UK/EU financial services after Brexit – cross-border regulation after the UK’s exit from the single market


Asymmetry: an open UK/City and a protected EU market

In financial services, there is an asymmetric starting point. On one side, the UK’s open stance towards the rest of the world - reflecting the City’s position as a major global centre - and on the other the relatively protectionist approach of the EU and its Member States. This asymmetry was amplified during the contingency planning for a no-deal. The UK acted unilaterally to put in place a generous transitional regime for EU/EEA firms, effectively maintaining single market passport rights into the UK whilst firms re-structured. EU and Member States took a much more hardline approach to incoming UK firms. The only EU-level measures took the form of temporary and time-limited equivalence decisions and related recognition of UK market infrastructure, which have now lapsed. The EU refused to grant any other equivalence decisions for the UK, despite the UK being committed to maintaining all EU regulation at exit.

As the UK has given up the idea of treaty-based bilateral mutual recognition and would be unlikely to threaten closing off the UK and the City, we should expect this asymmetry to kick in again as the UK leaves the single market at the end of the transitional period and for it to be a feature of the regulatory regime thereafter.

The UK has made legislative changes to update its transitional measures for single market exit, such as the Temporary Permissions Regime (see our recent article). For most EU firms, any core restructuring can be dealt with after the UK’s exit from the single market because the Temporary Permissions Regime (and other such UK transitional regimes) will enable them to continue, on a temporary basis, as if the UK were still in the single market.

For most UK firms, however, the position is different. The EU does not have equivalence-based mutual recognition legislation for third country firms, and it seems unlikely that the EU will provide UK-style transitional relief to maintain single market mutual recognition for UK firms after the transitional period. UK firms will have to operate within the restrictions of the host state regulatory regime without additional EU-based mutual recognition

The outcome of the negotiations with the EU

Under the Political Declaration, both sides were to have conducted equivalence assessments by 30 June this year. The EU’s negotiating mandate, however, makes no reference to this deadline or to the question of equivalence decisions being in place for the end of the transitional period. Indeed, the mandate puts strong emphasis on the EU’s discretion and autonomy. In any event, the Political Declaration provisions are not legally binding and there is no commitment in the declaration to have the related mutual recognition in place for the UK’s exit from the single market. UK firms cannot therefore count on this mutual recognition being in place or on there being any EU transitional measures.

The Government, on the other hand, had already confirmed[1] that it would be seeking equivalence decisions for the UK under all of the provisions (around 40) which are available under current EU financial services legislation. In its publication on 27 February, it pointedly removed this issue from the section on the Comprehensive Free Trade Agreement (CFTA) and stated in a later section that ‘The UK and the EU have committed to carrying out unilateral equivalence assessments for financial services, distinct from the CFTA. The fact that the UK leaves the EU with the same rules provides a strong basis for concluding comprehensive equivalence assessments before the end of June 2020’.

The mutual recognition available under the current EU financial services provisions varies enormously. Many are uncontroversial, such as those relating to the capital treatment of third country exposures, but several offer potentially very important mutual recognition to UK firms and UK market infrastructure. This is where the real battle lines are drawn.

In response to the 2016 referendum result, the EU toughened its third country regime and developed an objective rationale for a hardline approach to the UK. The current state of play is set out in the Commission’s communication on ‘Equivalence in financial services’[2].The EU has been at pains to develop objective sounding reasons for a tough approach towards the UK. It has created a differentiated approach with new special categories, expressed in general terms but clearly with the UK in mind, of ‘high risk’ third countries and those of ‘systemic importance:’

‘as a rule, "high-impact" third countries, for which an equivalence decision is likely be used intensively by market participants, will represent a more significant set of risks which the Commission will need to address in its assessment of the equivalence criteria and in the exercise of its discretion’ … ‘the EU expecting stronger assurances from high impact countries that they are able to deliver the required outcome.’

This has strengthened the EU’s position in the negotiations because it lays the ground for outright refusal of equivalence, or for mutual recognition on restricted terms, which can be presented as objectively justified. For example, the EU’s decision not to renew its equivalence for Swiss trading venues, a clear political manoeuvre, put forward an objective sounding rationale about legal uncertainty from the broader EU/Switzerland treaty dispute.

On narrow regulatory grounds, the only real issue will be the question of UK divergence from EU norms after single market exit. The EU equivalence provisions have review mechanisms to address this risk, but one can still see the EU asserting that these are not enough.

The UK will have a mirror image of the EU’s third country equivalence legislation and could in theory retaliate by refusing equivalence for EU Member States. This seems unlikely as it would involve reversing its established policy both on short-term transitional measures and its more open regulatory perimeter. The UK may therefore need to make concessions in other areas in order to secure even its now very limited objectives in financial services, including its goal of having a full set of equivalence decisions in place for single market exit.

This objective is independent of the envisaged CFTA provisions on financial services which now seem a second order issue for the immediate future. The Political Declaration envisages both a fishing rights agreement and equivalence decisions early in the process, by end of June this year (i.e. six months before the end of the transitional period). These issues were to be dealt with ahead of the main negotiations. This is an important milestone for the negotiations more broadly, and the Government is threatening to break off negotiations if sufficient progress has not been made by then.

If negotiations break down at that point or a later stage, we should expect the EU to continue to maximise the negotiating leverage which equivalence provides, and the EU may well follow its strategy for ‘no deal’. This means holding out until late in the day, and then only granting important equivalence on the most limited terms and only to the extent that the EU judges that it is critical for EU markets to have mutual recognition in place at the end of the transitional period.

The UK might achieve its objective on equivalence in various scenarios. First, consensus on fishing and equivalence decisions might be reached under the political declaration timetable, but this currently seems unlikely. Secondly, if negotiations continue after June, this might be on the basis of both sides agreeing to roll these issues forward into the main negotiations. Equivalence might then be ‘agreed’ during the last six months of the year, but financial services firms would not know the outcome until much later in the process. Another complication is that both sides currently accept the possibility that the transitional period may be allowed to expire before the negotiations have completed. At the point the UK leaves the single market some areas may be agreed and some may be left to be negotiated later. The UK may therefore find that the CFTA on financial services, and services generally, are not agreed by the end of the year. In that event, it would need to persuade the EU to grant equivalence ahead of the negotiations in deferred areas, at least on an interim basis.

Financial services mutual recognition will largely be turned off at the end of the transitional period, but for some operations of UK firms the issue of EU equivalence decisions is critical. This may go to the wire and the outcome will depend on the fate of the broader EU/UK negotiations over the coming months.

[1] See John Glen letter of 27/1/20 to HoL European Union Committee

[2] Commission communication on equivalence in financial services - 29/7/19