Goodbye Passport, Hello Equivalence? Brexit Banks Lower Sights

Updated on

British bankers are lowering their sights when it comes to securing a Brexit deal that will safeguard the U.K.’s biggest industry.

After months of pushing to keep the current form of unrestricted access to the European Union’s single market after the U.K. leaves, TheCityUK lobby group diluted its demands Thursday. No longer is it so vocal in seeking so-called passporting, which allows global banks with bases in London to provide services to the rest of Europe.

While Chief Executive Officer Miles Celic said his group isn’t “retreating from seeking continued access to the single market,” the absence of the word “passporting” in a two-page list of industry priorities comes after bank executives acknowledged privately that they are unlikely to still have it after Brexit.

The dream of maintaining the status quo has run aground on Prime Minister Theresa May’s reluctance to give finance special status in her negotiations and warnings from the EU that May’s focus on reducing immigration will come at an economic cost. Instead, banks are now increasingly focusing on securing a version of “equivalence,” an option that previously came low down their list of ambitions.

Why is passporting so hard to keep?

Passporting is the right of companies authorized in one country of the European Economic Area 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. The EEA currently comprises the 28 EU countries plus Iceland, Liechtenstein and Norway.

EEA membership comes at a price the U.K. government may not be prepared to pay, however: contributing to the EU budget and accepting the bloc’s rules, including free movement of workers between countries, while having no voice in making those regulations.

May signaled on Jan. 8 that regaining control of immigration and lawmaking are her Brexit priorities, even if that means quitting the single market. That’s a red line for Europe.

“Passporting rights are tied to the single market, and would automatically cease to apply if Great Britain is no longer at least part of the European Economic Area,” Bundesbank President Jens Weidmann told the Guardian in September.

If passporting is off the table, the U.K. may have to fall back on equivalence, which can give companies based outside the EU privileged, though targeted, market access.

What’s Equivalence?

Equivalence refers to the European Commission’s recognition that a non-EU’s 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 market 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.

Why isn’t it as good as passporting?

The main difference between passporting and equivalence is that one is a right, the other a privilege. Equivalence can be withdrawn at short notice, would probably cover fewer services and may mean the U.K. will have to accept rules it has no say over.

“Equivalence doesn’t carry any of the permanence of other regimes on the basis that it’s ultimately a political decision,” Simon Lewis, chief executive officer of the Association for Financial Markets in Europe, said on Jan. 12.

Douglas Flint, chairman of HSBC Holdings Plc, told U.K. lawmakers on Jan. 10 that it’s “a little bit hazardous to rely on equivalence, particularly where the industry involved is such a significant part of the GDP as our financial industry is to the U.K.”

How does equivalence 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 they involved “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 U.K. could have an advantage in that EU law will apply in the country until the day it quits the bloc, so it will start from a position of equivalence, assuming May follows through on her promise to convert the"body of existing EU law” into British law on exit day.

Are there any alternatives?

Trade Minister Mark Garnier said in an October interview that passporting was unlikely to be extended beyond Brexit. He instead suggested equivalence could be beefed up.

“If we can create a special hybrid version of that, with a better version of equivalence or a different version of passporting, then that’s what we will try to achieve,” Garnier said.

Citigroup analysts including Andrew Coombs wrote in a Jan. 11 report that the U.K. will likely try to negotiate an “equivalence plus" agreement with the EU. This would extend the equivalence principle to services not currently covered by third-country access provisions in the bloc’s financial-services acts.

Who’s affected?

The sheer scale of cross-border activity into and out of the U.K. gives an indication of what’s at stake.

If the U.K. lost all passporting rights, 35,000 industry jobs could be at risk, along with 20 billion pounds ($24.4 billion) of annual revenue and 5 billion pounds in lost tax receipts, according to an Oliver Wyman report published in October.

Nearly 5,500 firms authorized in the U.K. use passports to sell services via branches or cross-border without a branch in other EEA countries, according to the Financial Conduct Authority. More than 8,000 companies registered in Europe access the U.K. in a similar way.

What are the chances of a deal?

Goldman Sachs Group Inc. economist Andrew Benito predicted this month that both sides would come around to a deal in the end.

“That will involve some additional access being agreed between U.K. and EU markets in exchange for commitments being made to maintain financial sector regulations,” he said. “It is also likely to involve additional U.K. contributions to the EU budget.”

European Parliament officials have called for a “workable agreement” because Europe could suffer if the U.K.’s financial services industry is hurt. Bank of England Governor Mark Carney made the same point in saying there should be a transition.

“If you rely on a jurisdiction for three-quarters of your hedging activity, more than three-quarters of your FX activity, half of your lending, half of your securities transactions, you should think very carefully about the transition from where you are today to where the new equilibrium will be,” Carney told lawmakers on Jan. 11.

    Before it's here, it's on the Bloomberg Terminal.