On 9 November 2020, the Chancellor announced the publication of  “a set of equivalence decisions for the EU and European economic area member states.”

Equivalence is a system which can be used to grant domestic market access to foreign firms in certain areas of financial services. It’s based on the principle that the countries where they are based have regimes which are ‘equivalent’ in outcome.

This Insight explains equivalence and the latest developments.

Regulation of financial services

Performing many financial services in the UK requires authorisation by the Financial Conduct Authority (FCA) and sometimes the Prudential Regulation Authority too.

Most countries have a system for regulating financial services, although the exact process for obtaining authorisation and the exact activities that are regulated will differ. For example, the UK mostly does not regulate commercial lending (lending to businesses) but some EU countries do.

EU passporting helps firms to operate in other countries

Normally, a financial services firm operating internationally needs to get advice, and perhaps go through an application process, in each country it operates in. This can be both time-consuming and expensive.

The EU made this easier by introducing ‘passporting’. Over several years a number of  ‘single market directives’ were passed in the EU. These directives provided, in their own specific areas, that a firm authorised in one Member State would be able to operate in another without having to seek new authorisation.

Leaving the European single market

All passporting rights will be lost when the UK leaves the European single market on 31 December 2020. This could cause issues for:

  1. UK-authorised firms that currently passport their authorisations into Europe. In September 2016 there were about 5,500 of these,
  2. EEA-authorised firms that currently passport their authorisations into the UK.

By the time passporting rights are lost, these firms need to either stop operating in the countries they passport into, or gain separate authorisation there.

The UK’s temporary solution

To avoid a cliff-edge in which firms might need to suddenly stop operating, the Government announced a Temporary Permissions Regime. This would apply to EEA-authorised firms passporting into the UK (so category 2 above). It allows these firms to continue operating once the passporting regime falls away for up to three years, while they seek UK authorisation.

However, the EU has not reciprocated by putting in place a similar arrangement. UK-authorised firms passporting into the EU still don’t know whether they’ll be allowed to continue operating as they do now.

In theory, the UK and EU could agree rules on access for financial services as part of a trade deal. However, the Political Declaration agreed between the UK and EU did not mention that such an agreement would be reached. It only said that, “both Parties will have equivalence frameworks in place that allow them to declare a third country’s regulatory and supervisory regimes equivalent for relevant purposes.”

So, what is ‘equivalence’?

Over time, EU laws developed a system to allow market access for firms based outside the European Economic Area (EEA). Each such law allows, within its specific area, the European Commission to decide whether the financial services regime of a country achieves outcomes “equivalent” to its own. EU financial services law includes around 40 areas for equivalence decisions.

Equivalence allows for market access in specific areas but does not cover most core banking and financial activities, like accepting deposits or providing investment services to retail (non-professional) investors.

Equivalence could not, for example, be a solution to concerns some British residents of EEA countries have that their UK bank accounts may close when banks lose passporting rights.  Importantly, therefore, even if the EU granted the UK equivalence in all areas possible, this would still fall far short of the market access under the passporting system. Equivalence decisions can also be withdrawn at any time.

In theory, the European Commission’s equivalence decisions are based on a technical analysis; either a country’s standards are equivalent, or they aren’t. But it’s been recognised that these decisions have a “clear political dimension.” The European Commission has focused on concerns around the UK’s “possible divergence from EU rules,” as a reason for withholding equivalence decisions.

Current situation

In the Political Declaration, the UK and EU aimed to conclude equivalence assessments before the end of June 2020. That deadline was missed with each side blaming the other.

To date, the European Commission only lists one material equivalence decision as having been made in favour of the UK. This recognises UK clearing houses as being equivalent so EEA firms can use them for derivatives transactions. The Financial Times recently reported that further equivalence announcements are considered unlikely while talks on a trade deal continue, given the political sensitivities.

On 9 November, the Chancellor said the UK Government wouldn’t wait for the conclusion of the European Commission’s equivalence assessments before publishing its own. The Treasury then published a spreadsheet showing that equivalence was being granted to the EEA in 22 areas after the end of the transition period.

The 22 areas include access to the UK market for EEA credit rating agencies and investment firms. In areas not recognised as equivalent, the Chancellor announced a willingness to “continue the conversation” with the EU.

About the author: Ali Shalchi is a researcher at the House of Commons Library, specialising in banking and financial services.

Photo by Ed Robertson on Unsplash