On a Monday morning, just over a year ago, investment firms across the EU found they were no longer allowed to trade on the Swiss stock exchange. It happened almost overnight — simply because Brussels refused to extend a regulatory “equivalence” deal with Switzerland, which gave each side free access to the other’s markets.
This looks increasingly similar to the situation Britain could end up in next year, experts say, judging by the latest language coming from Boris Johnson’s government.
Ever since negotiations began on a post-Brexit trade deal, it has been the UK position that it wants a stable agreement on equivalence.
That would require the EU to assess that UK rules are as rigorous as its own, allowing much of the financial services business Britain does with EU clients to continue without significant extra costs to firms — business the Bank of England estimates to be worth £30bn a year.
But despite the optimistic tone of recent EU-UK talks (the latest round was due to end on Thursday), lawyers believe three recent developments make that less likely.
Late last month, the Treasury published draft UK financial rules for 2021, indicating there would be “changes” after the Brexit transition period as “the UK is making its own decisions about regulation”.
A few days later, a political row broke out over delays in assessing equivalence — with EU claims that Britain had been slow to answer its 28 regulatory questionnaires dismissed as “complete rubbish” by UK officials.
Then, at the end of June, Rishi Sunak, the UK chancellor, announced a finance pact with Switzerland, noting that “leaving the EU means we are now free to chart our own course, driven by our . . . innovative markets that drive change for the better, and openness to the whole world”.
Some lawyers say these words were directed squarely at Brussels rather than Bern, and indicate that divergence from EU rules is now valued more highly in London than equivalence.
“Recent signals from the UK government and regulators are clear that the UK plans to diverge,” said Clive Cunningham, a partner specialising in regulation at law firm Herbert Smith Freehills.
For some time now the UK’s desire to diverge has been well signposted. The former governor of the Bank of England, Mark Carney, told the Financial Times in February: “It is not desirable at all to align our approaches, to tie our hands and to outsource regulation and effectively supervision of the world’s leading complex financial system to another jurisdiction.”
Adrian Whelan, head of regulatory intelligence at Brown Brothers Harriman, argues: “All recent soundings point to an equivalence deal becoming increasingly unlikely.”
Rob Moulton, a partner in the financial regulatory practice at Latham and Watkins, even thinks the Swiss announcement last week represented a change in the UK’s agenda. “The events of the last 10 days [show] equivalence is not a key part of the government’s policy going forward,” he said.
For those exporting financial services to the EU, then, the next six months may require a rethink of how to do so in future — and how much more it may cost.
Firms providing essential transactional services to the EU are likely to be allowed to carry on, under a partial equivalence deal. “[EU negotiator] Michel Barnier has said that the EU retains the ability to grant equivalence in ‘areas where it is clearly in the interest of the EU’,” Mr Whelan said, noting that the EU relies heavily on London based clearing houses for derivatives trading. However, that would not provide any contingency for firms involved in other activities if there were a no-deal outcome come the expiry of the Brexit transition period at the end of December.
Many large multinational firms have now set up regulated subsidiaries in the EU, through which they could channel EU business if no equivalence deal were forthcoming. This would bring extra costs, though, for staffing and compliance functions, potentially making their offerings less competitive.
However, smaller and medium-sized UK financial firms that lack the scope to create subsidiaries would face expensive and time-consuming licence applications to individual national regulators across the EU.
Barney Reynolds, a partner at law firm Shearman & Sterling, said: “The costs are just regulatory costs of operating cross-border into the EU through subsidiaries or branches there — which are essentially duplicative and wasted costs that would be charged back to EU customers.”
Peter Bevan, global head of the financial regulations group at Linklaters, said firms facing that prospect would have to decide if the “piecemeal benefits” of limited cross-border access were worth paying for. “The result of this is likely to be an increase in costs for firms that have to operate two models for their EU and non-EU businesses,” he said.
In some cases, multiple applications would have to be made just to sell services in one country. “The UK firm would in essence apply to the individual country’s regulator but in Italy you could be dealing with three,” explains Mr Whelan “For UK entities, it could make the cost of complying higher than the benefit.”
Nevertheless, some still believe the EU will deem the UK fully equivalent, because it has become reliant on the City of London for financial stability. Mr Reynolds said UK rules help protect undercapitalised EU banks from the risk of debt default by member states.
“The UK currently mitigates this risk for itself and the rest of the world by imposing top-up capital requirements on businesses in the UK, where the EU meets the global markets,” he explained.
Ultimately, however, the costs and regulatory approvals that UK firms have to meet next year may be decided by the wider trade negotiations — in which bank capital will not be the sole consideration.
Ezra Zahabi, financial regulatory partner at law firm Akin Gump, said it could come down to the vexed issue of EU fishing rights to UK waters, a factor quite irrelevant to the ill-fated EU-Switzerland equivalence deal.
“The ability of the UK financial services sector to access EU markets may well depend as much on what happens with the fisheries as the prudential standards,” she said.
Copyright The Financial Times Limited 2020