Equivalence in Financial Services Regulatory Framework

Equivalence in financial services regulatory framework is a complex concept, but it's essentially about ensuring that foreign financial institutions operating in a country meet the same standards as local institutions. The EU's equivalence framework is based on the principle of mutual recognition, where the EU recognizes the regulatory standards of a non-EU country if they are equivalent to its own.

The EU's equivalence framework is not a one-size-fits-all approach, it's tailored to specific financial sectors, such as banking, securities, and insurance. This means that each sector has its own set of equivalence criteria, which are regularly reviewed and updated.

To be considered equivalent, a non-EU country's regulatory standards must be at least as stringent as the EU's, and must not pose a risk to financial stability or the integrity of the EU's financial system. This ensures that foreign institutions operating in the EU are subject to the same level of oversight and regulation as local institutions.

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The United Kingdom's departure from the European Union, known as Brexit, has had significant implications for the financial services sector. Brexit implies the loss of passporting rights for the UK, but it can still access the European single market through the granting of equivalence.

The City of London is Europe's biggest financial centre and remains the top financial centre for the long run, despite Brexit. However, Brexit has had an impact on the provision of financial services in Europe, including clearing and supervision.

The UK was initially in the forefront of the CMU project, which aimed to promote a more inclusive role for the City of London in the European financial system. However, losing the UK's wholesale market renders the project "less efficient" and reduces the EU's image as a "big finance hub" in the world.

The EU has ruled out the possibility of a permanent scheme of equivalence for the UK, citing that no other country has ever received the same benefits. Japan is the country with the biggest level of market access in financial services after the EU-Japan Trade Agreement.

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The EU's equivalence regime could be used to allow the UK financial sector to continue providing certain financial services to EU clients. However, the relationship between equivalence and EU financial stability is not clear, as equivalence brings both benefits and shortcomings to the latter.

The EU has recently launched a new Action Plan for the CMU project, which reflects the new reality without the UK. The plan aims to increase the international competitiveness of the Single Market for financial services and provide third-country institutions with a single point of access.

In one month after the end of the Brexit transition arrangements, Amsterdam overtook London in terms of the average daily value of Euro-denominated shares traded.

Here are some key facts about the EU's equivalence regime:

Equivalence decisions are a key concept in financial services, but they're not the only way to deal with cross-border provision of financial services.

Equivalence decisions can be complex and time-consuming to implement.

In the United States, foreign companies, entities, products, and services are treated as domestic ones, following the principle of National Treatment. Domestic regulators don't need to develop a detailed understanding of foreign regulatory regimes.

Exemptions are another approach, where countries like Japan or Switzerland focus on selected aspects of cross-border regulatory activity. Some jurisdictions, known for their "finance-friendly environment", apply broader exemptions in the field of finance.

Passporting is a system based on a single authorisation, allowing for the provision of services in the whole of the European Union as long as it follows its home country legislation. This is regulated under legislative acts such as MiFID II.

International Agreements imply mutual commitments between two or more jurisdictions aiming at the reduction of barriers to financial services provision.

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Passporting is the highest level of market access available for any country, implying membership of the EEA, but no third country has ever been granted passporting rights.

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Equivalence and passporting have different implications for market access rights. For example, under the Fourth Capital Requirements Directive (CRD IV), the EU recognizes third countries as equivalent but grants no market access rights for non-EU banks. In contrast, passporting provides cross-border rights and local treatment for branch operations.

The Market in Financial Instruments Directive (MIFID II) creates cross-border rights for non-EU firms on the condition that they are authorized by ESMA, but only for MIFID II services. Passporting, on the other hand, provides cross-border rights and local treatment for branch operations.

Here's a comparison between equivalence and passporting in key EU legislative acts:

Passporting is the highest level of market access available for any country, implying membership of the EEA. This means that only countries in the European Economic Area, such as Norway, Iceland, and Liechtenstein, have been granted passporting rights.

In fact, no third country that is not part of the EEA has ever been granted passporting. Not even Switzerland, a member of EFTA, has passporting rights. This is a key difference between passporting and equivalence, which we'll explore further.

Here's a comparison between equivalence and passporting in key EU legislative acts:

As you can see, passporting provides a higher level of market access than equivalence, with cross-border rights and local treatment for branch operations.

HM Treasury is responsible for making equivalence and exemption determinations, which can help reduce regulatory overlaps and provide firms with improved prudential treatment.

The UK's equivalence framework, inherited from the EU under the EU (Withdrawal) Act 2018, allows the European Commission to determine if a third country's regulatory regime is equivalent to the EU's.

Equivalence in financial services is not the only solution to cross-border provision challenges. National Treatment is an alternative, where foreign companies are treated as domestic ones, having the same obligations as domestic products. This approach is practiced in the United States, where domestic regulators don't need to understand foreign regulatory regimes.

In some countries, exemptions are the way to go. Japan and Switzerland, for instance, focus on specific aspects of cross-border regulatory activity. This approach is often applied in jurisdictions known for their "finance friendly environment".

There are several alternatives to equivalence decisions, including Passporting, International Agreements, and Exemptions. Here's a brief overview of these alternatives:

The legislative framework involving equivalence decisions in financial services is quite vast. It comprises over 40 provisions allowing for the commission to take action in different areas.

One of the key legislative acts is the accounting directive, which plays a significant role in this framework. The audit directive is another important act that is part of this framework.

The capital requirements regulation and credit rating agencies regulation are also crucial components of the legislative framework. EMIR, or the European Market Infrastructure Regulation, is another significant act that is part of this framework.

The benchmarks regulation and market abuse regulation are also key components of the legislative framework. The markets in financial instruments directive (MiFID II) and markets in financial instruments regulation (MiFIR) are also important acts that are part of this framework.

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The prospectus directive and solvency II directive are also part of the legislative framework. The transparency directive is another significant act that is part of this framework.

Here is a list of some of the main legislative acts that entail equivalence decisions:

The Statutory Audit (2006/43/EC) also has a specific provision related to equivalence decisions. Article 25(9) of this directive specifically mentions the United Kingdom in relation to CSDs.

The Commission assesses equivalence by comparing the intent and outcomes of third-country rules to EU rules, rather than just focusing on the exact wording of EU law. This approach allows for a more nuanced understanding of how different regulatory regimes align.

In some cases, the Commission's decision on equivalence is based on reciprocity for EU firms, where the third country grants similar treatment to EU businesses. This can be a key factor in determining whether a third country's rules are equivalent to EU rules.

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The Commission carries out a technical analysis of the third country's regulatory regime, which is supported by relevant European Supervisory Agencies. This helps to ensure that the assessment is thorough and comprehensive.

The assessment process involves reviewing the core and supporting legislation of the third country, as well as considering any potential risks related to cross-border activity. This is a rigorous process that requires careful consideration of multiple factors.

Here are the different steps involved in the assessment process: