Financial Services: is there an equivalent to passporting?
In the days and weeks following the referendum result, much of the UK financial services industry was focussed on issues of “passporting”. Being part of the EU allows firms regulated in the UK to sell financial services across the EU under a common set of rules and retaining this ability was identified by most as business critical.
We are fast approaching the end of March, the date Theresa May has said she will serve notice under the now famous Article 50 which will formally begin the process under which the UK will withdraw from the EU. The Government has now made clear that it will not be seeking membership of the Single Market, but will pursue instead a new strategic partnership with the EU. This means alternatives to passporting need to be considered, and the concept of “equivalence” may be the answer.
Under equivalence, the legal, regulatory and/or supervisory regulations of a third country are deemed by the EU to be as good as, or equivalent to, those of the EU. Certain EU financial regulations envisage the possibility for third countries to obtain equivalence, and can bestow passport-like rights in some cases. MiFID II is an important example of this, and the equivalence provisions within it have given some commentators optimism that banks will not be as badly affected by a loss in passporting rights as was initially predicted. Some third countries have already obtained equivalence in some areas (Switzerland and Bermuda have obtained full equivalence under Solvency II – the EU directive setting out prudential requirements for the insurance sector). The process to obtain equivalence can take several years, but the fact that the UK starts from a position where its financial services rules already meet EU requirements means that equivalence should, in theory at least, be easier to achieve.
A downside to equivalence is that it must be obtained in relation to specific requirements of individual pieces of legislation, and the possibility of equivalence is not envisaged in all areas of regulation. The largest ‘hole’ is arguably the Capital Requirements Directive (CRD IV) – which covers a number of key wholesale and retail banking services such as deposit-taking, commercial lending and payment services, so it may be that the UK still needs to negotiate bespoke deals to replicate passport-like arrangements in some areas. Also, a finding of equivalence can be withdrawn at any time by the Commission, which is a risk if UK rules come to diverge materially from EU standards over time (although the EU has not to date withdrawn an equivalence finding and inter-state cooperation at a regulatory level should lessen the risk of such divergence arising).
So what is the Government’s position on this? On 2nd February the Department for Exiting the European Union published a white paper on the UK’s exit from the EU, which includes a section on the Government’s aims for financial services. As probably expected, there is no particular detail or much in the way of concrete proposals. Although there is reference to the existence of passporting and equivalence, the white paper states only that the UK’s “new strategic partnership agreement” with the EU would be aiming for the “freest possible trade” in financial services between the UK and EU member states, strong co-operative oversight arrangements with the EU (reflecting the interconnectedness of financial markets), and the UK continuing to support and implement international financial standards. Whether equivalence forms the basis for this new partnership agreement remains to be seen.
The white paper talks about the Government’s desire to reach agreement on a “phased process of implementation” for the new arrangements that will apply following the UK’s departure from the EU, which might relate to the future legal and regulatory framework for business. The paper confirms that if no deal is reached, the Government will take steps intended to mitigate the impact on economic and other functions, including passing legislation if necessary. The Government is confident that factors such as the UK’s legal system, language and infrastructure will help ensure that the UK remains a pre-eminent global financial centre, and stresses the need for EU businesses to continue to serve UK customers as well the mutual interest it believes the UK and the EU has in maintaining the UK’s role in the funding and growth of European business. We will have to wait to see how negotiations with the EU pan out in order to see whether the Government is correct about this.