Today the financial services industry was buzzing with reports that UK Prime Minister Theresa May has agreed to a “tentative” Brexit deal that would give UK’s financial services sector regulatory equivalence to the EU. With no official comment from the UK Government or confirmation from negotiator Michel Barnier, a deal on equivalence may be speculative. But if a deal were to happen – what would its impacts be for financial services?
Equivalence would allow a third country’s (non-EU) laws and regulations pertaining to a specific EU requirement be recognized as ‘equal’ to those of the EU. To put it simply: equivalence is the recognition by Brussels that UK oversight and regulations are as strict as its own, thereby allowing the UK to operate certain business in the EU. Therefore, the third country has no need to replicate the EU law or reference it into their own statutes in order to comply with EU requirements. Without a deal on equivalence, come “Brexit Day” on 1 April 2019, the UK would have to either implement the EU requirements into its regulations or cause bifurcation for financial firms wanting to do business between the EU and UK. The agreed transition period through 31 December 2020 would allow financial firms more time to create separate processes for EU and UK business activities but would not have mitigated the issue.
Too little too late?
Given many banks and asset managers have already taken significant steps to adjust their business models and structures to allow them to operate in two separate regulatory regimes (EU and UK,) a possible announcement of an “equivalence deal” may seem too little and too late. However, firms setting up management companies for their fund ranges and banks establishing new trading branches in an EU member state when they previously only traded out of the UK, only solved for their ability to undertake certain business practices within the EU, still leaving significant challenges with clearing, reporting requirements, and derivatives contracts (impacting $595 trillion of open positions). Broker dealers and central clearing counterparties will feel the most initial relief of burden if an equivalence deal applies to such transaction-level requirements.
Therefore, an equivalence deal would be a welcome development to the industry and the currency markets have already shown an uptick in GBP in the wake of the news. However, firms should remain cautious until there is a detailed break-down on a requirement-by-requirement equivalence declaration from regulatory bodies. Furthermore, many of the steps investment managers have taken in light of Brexit have been with respect to their UCITS funds, an investment vehicle governed by a regulatory construct that does not recognise the concept of equivalence.
In the event that equivalence is sufficiently broad in its application across asset classes, sectors, and regulatory requirements, it will save financial services from the immediate aftermath the industry expected between 1 April 2019 and the end of the transition period in 2020. Another possible impact is that given equivalence allows the “harmonious provision of financial services” across EU member states, it may make the loss of the MiFID passport more palatable.
Firms that have invested significant resources in restructuring their business have not taken action in vain given the expectation that the Financial Conduct Authority (FCA) and politicians will use Brexit as an opportunity to depart from key EU requirements for funds and banks. One of the initial goals of Brexit was to make the UK a distinct and attractive financial market place that can compete with its EU neighbours globally.
The FCA has long been an influential voice in the EU and has often led the way with regulatory requirements as well as critical financial services architecture such as MiFID II and EMIR. However, through EU Trialogues and FCA Q+As, the industry has a clear indication as to how the FCA views certain requirements and where it may seek to re-assert its own standards in the UK market.
More to come…