(Bloomberg) — The City of London is starting 2021 free of the European Union’s rules. But despite a trade deal being reached, its status as a global financial hub is under threat, resting on a separate process controlled by politicians and technocrats in Brussels known as “equivalence.” The EU granted two big equivalence decisions to the U.K. in 2020 — but with 28 areas still open, it’s unclear how much investment banking business can stay in Britain. The EU hasn’t been in any rush to come to London’s rescue, and the U.K. is signaling that it intends to veer from the bloc’s rules.
1. What does ‘equivalence’ mean?
Generally speaking, it’s Nation A accepting that Nation B’s rules are as strict as its own and letting Nation B’s companies do certain business in its territory. For the EU, the European Commission determines whether a non-member’s rules are equivalent to its own in a given area.
2. What’s the worry about equivalence?
Beside the criticism that it’s a byzantine, patchwork system, the main U.K. concern is that the commission can unilaterally withdraw equivalence at short notice. The British have pressed for a longer notice period for withdrawal.
3. Is that the only concern?
More broadly, EU and U.K. politicians are under no obligation to maintain close ties with each other. Commission President Ursula von der Leyen declared in January 2020 that “all will change” in the City of London’s relationship with the EU. As the two sides struggled to reach a trade agreement, financial companies became worried that equivalence decisions were getting sucked into the wider political battles. Cboe Global Markets, Goldman Sachs Group, London Stock Exchange Group and Aquis Exchange set up divisions in the EU to handle a shift of stock-trading should Brussels withhold equivalence.
4. What changes now there’s a trade deal?
5. Has equivalence been withheld before?
Yes, just ask Switzerland. When talks about the Swiss relationship with the EU didn’t advance to the bloc’s liking, the commission refused to extend equivalence covering market access to the nation’s stock exchange. Swiss shares were barred from trading on EU exchanges in mid-2019.
6. Does the U.K. really want equivalence?
The U.K. has made clear that it will set its own rules and may diverge in places from the EU’s approach. Equivalence “is still something worth having, but it’s not worth having on any terms,” Bank of England Governor Andrew Bailey told U.K. lawmakers. The central bank has estimated that only about 10 billion pounds ($13.5 billion) of finance revenue in the U.K. relies on equivalent U.S. and EU rules — about half the amount that’s not reliant on such regulations.
7. Is there much wiggle room?
Britain argued that it should keep access to financial markets from the outset since it’s so closely integrated with the EU as a decades-long member. Chancellor of the Exchequer Rishi Sunak unilaterally granted equivalence to the EU for capital, auditing and insurance standards, and the U.K. Financial Conduct Authority has committed to flexible trading of shares across the U.K. and EU. The U.K. also wants flexibility in how financial firms are policed, arguing for “outcomes-based” equivalence even if the wording of its rules doesn’t precisely tally. The commission, however, says decisions on market access won’t be subject to negotiations and that it will protect its own interests.
8. So it’s an uphill struggle for the U.K.?
Yes, for both winning and keeping equivalence. Since the 2016 Brexit referendum, policy makers in Brussels have been tightening the rules. For example, the EU now has greater powers to inspect and scrutinize derivatives clearinghouses — giving it authority over the British firms that handle the bulk of euro-denominated contracts. The commission has also indicated the U.K. can expect close monitoring if equivalence has been granted, to make sure that the two sets of rules don’t drift apart.
9. Which equivalence decisions matter most?
The most important decision for financial stability has already been granted, allowing European firms to continue using London’s dominant clearinghouses for derivatives, energy and metals trades. This lasts until the end of June 2022, with the EU planning a more significant review that could eventually force clearing business to relocate to the bloc. The EU has maintained that it’s in no rush to grant equivalence decisions for derivative- and stock-trading or to give a broader pass to portfolio management, investment advice, underwriting and trade-execution. The financial industry has lobbied for decisions for shares and derivatives to prevent market disruption.
10. What isn’t covered by equivalence?
Core banking activities such as deposit-taking, investment services to retail clients and syndicated and other cross-border lending services. If U.K.-based banks want to continue those lines of business, they’ll most likely need to do so from offices in the EU — hence the recent shift of some operations to Frankfurt, Paris, Dublin and other cities. Banks are now moving more executives and banking business, with JPMorgan Chase & Co. planning to transfer 200 billion euros in assets to Frankfurt.