Enhanced Equivalence: Principles and Practice for a UK-EU Financial Services Trade Deal

There is little doubt about what would be the best picture for UK-EU free trade in financial services after Brexit. But what will be critical is how durable the chosen framework will prove. Although the Government's current proposal is fundamentally sound, improvements should be made and careful implementation is needed if it is to succeed.

Mutual Recognition

The negotiation on financial services must, as has been made clear by the UK Government, result in some form of mutual recognition of regulatory provisions and supervision. For many reasons, as set out in a previous publication A Template for Enhanced Equivalence (hereafter, the Template),1 it is now common ground that there is no other viable method for allowing the cheapest possible access to liquid capital across Europe and the avoidance of the unnecessary costs of duplicative regulation, consistent with the referendum decision. The UK is host to global financial markets, most of which have nothing to do with the EU. From the EU's perspective, the prize is to come up with an arrangement that allows global businesses most easily to serve European customers and for European customers to have the most efficient access to global capital. Capital costs are crucial for economic welfare and growth, enabling European businesses to build, invest and prosper – and enabling European citizens to save for health, lifestyle, retirement and other purposes. From the UK's perspective, the prize will be minimal disruption to its markets, market participants and access to the EU customer-base.

In the language of EU financial services, this mutual recognition manifests itself in the concept of 'equivalence', whereby the EU recognises the regulatory standards of another jurisdiction to be 'equivalent' to its own (and vice versa), and therefore does not seek additionally to impose its own regulatory standards on firms regulated in that other jurisdiction, even when they are performing services within the EU.2 The standards need not be identical, but must overall be seen as achieving equivalent high-level outcomes — a principle which acknowledges individual jurisdictions as being better placed to identify local problems.

In order to recognise the other jurisdiction in this way, key interests need to be protected, often with common aims. In particular, both parties will need to ensure they do not incur unacceptable systemic risk, since that puts taxpayer monies at risk as was seen in the 2007-8 financial crisis. Both parties will also wish to protect their consumers (i.e., retail customers) by ensuring products or services sold or delivered to their consumers meet certain requirements and the sales process makes clear where protections are different when buying from abroad rather than from local suppliers.

Why is any Equivalence-type Concept Necessary at All?

Equivalence is not required in every context. For wholesale investment business, the UK allows foreign businesses to deal with parties in the UK without regulation, using its 'overseas persons' exclusion.3 The EU seeks to do the same through its so-called 'reverse solicitation' exclusion, under which EU customers can reach outside the EU to access services and products from elsewhere, becoming subject solely to the protection of the provider's regime.4

However, across other matters, such as commercial banking and insurance, this is not the case. Nor is it the case that the EU applies reverse solicitation in as clear-cut and expansive a manner as that in which the UK applies the overseas persons exclusion for investment business, allowing free and unrestricted relationships to be formed in a broad context. The EU has generally so far been reluctant to allow foreign businesses to market financial services and products to the benefit of EU customers without seeking to exercise control.

Equivalence - What it Promises

The advantage of equivalence is that in those areas of financial services where equivalence is granted from time to time, UK businesses will be permitted to operate across the EU markets without further licensing, additional compliance requirements or EU supervision. The same is true for EU businesses wishing to operate in the UK markets so long as EU standards are equivalent to those in the UK.

In this way, the end result that the City's financial businesses have urged would be achieved.5 Such an equivalence agreement would avoid the need for business adjustment as a result of Brexit or additional expense being incurred in altering current business models for servicing EU27 clients.

A successful equivalence framework in the Brexit context would provide for mutual recognition of financial regulatory standards between the UK and EU in a flexible manner. It would allow each jurisdiction, after Brexit, to operate in its own way, not being formally tied to the other – although, of course, in many cases they are likely to mirror each other in terms of making rules for and regulating safe financial markets, as those areas are mostly driven by global standards.

Because it is based on the existing EU legal concepts for financial services, equivalence could form one of the best workable bases for both parties, having been developed by, and therefore being familiar to, both the UK and the EU. Equivalence as a concept has been extensively worked out in law already and is now used internationally as a proven basis for successful financial services trade.

There are numerous equivalence regimes already operational in EU law,6 and the approach is already in use for the EU's trading relationship in financial services with the US, Japan, Singapore and elsewhere.7 For the US, for instance, central counterparties based there can be recognised by the EU as being acceptable to satisfy the G20-driven obligations requiring certain EU businesses to enter into any liquid derivatives contracts with central counterparties rather than bilaterally with other market participants. By building on this approach, the proposal goes with the grain of existing law which the UK has worked on whilst part of the EU.

Improving the Equivalence Concept

As explained in previous publications, the concept of equivalence as it stands is inadequate for the UK-EU relationship, in part because it was not developed to cover the extensive activities and depth of such a significant relationship.8 Therefore, improvements need to be made.

It should cover the full range of services, activities and products, including lending, insurance, settlement finality and retail financial business.9 Moreover, in terms of definition and legal certainty, it should be made clearer that equivalence is determined by reference to high-level outcomes, where possible based on international standards.10 The existing equivalence processes need to be rendered more consistent.11 And there needs to be objectivity and procedural certainty over when equivalence is to be granted.12

The definition of outcomes is key, since it is on this that the workability of the equivalence concept depends. The proposal in the Template is that the outcomes achieved by both sets of rules should be defined at a sufficiently high level such that neither party is a rule taker from the other. This is accomplished by ensuring any outcomes required are, where possible, based on objective international standards. Where those standards are inapplicable or ill-defined, the outcomes would be agreed upon at a technocratic level between the UK and the EU.

The Goal

The goal is to establish an attractive and workable solution for both parties:

  • The UK would be able to legislate and regulate in a manner consistent with the Common Law, ensuring a proper marriage of legislation, regulation and predictable judicial interpretation.
  • The EU could continue unfettered with its own legislative and judicial approach, which works for the EU.
  • The proposed regime would fill in the gaps found in the existing EU framework,13 to the benefit of the EU, not just in relation to the UK.
  • It would provide for cooperation mechanics for supervision and enforcement, and information flows between regulators.14
  • There would be collaboration on new legislative and regulatory initiatives.15
  • There would be an independent tribunal which oversees the application of the equivalence definition and the procedures for granting and withdrawing equivalence,16 providing the necessary certainty for businesses.
  • So long as the relevant outcomes are met in a particular area of financial services business, then access would be maintained in that area.

Because each party's rules are currently identical there would be equivalence across all areas on day 1 of Brexit. After that, either party could at any point decide not to continue with equivalence-based access in a particular area for its businesses to the other party's jurisdiction and could make entirely different rules in that area which did not achieve equivalent outcomes to those achieved by the other party. This seems unlikely for the UK since the UK has been and remains instrumental in developing international standards, but the optionality is built into the arrangement for such radical divergence to occur.


1 A Template for Enhanced Equivalence: Creating a Lasting Relationship in Financial Services Between the EU and the UK, by Barnabas Reynolds, Politeia, July 2017.

2 For further information on equivalence in the Brexit context, see Section 2, A Template for Enhanced Equivalence ('Introducing Equivalence: The EU and the Concept of International Mutual Recognition').

3 Article 72, Financial Services and Markets Act 2000 (Regulated Activities) Order 2001 (SI 2001/544).

4 Recital 111 and Article 42, Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Directive 2002/92/EC and Directive 2011/61/EU (MiFID II); and Recital 43 and Article 46(5), Regulation (EU) No 600/2014 of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments and amending Regulation (EU) No 648/2012 (MiFIR).

5 See, for example, Brexit and UK-based Financial and Related Professional Services, TheCityUK, 12 January 2018.

6 These are set out in Annex A, A Blueprint for Brexit: The Future of Global Financial Services and Markets in the UK, by Barnabas Reynolds, Politeia, November 2016.

7 See Annex C of A Blueprint for Brexit.

8 Section 3, A Template for Enhanced Equivalence ('Making Equivalence Work').

9 See Annex B of A Blueprint for Brexit.

10 See Section 5 of A Template for Enhanced Equivalence and Section 8 of EU-UK Financial Services After Brexit - Enhanced Equivalence: A Win-Win Proposition, Barnabas Reynolds, New Direction-Politeia, February 2018.

11 Ibid.

12 Ibid.

13 Article 5(1) of the Draft Equivalence Regulation in A Template for Enhanced Equivalence.

14 Article 3(2)(e) of the Draft Equivalence Regulation in A Template for Enhanced Equivalence.

15 Article 6 of the Draft Equivalence Regulation in A Template for Enhanced Equivalence.

16 Article 9 of the Draft EU-UK Bilateral Agreement in A Template for Enhanced Equivalence.

To view the full article, please click here

Originally published in Politeia

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.