’s markets regulator.
The deal with the CFTC, announced in February, enabled companies such as Chicago-based CME Group Inc. to continue providing services to EU firms. Without it, traders would have faced higher EU capital requirements to clear swaps, futures and other derivatives in the U.S.
How long can equivalence talks take?
While the EU’s equivalence talks with the CFTC were successful, they dragged on for nearly four years even though at issue was “one tiny subset of the whole financial services sector landscape,” as Jonathan Hill, the EU’s former financial-services chief, said in June. What’s more, this was a case in which both sides “wanted to conclude it quickly,” he said.
“The bureaucratic process of gaining equivalence is complex,” said Edward Chan, banking partner at Linklaters LLP in London. The process is “likely to take a minimum of six months upon exit,” he said. The European Commission is under “no obligation” to grant equivalence, and “the decision can be time-bound and reversed, so, although it is not meant to be a political process, it is likely that political considerations will influence this decision.”
How do the banks see it?
As May prepares for talks on withdrawal from and future trade relations with the EU, the banks’ starting position is clear: They want to hang on to what they have. “The banking sector unequivocally wants to maintain the current level of full access to the EU market,” Anthony Browne, chief executive officer of the British Bankers’ Association, said earlier this month.
If the current passporting regime can’t be maintained, Barclays Plc sees three main options: creating or building out EU subsidiaries with passporting rights; licensing EU branches for specific operations; and reliance on the third-country access provisions in EU financial-services acts.
All of these involve costs and risks. As Royal Bank of Scotland Group Plc put it, loss of passporting could mean the firm would need to apply for authorization in “multiple EU jurisdictions, the costs, timing and viability of which is uncertain,” and this “may have a significant impact on the group’s operations, profitability and business model.”
What’s at stake?
The sheer scale of cross-border activity into and out of the U.K. gives an indication of what’s at stake.
Sam Woods, head of the Prudential Regulation Authority, said last month that 66 EU banks have branches in the U.K., while 24 British-based banks passport out to the rest of the bloc. On the insurance side, 79 companies branch in and 41 branch out, he said. And when it comes to services sold cross-border without a branch, “probably something north of 200 insurance companies and 100 banks are doing that kind of activity,” he said. And that’s before you consider all the asset managers, investment firms and so on.
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