Financial services equivalence regime: rules-based vs outcomes-based

Equivalence is the process through which the European Commission formally recognises that the regulatory or supervisory regime of a non-EU country is equivalent to the corresponding EU regime. Equivalence allows the EU to rely on supervised entities' compliance with equivalent rules in a non-EU country and may make certain services, products or activities of non EU authorised entities acceptable for regulatory purposes with the EU. It also has the benefit of creating a consistent regulatory regime and accordingly reduces capital and compliance costs.

The UK is in the unique position of having been a member of the EU and therefore should, in theory, have no trouble obtaining equivalence across the full range of equivalence provisions at the end of the withdrawal agreement implementation period. As Nausicaa Delfas, the executive director of international at the Financial Conduct Authority (FCA), said in a recent speech: “The UK will have the most equivalent framework to the EU of any country in the world".

The UK and the EU agreed shared values for the financial services industry in the political declaration on their future relationship, and agreed the mutual benefit of close and structured cooperation on regulatory matters. In this context, equivalence seems a good solution for providing access from the UK to EU customers. However, equivalence is governed by individual directives and does not cover all aspects of financial services. For example the Insurance Distribution Directive, which governs the sale of insurance, has no equivalence framework. The EU and the UK would have to agree new equivalence frameworks in order to avoid the impact of a later 'hard Brexit' for some aspects of the UK financial services industry.

Even for those areas where there is an equivalence framework, it is not yet clear on what basis equivalence will be assessed. The UK’s stated preference is for an 'outcomes-based' equivalence, as indicated by chancellor Sajid Javid in an interview with the Financial Times on 17 January (registration required).  Nausicaa Delfas also said in her speech that “in the future, it is not about whether we have identical rules, but whether they achieve common substantive outcomes. This is the established model currently used by the EU and it’s an approach we strongly support.” 

Despite this assertion, it is far from certain that the EU will agree to an outcomes-based equivalence framework. The EU single market is built on a rules-based framework, to give comfort to each member state of the creation of a level playing field throughout the single market.  In the event that the UK moves to a more outcomes-based framework, as championed by the FCA, it may cause concern amongst EU members that this level playing field would be compromised.

The gap between the EU and UK negotiating positions could be exacerbated by the possibility that the UK could use Brexit as an opportunity to move to a more relaxed regulatory regime, with a more pragmatic approach to maintaining financial stability, market stability, investor and consumer protection and fair competition. Any perception in the EU that the UK is relaxing its regime might affect equivalence rulings, although the alternative could mean UK financial services firms abiding by future rules over which the UK has no influence. Given the UK's historical role in influencing EU regulation as a member state, it is also possible that UK divergence could include more stringent rules – and so firms may be prepared to accept this risk to access the EU market.

The EU and UK have targeted completion of the equivalence assessments by the end of June 2020, and financial services is expected to be a priority area of negotiation. By the middle of this year we should have a clearer indication of the likely endpoint and, in any case, the outcome of those negotiations will be keenly awaited by firms with cross-border customers in particular.