Jannah Patchay of Markets Evolution advises firms to keep their eye on the ball and not let Covid divert their attention from the job at hand.
In light of the current global Covid-19 pandemic, with the UK and much of Europe in varying forms of lockdown, and very much focussed on preserving national economies and interests in the short term, one might reasonably expect that the UK’s impending departure from the EU might be delayed once again. Yet this is clearly not the case, at least from the UK’s perspective: the current government, elected on its pledge to “get Brexit done”, appears to remain entirely committed to delivering on this commitment come hell or high water. From the EU’s perspective, member states are looking inward, and lack the will or capacity to deal with complex and often-tedious Brexit negotiations at present. This poses an existential challenge to any potential Brexit deal – with one side increasingly gung-ho, and the other unable to commit fully to the negotiating table, are we once again headed for a hard Brexit?
Many financial institutions, perhaps encouraged by the last-minute sprint on both sides to a successful negotiation of the Withdrawal Agreement in 2019, have quietly paused their Brexit plans and programmes. Others, particularly those whose business models rely on access to European markets and clients, but which also lack the size and scale to commit the resources required for a full Brexit contingency plan, may never have kicked off these programmes in the first place. Some firms may even be hoping that an equivalence agreement for financial services will still be possible, given it is a process enshrined in MiFID, applicable to any third country, and therefore, in theory at least, separate to any other Brexit negotiations.
Whilst the general public might be forgiven for not fully understanding the impact of a hard Brexit on financial services, it is still surprising that many participants in the space do not fully appreciate the consequences for their firms and business models. It’s worth taking a look at what “equivalence”, from a financial services perspective, actually means, and clearing up some of the misconceptions associated with it.
- An equivalence determination can only be made where there is a legislative provision for it. Financial instruments, including equities, bonds and derivatives, are governed by the EU’s Markets in Financial Instruments Directive (MiFID), in which equivalence is a concept that is clearly defined and provided for. However, the core banking activities of deposit-taking and cross-border lending are governed by the Capital Requirements Directive (CRD), which has no provisions for an equivalence framework.
Similarly for payments and e-money, governed by the Payment Services Directive (PSD) and the E-Money Directive (EMD) – there is simply no concept of equivalence for these activities. Firms providing services under these frameworks must either abandon their EU operations, or establish a local EU base.
- Without the legislative provision for an equivalence framework, there is no ability to undertake regulated activity on a cross-border basis into the EU, unless it is subject to the specific exemptions available from individual member states. These must, however, be examined and applied for each member state individually, and there are usually conditions attached – creating a high compliance and operational burden for any UK firm wishing to leverage these as a means of carrying on cross-border business into the EU.
The only other option available for firms is to have a local establishment and authorisation in an EU member state. There are no quick wins here.
- Equivalence is a political consideration – the EU has explicitly stated that political motivations can be taken into account when making an equivalence determination for another jurisdiction. Brexit is a political motivation; it’s simply not the case, from the EU’s perspective, that equivalence should be granted to the UK just because the regulatory regimes on both sides are currently identical. Think about it this way: if North Korea copied and pasted all of MiFID into their national law, neither the UK nor the EU would be much inclined to grant them equivalence – not based on the technical assessment, but on the political considerations.
- Equivalence is not permanent – it can be subject to review and revoked with only 30 days’ warning. Again, this is not entirely unreasonable, given that both national regimes and political relationships can change.
- Even MiFID equivalence is not a free passport into the EU. It is subject to restrictions around the types of clients to which services can be provided – Per Se Professionals and Eligible Counterparties only. MiFID equivalence also doesn’t solve such challenges as trading venue equivalence for the Derivative Trading Obligation (DTO), in which both the UK and the EU require execution of trades in certain derivatives on UK / EU authorised platforms respectively. This creates a Catch-22 situation for counterparties to these trades, and remains the subject of ongoing (again, highly politicised) negotiations.
- It’s all going to change anyway. In February 2020, the European Commission launched a long-awaited public consultation on proposed revisions to MiFID II and its accompanying regulation, MiFIR. Amongst the proposals were included a number of changes to the equivalence regime. If finalised, then not only must equivalence determinations be made at the jurisdictional level, but individual firms from equivalent jurisdictions must also register with the European Securities and Markets Commission (ESMA) when they wish to provide cross-border services into the EU. Registration will be subject to the provision of substantial and detailed data on the firm, the nature of its business, its clients and transactions, governance and compliance mechanisms, and much more. Furthermore, this data must be provided on an annual basis for review by ESMA – a huge burden for any firm (not just in the UK, but US and APAC as well) wishing to provide services into the EU.
Once we accept that equivalence is political, it also becomes clear that the current political situation has multiple dimensions, of which Covid-19 is a significant one. Though it’s so far unclear as to the extent to which the EU will take into account the impact of the Covid-19 crisis and lockdowns on factors such as access to foreign capital by European firms and market access for European investors. These may all have repercussions for both the final version of the revised MiFID, as well as for the UK’s equivalence discussions.