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UK white paper —
the problem with equivalence

Ashley Kovas, Thomson Reuters Regulatory Intelligence

The UK government has published its detailed white paper on the UK’s proposed future relationship with the European Union after the UK leaves the Union. This article will explore whether the new “equivalence” concept differs meaningfully from “mutual recognition” and whether the EU can adopt either idea without damaging its own internal market

Chapter One

Mutual recognition

The UK excluded in the white paper its previously vaunted proposal for mutual recognition in financial services. Mutual recognition featured in a speech by Philip Hammond, the Chancellor of the Exchequer, on March 21, 2018.

Hammond said that when the UK leaves the EU, its regulatory regime will be fully compliant with the EU regulatory regime. “So the way forward must surely be to bank our Day 1 de facto equivalence and shape a regime to manage future regulatory change that ensures that while our rule systems may evolve separately, we deliver fully equivalent regulatory outcomes maintaining commitments to support open markets and fair competition,” he said.

This approach would avoid the UK being an automatic “rule taker”.

“We must have the ability, if necessary, to deliver an equivalent outcome by different means,” Hammond said.

If the UK failed to provide the necessary outcomes, the result would be a consequential loss of access to the market. That, however, would be a deliberate decision and the UK would have to live with the consequences.

Chapter Two

Mutual recognition and equivalence

Hammond compared the mutual recognition concept with the principle of “equivalence”, saying: “At first glance, this may appear to point to a solution based on the EU’s established third-country equivalence regime. But that regime would be wholly inadequate for the scale and complexity of UK-EU financial services trade. It was never meant to carry such a load. The EU regime is unilateral and access can be withdrawn with little to no notice. Clearly not a platform on which to base a multi-trillion-pound trade relationship.”

As recently as June 2018, Hammond reiterated his dislike of equivalence, saying: “It is piecemeal, unilateral and unpredictable. And therefore does not provide the stability that a well-regulated market requires. And I think these weaknesses are increasingly recognised.”


Chapter Three

The problem with mutual recognition

There were three fundamental problems for the EU with the UK’s idea of mutual recognition. First, it would provide access to the single market for services to firms established in a non-member state. The negotiating mandate of Michel Barnier, European chief negotiator for the UK exiting the EU, requires him to respect the indivisibility of the four freedoms on which the European single market is based. Freedom of services is one of those freedoms.

Secondly, if such access were granted to the UK, other member states would want the same degree of flexibility. Firms in third countries cannot be treated more favourably than established EU firms, and other member states would also want to be able to propose their own equivalent means of reaching outcomes. This would in turn subvert the extremely detailed and hardfought EU regulatory regime. The EU single market would be fragmented.

Thirdly, a looser form of regulation would risk a “race to the bottom”, providing some member states with the ability to interpret EU law in a way to entice firms to establish in their jurisdiction. That is still perceived as a problem nowadays, even with the detailed EU regulatory regime in place. Mutual recognition would make that worse.

Chapter Four

Old equivalence

Hammond’s comments about equivalence refer to the existing concept: what might be called “old equivalence”. Some pieces of financial services legislation, but by no means all, contain equivalence provisions, allowing third countries that meet a standard of regulation which is equivalent to that of the EU to have access to the EU market.

The equivalence provisions do require application, and that has hitherto been carried out by the European Commission, which is responsible for assessing equivalence. It published a staff working document on equivalence in February 2017. The proximity of this publication to the UK’s June 2016 referendum suggests the referendum may have triggered production of the paper, but that is not known for sure.

The Commission explained in the paper that, even where equivalence provisions exist in legislation, the Commission has rarely granted it in practice. In addition, the Commission can withdraw its equivalence assessment at any moment.

In short, third-country firms that enter the EU in reliance on equivalence do so at their own peril. There is a clear indication that the Commission finds something objectionable in equivalence.

Chapter Five

New equivalence

The UK has made a plea for a new form of equivalence. As Hammond implied in his June speech, this must be an altogether more substantial form of equivalence from that currently in place.

The white paper said: “… the existing autonomous frameworks for equivalence would need to be expanded, to reflect the fact that equivalence as it exists today is not sufficient in scope for the breadth of the interconnectedness of UK-EU financial services provision. A new arrangement would need to encompass a broader range of cross-border activities that reflect global financial business models and the high degree of economic integration. The UK recognises, however, that this arrangement cannot replicate the EU’s passporting regime.”

This new equivalence is potentially nothing more than … mutual recognition. Mutual recognition would require an assessment to ensure that outcomes were being met. It is difficult to use any other word than “equivalence” to describe that assessment. There is little difference between the two concepts.

Chapter Six

Why change the nomenclature?

The UK has decided to ask for a new form of equivalence, rather than clinging to the idea of mutual recognition. One might ask why, given that the result is broadly the same. There are two reasons why this might be a good idea.

First, mutual recognition has a bad name. It is frequently used during debates in opposition to “mutual harmonisation”. The EU single market was originally regulated under mutual harmonisation, where EU regulation inevitably drifted to the standard of the most permissive member state. This was seen in the famous 1978 Cassis de Dijon case where the eponymous French liqueur was lawfully sold in France and hence had to be lawfully saleable in Germany even though it did not meet the requirements of German regulation. Secondly, equivalence is an existing concept in EU law and as a result it will be difficult for the EU to argue conceptually against equivalence. The UK will argue it wants to make something that already exists work better. There is room for manoeuvre.

Chapter Seven

Likelihood of success

The European Commission will have already realised that the UK’s desire for an enhancement to the equivalence concept is not really any different from mutual recognition. It will be against the idea for the reasons explored above in relation to mutual recognition. Equivalence on the scale suggested by the UK would undermine the EU’s established regulatory order and would weaken substantially the EU’s existing financial services regulation.

Barnier may conclude that the equivalence approach would be tantamount to allowing UK firms freedom to offer services in the EU. As mentioned, that is something he cannot allow under the mandate he has been given by the EU Council: the four freedoms are indivisible.

Whether or not the idea can succeed is therefore likely to be a political question and would rely on the UK convincing member states’ governments. It is unclear that an existential question of such magnitude can be answered politically in the time left to conclude the Brexit negotiations. It is also doubtful the answer would be to the UK’s advantage.

It is possible, however, that at least some enhancements to the equivalence concept might be achieved without damaging the EU regime. If negotiations take that turn, it remains to be seen how much can be achieved, and the extent to which it can help UK financial services firms to secure continued access to the EU market

About the author

Ashley Kovas is a senior regulatory intelligence expert for Thomson Reuters. He has held senior compliance roles in asset management, banking, insurance, as well as at the Financial Services Authority.


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