Editorial: So long, equivalence!  

Editorial: So long, equivalence!  

Thursday’s European Banking Authority opinion on relocation of UK firms to the continent has dealt a blow to the prospect of continued access the EU financial markets after Brexit.

The opinion called the current equivalence regime included in Mifid II “suboptimal” for these purposes. Unfortunately, the City had set its sights on using the equivalence regime as a way to continue trading with European counterparties post-Brexit.

Way back in August 2016, when Brexit had not yet been split into a ‘hard’ and a ‘soft’ version, implementing Mifid II and coaching the country through the equivalence process was hailed as a sure-fire way for UK financial services firms to replace passporting and continue access to the European financial markets.

Way back in January of this year, right after “red white and blue” Brexit became a thing, two City of London lobby groups issued reports hailing equivalence as the way forward for financial services after the UK leaves the European Union.

Finally, only a few weeks ago, the International Regulatory Strategy Group highlighted equivalence as a key component of future access to European and UK financial services post-Brexit.

Equivalence, simply put, is a European concept that allows firms located in non-EU countries (so-called ‘third country firms’) to trade with EU firms without having to obtain a license or establish a branch inside the Union. If a country’s regulations and legislative processes are deemed to have the same outcomes as EU rules, the Commission can designate it as ‘equivalent.’ The Commission also has the power to rescind its equivalence decision with only 30 days’ notice.

The regime governs many aspects of financial activity between the EU and third countries. For example, under Mifid II EU firms and counterparties will be restricted in trading derivatives subject to the rules on third country markets, unless the Commission has decided the third country market is equivalent. For example, under Emir, central counterparties (CCPs) can only offer clearing services to EU firms if they are recognised under the third country equivalence regime by Esma. A similar rule exists for trade repositories.

Furthermore, under the Capital Requirements regulations, the exposures an EU firm has to an EU-authorised CCP are given a lower risk weighting than those to a third country CCP unless, again, the third country has been deemed equivalent. In other words, after Brexit, EU firms will have to hold more regulatory capital if they continue using UK CCPs to clear their trades in absence of an equivalence determination.

The bad Brexit news has been piling on in recent months. European regulators have been hard at work to signal the pain points in EU-UK financial markets relations. The banking watchdog has called for increased scrutiny of so-called ‘letterbox entities’ for firms looking to relocate from the UK to the EU. Last but not least, it has proposed increased oversight of non-European CCPs and requiring the relocation of those clearing houses that are most systemic for euro-denominated clearing.

The proposals, which were received with considerable controversy when they were first introduced in June, were give broad support in the European Parliament on Tuesday.

Even as the Brexit negotiations are in deadlock and the government has opened the door for a possible transition after the two year clock runs out, business-as-usual seems like an increasingly unlikely prospect for financial services after March 2019.