Chapter 2: Equivalence
Background
62.By granting equivalence decisions, the UK Government or the European Commission affirm that a foreign jurisdiction’s rules and supervision in certain areas of financial services are equivalent to their own. In some cases, this allows providers of financial services from the other Party to benefit from the same market access as domestic providers.
63.Equivalence decisions are unilateral. It is therefore not in the gift of either the UK Government or the European Commission to secure or negotiate equivalence from the other Party—a point that was stressed by several of the Committee’s witnesses. Dr Andromachi Georgosouli and Professor Rosa Maria Lastra, from the Centre for Commercial Law Studies at Queen Mary University of London, described equivalence as “a privilege, not a right”, and stressed that, as far as EU decisions are concerned, “Third countries neither have a right to obtain equivalence status, nor indeed a right to receive a positive determination”.82 Similarly, Miles Celic of TheCityUK told us that: “Equivalence is not something that is done jointly. That is certainly not the way the EU sees it.”83
64.Equivalence decisions can be granted or withheld for any reason, and not necessarily on the basis of purely technical criteria. Lord Hill gave the Committee his insights into EU decision-making in this area as a former European Commissioner: “I used to be responsible for [EU] equivalence decisions and I naively started off thinking there must be some kind of technical process … Then you realise very quickly, of course, that it is just a political process and the answer fits the politics.”84
65.Because they are unilateral, equivalence was omitted from the scope of the UK-EU negotiations that culminated in the TCA. The European Commission’s ‘Q&A’ explainer on the TCA states: “The Agreement does not include any elements pertaining to equivalence frameworks for financial services. These are unilateral decisions of each party and are not subject to negotiation … the EU will consider equivalence [decisions] when they are in the EU’s interest.”85
66.It was emphasised to the Committee that equivalence decisions vary in both nature and importance, and many do not deal with market access or cross-border trade. Both Sir Jon Cunliffe of the Bank of England and Miles Celic estimated that the majority of the available equivalence decisions in a UK-EU context did not relate to market access.86
67. Finally, the governance and termination procedures for equivalence decisions may also vary, particularly as far as EU decisions are concerned. Dr Georgosouli and Prof Lastra explained: “The relevant Implementing Act may grant equivalence in full or in part, on a temporary or more long-term basis or subject to certain conditions. Equivalence may be later adjusted or may be even withdrawn or terminated at a short notice.”87 Similarly, Miles Celic highlighted that “there is no single framework of equivalence. It is a patchwork, which is one of the problems with it.”88
The state of play
UK equivalence decisions
68.UK equivalence determinations are issued by the Treasury, supported by technical advice from the regulators and the Bank of England.89 To date, the UK has adopted a more generous approach to granting equivalence to the EU than vice versa. It has issued positive determinations for EU and European Economic Area (EEA) states in 28 of the 32 areas identified for the equivalence process.90
69.The UK’s approach to termination of equivalence also contrasts with that of the EU: like the European Commission, the Treasury reserves the right to revoke equivalence decisions at any time, but its guidance stresses that “withdrawal of equivalence will be considered as a last resort”, in light of “the importance of clarity and stability … and the negative impact that the possibility of withdrawal can have on confidence in the overall system”.91 The European Commission’s July 2019 Communication on its approach to equivalence contains no such commitment.92
70.Sir Jon Cunliffe described the UK’s approach to equivalence decisions as “open” and asserted that it would “continue to facilitate cross-border activity into and out of the UK.”93 Similarly, the Economic Secretary said that the Government had “proactively made equivalence decisions ourselves towards the EU … because we believe in openness, and we believe that London as a financial centre needs to be open to other jurisdictions”.94
71.Representatives of trade associations from the City welcomed the Treasury’s approach to equivalence, with UK Finance urging the Government to continue pursuing “a more outcomes-based approach than the EU rules-based approach”.95
72.We welcome the UK’s open approach to granting its own equivalence decisions. We view this openness as one of the UK’s great strengths in navigating its global relationships in the post-Brexit era.
EU equivalence decisions
73.In contrast to the UK’s approach, the EU has so far granted the UK only two equivalence decisions since the signing of the TCA, both of which were time-limited. One, which was for six months and expired on 30 June 2021, concerned central securities depositories. The other, which concerns the UK’s Central Counterparties (CCPs),96 was granted for an initial 18-month period. It was therefore due to expire on 30 June 2022 but was recently extended for a further three years until 30 June 2025.
74.In a speech to the ECB on 6 April 2022, Mairead McGuiness, European Commissioner for Financial Stability, Financial Services and Capital Markets Union, said that this extension was “really important for [EU] financial stability in the short term.” She added, however, that “in the medium term, we need to build up capacity in the EU and reduce our over-dependence on UK-based CCPs … being heavily dependent on a third country for clearing is unprecedented and it is not sustainable in the medium term.”97
75.It remains unclear, however, whether the EU will be able to build up its own CCP capacity by the expiry of the equivalence decision in June 2025. Rachel Kent of Hogan Lovells told the Committee that setting up clearing houses “is probably one of the most complex legal tasks there is. That means that any process for establishing clearing houses anywhere will take time.”98
76.The Economic Secretary would not be drawn on whether he expected a further extension to CCP equivalence, which he characterised as a matter for the EU. He did, however, observe that “it is quite challenging … to build up that [CCP] infrastructure” because “to switch and ask people to move from one jurisdiction to another involves additional costs”.99
77.As for other equivalence decisions, Sir Jon Cunliffe explained that the EU had initially been in the process of considering these for the UK, but that the process had since been “paused”.100
78.As part of this consideration process, the Committee heard that the UK Government had “painstakingly” filled in numerous EU questionnaires on its domestic regime, amounting to “2,500 pages”.101 Sam Woods of the PRA said that there was “a little bit of frustration around the enormous volume of work that went into [the questionnaires] … with the very limited results”.102 The Economic Secretary said: “we have done everything that the EU has asked of us in co-operating and giving it the materials it needs to deem us equivalent or not. What I cannot then do is force it to make a decision on that”.103
79.At present, therefore, the UK holds just one, time-limited equivalence decision from the EU. This contrasts with the position of other jurisdictions with large financial services sectors: the Committee understands that, as of October 2021, the EU had issued 22 equivalence decisions to the US, 16 to Singapore, and 14 to Switzerland.104
Explaining the lack of EU equivalence decisions
80.We sought the views of witnesses on possible explanations for the lack of EU equivalence decisions to the UK. There was a broad consensus that, compared to its equivalence processes for other jurisdictions, the EU was “holding the UK to a higher standard”.105 Sir Jon Cunliffe explained: “The Commission have said that further equivalence decisions would not just consider current regulation in the UK—which largely mirrors the EU—but also future plans. This a standard that we are not aware of them holding any other country to.”106 Similarly, Miles Celic expressed the view that many of the EU’s equivalence decisions with other third countries “represent a different time in regulatory dialogue between the European Union and its partners”, and that the EU “now see equivalence as a process of managing future and ongoing alignment”.107
81.We heard that this differential treatment could be partially explained by the UK’s size, proximity, and the high trade volumes between the two parties. Sam Woods emphasised that, for the EU, the UK represents “a very large financial services centre right on the edge of its jurisdiction”.108 Andrew Pilgrim of EY agreed: “the European Commission does think about the UK differently from other markets … [equivalence decisions] for a jurisdiction a long way away, where it expects occasional trade, are a very different kettle of fish”.109
82.The Committee also heard that the EU’s decision-making over equivalence for the UK could be attributed to its broader push for what it calls “open strategic autonomy”.110 In the view of Dr Georgosouli and Prof Lastra:
“The reluctance of the Commission to grant equivalence may appear at odds with the fact that almost all of the UK financial regulation stems from existing EU legal instruments but, it is fully consistent with the EU’s future plans to become strategically autonomous and to increase its own international competitiveness.”111
83.More broadly, several witnesses suggested that the lack of equivalence decisions reflected political rather than purely technical considerations on the part of the EU. Miles Celic said “there was no technical reason … why the UK should not be deemed equivalent”, but added, “there has always been a degree of politicisation to equivalence”.112 UK Finance stressed that “the UK rulebook is substantively closer to the EU rulebook than those of other jurisdictions”.113 Lord Hill’s assessment was blunter: “They think that an equivalence decision is a plum to give, and why would you give that before you know you want to give it and in exchange for something else?”114
84.There have been suggestions that the EU’s withholding of equivalence decisions is linked to wider disagreements between the Parties. In June 2021, Commissioner McGuinness suggested that the EU’s financial services equivalence assessments regarding the UK could be resumed once the Memorandum of Understanding on UK-EU regulatory cooperation was finalised, which in turn was linked to the UK “abiding by its obligations and engaging in good faith” in other areas of the relationship (see Chapter 3).115
85.In this context, several witnesses said they did not expect that further equivalence decisions would be forthcoming.116 Lord Hill told the Committee that he had not expected it since the referendum: “I spent a lot of time after 2016 saying to people in the City, ‘I promise you, you are not going to get equivalence’”.117 Caroline Dawson of Clifford Chance, however, was slightly more optimistic, arguing that the lack of decisions to date was partly because “equivalence decisions take a really long time”, and suggested that further decisions might be forthcoming once “the UK financial system stabilises and the EU gets more confidence that we are not going to see a complete bonfire of red tape”.118
86.The Economic Secretary’s evidence to the Committee reinforced the unilateral nature of EU equivalence decisions: “I cannot account for what the EU has decided to do with respect to us. That is a matter for it. It is obviously sovereign to make those decisions itself”.119 He also argued that the UK could not operate on the assumption that further equivalence decisions would be granted: “The question of equivalence will always be there, and we will always be open to discussing whatever the EU wants to discuss, but I am not sitting waiting for that decision.”120
The importance of EU equivalence decisions
87.The Committee sought to ascertain the importance of equivalence determinations for the UK financial services sector. Several witnesses emphasised the benefits of equivalence; Miles Celic said receiving further decisions from the EU would be a “preferable” outcome, while Andrew Pilgrim highlighted the costs of non-equivalence for both UK firms seeking EU market access and for firms in the EU.
88.However, the overall balance of the evidence was that while further equivalence decisions might be beneficial, they were not necessarily of vital or fundamental importance. Peter Bevan of Linklaters suggested that the importance placed by the sector on equivalence had diminished over time: “It is a topic we talked a lot about a year or two ago, but perhaps it is not something we hear being called for so much these days”.121 Similarly, Sir Jon Cunliffe argued that equivalence was just one factor among many that firms take into account, and that it “perhaps gets too much attention as a key determinant of where business will move in the future”.122
89.Peter Bevan also highlighted the fact that, for the sector, “it was always understood that you needed to prepare on the assumption that that equivalence would not be forthcoming … Firms are well prepared for the reality that they find themselves in.” He added that, since firms have now adjusted to this new reality, the value of future equivalence decisions had diminished.123 This was corroborated by the London Market Group: “Given the ongoing uncertainty over equivalence, and that it was never a perfect solution anyway … much of the London Market is moving on from that debate and looking towards the potential that domestic reform could bring.”124
90.Another limitation to the value of EU equivalence decisions is the uncertainty around the withdrawal of equivalence once granted. Dr Georgosouli and Prof Lastra said that the EU’s approach to withdrawing equivalence “entails significant risks for third-country financial firms because the legal basis for their activities might be pulled out at short notice and with little or even no warning.”125 Peter Bevan agreed that, without assurances that equivalence would not be withdrawn once granted, firms would be “building a business model and making an investment on the basis of shifting sand”.126
91.As highlighted in paragraphs 80–81, there is evidence to suggest that the EU is holding the UK to a higher standard than it has done for other countries by including future regulation in its consideration of equivalence. In this context, some witnesses questioned whether further equivalence decisions were worth the terms on which they might be granted to the UK. Dr Gerard Lyons, of Policy Exchange and Netwealth Investments, said: “Some might say that [equivalence] is a nice to have, but regulatory independence is a must have”.127 New Financial argued that, because further equivalence decisions were unlikely, “it would be misguided to base the future regulatory strategy for the UK on any sense of maintaining access.”128
92.It was also highlighted to us that equivalence is not relevant at all for all sub-sectors of financial services. Michael Dobson said that Schroders, and asset managers more broadly, “generally do not rely on equivalence to conduct our core business” but added that “it is a much bigger issue for investment banking, commercial banking and other areas.”129 The London & International Insurance Brokers Association (LIIBA) said that the picture was similar in their sector: “the EU legislation governing our sector has no equivalence provisions. There is no mechanism therefore for [the] EU to grant further market access rights to UK insurance brokers”.130
93.In terms of areas where equivalence decisions might be important, representatives of the Bank of England and the regulators highlighted two specific decisions: Article 25 of the European Market Infrastructure Regulation (EMIR 25), which covers the recognition of CCPs, and Article 47 of the Markets in Financial Instruments Regulation (MiFIR 47), which covers cross-border investment banking services. However, equivalence under EMIR 25 is the one decision the UK currently holds, while equivalence under MiFIR 47 was described as a particularly unlikely outcome: “the EU has not found the UK equivalent, the UK has not found the EU equivalent, and, as far as I can work out, the EU has not found any other country equivalent and is reviewing that clause.”131 Separately to these two decisions, equivalence of trading venues and reinsurance equivalence under Solvency II were also highlighted by other witnesses.132
94.The Economic Secretary expressed no significant concern about the absence of equivalence: “Time moves on. Increasingly, for both the EU and the UK, the further we get away from the TCA, the initial agreement and the initial decisions or lack of decisions on equivalence, the more we will naturally both develop our own regulatory regimes”.133
The impact of the ‘imbalance’ in equivalence decisions between the UK and other third countries
95.As set out in paragraph 79, the EU’s apparent reluctance to grant the UK equivalence decisions marks a striking contrast to its historical approach to equivalence for other jurisdictions with major financial services sectors. We therefore took a particular interest in whether this ‘imbalance’ in the number of equivalence decisions put the UK at a competitive disadvantage.
96.Witnesses who addressed this question conceded that there was something of a competitive disadvantage, but stressed that it was not as great as the numerical imbalance in equivalence decisions would suggest. Sam Woods argued that certain third countries did have “an advantage” over the UK, but “it is not necessarily as great as you might think”.134
97.The reason for this is partly because, in the words of Caroline Dawson, “not all of those equivalence decisions are equal in importance”. Dawson added, “just because the US has 21 equivalence decisions and the UK only one, there is not automatically some sort of imbalance in the ability to do cross border business. Clearly in practice there is, but it is not in the ratio of 21:1”.135 Sir Jon Cunliffe similarly highlighted that “of the equivalence decisions granted by the EU to the US, Singapore and Switzerland, the majority are unrelated to trade and market access”, which underpinned his view that the competitive disadvantage was “relatively limited” and not “of first-order importance”.136
98.We did, however, receive evidence that for one specific equivalence decision, related to trading venues, the UK had lost out on business activity to the US as a result of the imbalance. Sir Jon Cunliffe explained:
“EU firms in scope of the EU Derivative Trading Obligation (DTO) are no longer able to trade some classes of derivatives on UK trading venues, and UK firms in scope of the UK DTO are no longer able to trade these derivatives on EU trading venues. This has resulted in relocation of some of this trading activity to venues in the United States [which has equivalence from both the UK and the EU]”.137
Peter Bevan also highlighted this matter, adding, “It seems extraordinary, really, that when Europeans and UK counterparties want to trade with each other, they have to go to another continent to find a venue to do so”.138
99.The Economic Secretary dismissed suggestions that the imbalance in equivalence decisions meant there was a competitive disadvantage (“not necessarily. In fact, probably not”), but his answer provided little detail as to why this was the case.139
100.We regret that the EU has opted not to grant equivalence to the UK in a number of areas where it would be beneficial to market actors in the UK and the EU. We note that the Government does not consider the lack of equivalence in these areas to pose a significant problem, despite the effort originally expended in submitting information to the EU as part of the latter’s consideration of the UK’s regime.
101.However, we recognise that further equivalence decisions are ultimately a matter for the EU. We therefore agree that it would be misguided to base the UK’s future strategy for the sector on something that is not in the Government’s gift and that currently seems unlikely to be forthcoming.
102.Contrary to the Committee’s expectations at the outset of this inquiry, we recognise now that the low number of equivalence decisions is not seen within the sector as a matter of fundamental concern. The sector has successfully adapted to operating without equivalence and sees limited benefit now in making further adaptions to accommodate it. We also recognise that the EU currently seems unlikely to grant further equivalence decisions without the UK constraining its regulatory flexibility and ability to diverge.
103.Although the imbalance between the number of decisions the EU has granted to the UK compared to other jurisdictions is striking, the evidence we received suggested that the impact of this on UK competitiveness has been limited. We also recognise that not all equivalence decisions are equal and that most granted to other jurisdictions are unconnected to the crucial issue (as far as the UK is concerned) of market access.
104.We ask the Government, in its response to this report, to set out the extent to which it believes there to be a competitive disadvantage as a result of the imbalance in equivalence decisions, and how it intends to address any such competitive disadvantage.
105.We also note that there is continued medium-term uncertainty. While the lack of equivalence has been less detrimental than anticipated prior to the end of the transition period, this has partly been as a result of specific business-model adaptations.
85 European Commission, ‘Questions & Answers: EU-UK Trade and Cooperation Agreement’, (24 December 2020): https://ec.europa.eu/commission/presscorner/detail/en/qanda_20_2532 [accessed 7 June 2022]
90 HM Treasury, ‘HM Treasury equivalence decisions for the EEA States’ (9 November 2020): https://www.gov.uk/government/publications/hm-treasury-equivalence-decisions-for-the-eea-states-9-november-2020/hm-treasury-equivalence-decisions-for-the-eea-states-9-november-2020 and HM Treasury, ‘Guidance Document for the UK’s Equivalence Framework for Financial Services’, (14 January 2021): https://www.gov.uk/government/publications/guidance-document-for-the-uks-equivalence-framework-for-financial-services [accessed 7 June 2022]
91 HM Treasury, Guidance Document for the UK’s Equivalence Framework for Financial Services (November 2020): https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/937799/Guidance_Document_on_the_UK_s_Equivalence_Framework_Amended.docx [accessed 7 June 2022]
92 Communication from the Commission to the European Parliament, the Council, the European Central Bank, the European Economic And Social Committee and the Committee of the Regions on equivalence in the area of financial services, COM(2019) 349 final
96 CCPs take on the credit risk between the parties to a transaction and provide clearing services for trades in various financial products. Since the 2007–08 financial crisis, the global financial system has become increasingly reliant on CCPs to manage the risks associated with derivatives contracts. According to evidence the Committee received from independent financial services consultant Graham Bishop, this reliance creates “potential systemic risks” and means that CCPs have become “the nuclear power station of the financial system: brilliant in success, catastrophic in failure.” Written evidence from Graham Bishop (RFS0011)
97 Mairead McGuinness, Speech at the ECB/European Commission Conference on European financial integration, ‘An EU financial system for the future’, (22 June 2021): https://ec.europa.eu/commission/presscorner/detail/en/SPEECH_22_2327 [accessed 7 June 2022]
104 The European Commission’s latest published table of equivalence decisions, dated February 2021, puts these numbers at 21, 15 and 13 respectively. However, Sir Jon Cunliffe highlighted to the Committee his understanding that the Commission issued one further decision to each of these three countries in October 2021. European Commission, ‘Equivalence Decisions taken by the European Commission as of 10 February 2021’: https://ec.europa.eu/info/sites/default/files/business_economy_euro/banking_and_finance/documents/overview-table-equivalence-decisions_en.pdf [accessed 9 June 2022] and supplementary written evidence from Sir Jon Cunliffe (RFS0012)
115 Mairead McGuinness, Keynote address at CityWeek 2021: ‘The EU’s financial services strategy’, (22 June 2021): https://ec.europa.eu/commission/commissioners/2019–2024/mcguinness/announcements/keynote-address-cityweek-2021-eus-financial-services-strategy_en [accessed 7 June 2022]; see also Q 30 (Sir Jon Cunliffe).