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What Next? The Shape of the UK-EU Financial Services Deal

The aim now – in the words of Article 50 – is to reach an agreement on the arrangements for the UK’s withdrawal, ‘taking account of the framework for its future relationship with the EU’. Attention must be turned to what the UK is seeking.

Financial services and the City’s future will be one of the areas for discussion. This will require simple but subtle thinking for the optimum execution.

Principled Negotiation

First there must be a clear view of the result for which the agreement aims: the UK’s sovereignty must be respected. Any imposition of EU federal jurisdiction or oversight would make a deal unworkable, not least because that would be at odds with the basis on which the UK is negotiating.

As close and friendly partners, it is expected that the UK authorities will work closely with the European supervisory agencies, the European Banking Authority (based now in London), the European Securities and Markets Authority and the European Insurance and Occupational Pensions Authority. None of these will have formal authority or jurisdiction in the UK. Nor will the European Court of Justice (ECJ), whose judgments and (confusingly purposive, rather than literal) interpretative methods will no longer be authoritative in the UK.

At the same time, it is no secret that for the EU, there is more at stake here than simple economics. Serious politicians may have no interest in ‘punishing’ the UK for its decision to leave, but nor will they have an appetite to ‘reward’ the UK by granting it special privileges. The EU is also keen not to set an attractive precedent which might incentivise other member states to consider their position.

Nonetheless for financial services the UK is in a unique position. A solution that provides for continued EU access to London’s markets and customers is of paramount importance in a way that would not be replicated with respect to any other member state.

Equivalence: A Basis for a Mutual Recognition

With such aims for policy to the fore, attention must now turn to how best to achieve them. The best solution is that of mutual recognition of each other’s regulatory standards. Indeed, already the EU has developed a concept of ‘equivalence’, which provides a good starting point for improvement.

Many EU financial services laws provide for third country arrangements to allow institutions to be recognised for EU purposes. After Brexit, UK institutions will be able to trade into EU member states in reliance on the UK’s regime and regulatory oversight, if the UK has ‘equivalent’ laws and regulations in the relevant areas.

Requiring ‘equivalent’ laws is not the same as requiring ‘identical’ laws. Equivalence-based access allows for a certain amount of flexibility. It preserves third-country (i.e. UK) sovereignty. It does not bring with it EU institutions or ‘freedoms’. But it nevertheless permits full cross-border access to EU counterparties and customers in the relevant sector of the market.

Post-Brexit, mutual recognition will work both ways. The UK will declare the EU’s legal framework to be satisfactory, perhaps even deploying a version of the current equivalence concept, allowing EU businesses access to UK markets and customers. The EU will do the same, allowing UK businesses access to EU markets and customers, benefitting those EU markets and customers.

Making Equivalence Better

This mutuality and reciprocity is a good start and has the potential to be the basis for a strong working relationship between the UK and the EU. Certain aspects to equivalence, as now constituted, must be addressed if the model is to work successfully for future UK-EU relations in the sector. In particular:

  1. Only certain measures should be considered when deciding whether the UK or EU is ‘equivalent’: those designed to minimise systemic risk in the other party’s markets, to ensure free and transparent markets there and (in a retail context) to give proper protection to the other party’s consumers. EU-specific requirements, such as social policy, competition measures and rules designed to further the EU’s ‘single market’ may not be seen by the UK as relevant to it any longer and should not be factored in to any equivalence determination. Such rules have nothing to do with financial services equivalence.
  2. Even within those measures that do deal with the other party’s systemic risk, free and transparent markets and retail consumer protection, it must be clear that ‘equivalent law’ does not mean the same as ‘identical law’. The UK should be free to achieve these outcomes in its own way. This will involve a traditional, common law-based approach, which will not seek to replicate the EU’s civil law-influenced, codified and purposive approach.
  3. Both the UK and the EU must have a proper say in working together on new laws that might affect equivalency. There must be a satisfactory definition of ‘materiality’, such that neither the UK nor the EU is subject to a veto on every little divergence.
  4. Where agreements are required to ensure continued equivalence – for substantial matters relating to the other party’s systemic risk, free and transparent markets and retail consumer protection – discussions will be on a sovereign-to-sovereign basis, where each party’s voice is as important as the other’s. Given that all key areas on which agreement will be necessary are driven primarily by global standards, it is to be expected that reasonable compromises on each side should be achievable. The UK has a long history of working successfully with other EU states.
  5. If an agreement still cannot be reached, either party must be able walk away from equivalence on that specific area, without prejudicing equivalence deals already in place on other topics.
  6. Procedural certainty must be enhanced – e.g. notice periods for the making of new laws and regulations or amendments to existing ones, dispute resolution mechanisms and collaboration agreements.
  7. The assessment of equivalence on both sides must be de-politicised so as to maximise the technocratic nature of the decisions.

These proposals are manageable. Properly implemented, they would form the basis of a stable, predictable and functional relationship. They would provide maximum access for financial market participants across Europe. And they would preserve sovereignty for the UK and respect for the integrity of the EU’s ‘four freedoms’.

Equivalence across the Board – Which businesses in the sector?

Third-country equivalence regimes are a relatively new concept in EU law and have been developed in a piecemeal way. There are therefore certain areas in which the regime has not yet been developed and as a result access based on third-country equivalence is not currently available.

For the future, the best course would be for the EU to adopt an Equivalence Regulation to provide for a single mechanism for equivalence, with full coverage. The differences as currently constituted – in terms of applicable tests, bodies involved and outcomes – now add to the complexity of equivalence as a concept. By contrast, an Equivalence Regulation would rationalise the whole idea and make it more usable, and therefore a more workable basis for a long-term relationship.

This does not mean that such recognition must be granted for all sectors. Obtaining an equivalence determination will necessarily involve a trade-off of some legislative flexibility on both sides. Under any realistic model, the UK and the EU will each have to have flexibility to consider, sector-by-sector, the value of such a trade-off and whether the cost of equivalence – e.g. the implications of regulation and its cost – is worth the mutual access benefits which result. Furthermore, the model depends on the on-going good faith cooperation of both parties.

Here the UK could help by voting on such a Regulation under QMV before leaving, especially as most of the fundamentals discussed here would be covered by the Equivalence Regulation. I would also expect there to be a bilateral UK-EU deal (under the Article 50 QMV mechanic) that sets up the working arrangements going forward.

Domestic Resetting: Preparing for Brexit

Many significant EU developments are due to be implemented in member states from 3 January 2018, in particular the new – and onerous – trading rules under MiFID II/MiFIR and on the financial Benchmark Regulation. They are due to be implemented at an untimely moment in the light of Brexit. Some of the measures allow national regulators to delay their implementation – e.g. the ability to postpone applying what are called open access provisions until 2020 (under Article 54 of MiFID II).

The UK should invoke these discretions to the fullest extent possible, in order to minimise the disentanglement process after Brexit and the wasted costs of forcing people to comply with rules which may be re-thought by the UK in light of Brexit. The UK Parliament should separately oversee a review of our own, UK regulations reflecting global standards and best practices, but implemented within the context of a traditional common law framework. The aim should be to design the most imaginative possible approach from which everyone would benefit from outside questioning. There could be a ‘Bretton Woods’ for regulatory practitioners to identify the best new template.

The outcome of the Brexit negotiations could be optimal for both the EU and the UK. Free of the British thorn in its side, the EU can integrate further and focus on the development of a single market in accordance with its social policies and principles. Free of the EU’s more protectionist instincts, the UK can focus on developing itself as an attractive financial centre, with sensible, free-market regulatory policies, carefully calibrated to minimise systemic risk, maximise free and transparent markets, and guarantee consumer protections.

The prize, for everyone, is obvious. Achieving it is within our grasp.


Barnabas Reynolds

Barnabas Reynolds is a partner at Shearman & Sterling LLP and Global Head of the Financial Services Industry Group. He is the author of Restoring UK Law: Freeing the UK’s Global Financial Market, (2021) and co-author of The Lawyers Advise: UK-EU Trade and Cooperation Agreement – Unfinished Business? (2021).

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