How ‘Equivalence’ Stands to Shape Post-Brexit Banking

(Bloomberg) -- British banks have had to lower their expectations for how they’ll do business with the European Union after Brexit. The U.K. government had to drop its initial demand that British-based banks retain easy access to the single market. Now it’s certain that the City of London financial district will have to make do with the same framework available to other non-EU countries, an arrangement known as regulatory “equivalence.”

1. What does ‘equivalence’ mean?

Generally speaking, it’s Nation A accepting that Nation B’s rules are as strict as its own and letting Nation B’s companies do a limited amount of business on its territory. For the EU, it’s the job of the European Commission to decide on whether a non-member’s rules and oversight of specific businesses are “equivalent,” based on assessments by the bloc’s supervisors. The commission can take as long as it likes to make a decision.

2. Is that good enough for British banks?

It’s far from ideal. A standard equivalence arrangement has significant shortcomings, the most important of which is that it’s granted unilaterally by the EU and can be withdrawn at any time. That hardly provides the predictability and stability that businesses covet. Also, equivalence procedures would open doors only to certain parts of finance, such as investment services, clearing and hedge funds, while leaving out traditional banking activities such as deposit-taking and lending. This is one of the reasons why many banks are shifting some of their U.K. operations to Frankfurt, Paris and other cities on the continent.

3. Is any of this negotiable?

Some. U.K. negotiators have won a small concession from the EU. A political declaration that’s part of the proposed Brexit deal between the U.K. and the EU includes a commitment to have “transparency and appropriate consultation in the process of adoption, suspension and withdrawal of equivalence decisions.” The two sides also agreed that work on equivalence assessments should start as soon as the U.K. leaves the EU, next March 29, so that they’re in place by July 2020, before the planned transition period expires. There’s also a pledge that the EU and the U.K. will keep their equivalence agreements “under review.”

4. How did we get to this point?

Initially, the banks hoped to keep so-called passporting rights to continue selling their products and services throughout the EU after Brexit. Once that prospect dimmed, they hoped at least for “mutual recognition” by the U.K. and EU of each other’s regulations, which would have allowed the London-based banks to keep serving the EU with minimal disruption. To the EU, both passporting and mutual recognition looked like “cherry-picking” -- the U.K. trying to retain the benefits of being in the bloc while dumping the obligations of membership. The U.K.’s shift reflected its realization that the EU would never allow British banks, post-Brexit, to continue operating as they have.

5. What has the U.K. side said about the plan?

There was widespread disappointment when May first proposed equivalence in July. TheCityUK, which represents the financial-services industry, angrily mourned the decision not to push for mutual recognition. So did the City of London Corporation, which manages the British capital’s financial district and called the proposal “a real blow.” More recently, there’s been some relief over the contours of the deal. TheCityUK declared that the importance of financial services had been recognized. The Association for Financial Markets in Europe, whose members focus on wholesale markets, welcomed the stated objective to begin assessing equivalence as soon as possible. And while Chancellor of the Exchequer Philip Hammond initially dismissed equivalence as “wholly inadequate,” the head of the U.K.’s top markets regulator, Andrew Bailey, said in November that the deal that’s on the table “could provide appropriate assurance and continuity for the operation of financial markets.”

The Reference Shelf

  • The declaration on the future relationship between the U.K. and the EU, which includes a part on financial services.
  • Bank of England Governor Mark Carney’s testimony to Parliament on “dynamic equivalence.”
  • The slides summarizing the EU’s preliminary position on regulating services in a Brexit deal.
  • QuickTake explainers on the prospect of a “no-deal Brexit” and on the Brexit issues facing the U.K. financial industry.

©2018 Bloomberg L.P.