Understanding mutual recognition and equivalence

23 February, 2018
by: Cripps Pemberton Greenish

This week the trainee solicitor blog team caught up with Alex Aristodemou, currently in his third seat with Corporate Real Estate. Alex has been following the ongoing debate around the future of the financial services industry following Brexit…

Given the continuing debate around the future of market access to the European Economic Area (EEA) for the UK’s financial services industry, this post briefly explains two principles upon which access could be maintained.  These principles are ‘mutual recognition’ and ‘equivalence’.

Mutual Recognition

The principle of mutual recognition is well established as a cornerstone of EU law, currently applying between financial institutions in the EEA.  Using the system of ‘passporting’, EU legislation allows UK financial institutions to gain authorization by the UK authorities to provide certain services in other member states.  For example, compliance with the Capital Requirements Directive IV allows UK banks to apply to the Prudential Regulation Authority for passporting rights to allow them to take deposits and lend to entities in the EEA.

Similarly and based upon the same principle, firms in other EEA countries which also comply with the Directive are able to access the UK market to provide these services.  This system of mutuality is made possible even if national legislation between EU member states is not harmonised, as an EU framework exists at the supranational level providing a set of standards.

Moving forward, ensuring the continued level of market access for financial services would probably involve setting criteria for access.  These criteria would be based on international standards wherever these are available.  Common objectives could be agreed with a system of monitoring and a dispute resolution mechanism guarding against significant divergences.

A comprehensive arrangement of this nature could guard against loss of market access. This is reportedly the negotiating position of the UK government for post-Brexit Britain.  Achieving this should in theory allow a smooth transition for the sector with continued access for the foreseeable future, therefore minimising risks to the financial industry in the UK.  This arrangement seems to be resisted by Brussels, as it is argued this would open the way to an à la carte Europe.  That is, a non-uniform method of European integration which would allow member states to become increasingly selective about implementation of EU policies.

Equivalence

The principle of equivalence is a relatively recent concept, allowing non-EEA entrants to access the market in certain sectors.  It is said to be the EU’s preferred mechanism for continued market access by the UK following Brexit. 

The rules of equivalence essentially set out what standards third states must comply with to gain access to the market.  They broadly follow existing EU standards and the UK would have to demonstrate compliance with these in its own legislation.  Determining equivalence is typically a decision taken by the European Commission working with the relevant supervisory bodies. 

At least in the short-term following Brexit, demonstrating compliance should be unproblematic, given the fact that the UK currently intends to retain EU law already in force at the time of leaving, as provided by The European Union (Withdrawal) Bill.  Looking ahead however, as EU law develops, Parliament would have to legislate to maintain compliance with EU standards to ensure continued market access.  This is particularly important in the financial sector where legislation and standards are frequently changing.

It must also be noted that the equivalence mechanism is not available for all financial services sectors, as it is adopted in a piece-meal approach in current EU legislation.  Only some of the EU’s financial services legislation therefore contains mechanisms of equivalence for access to the market by third countries.  Under such an arrangement, UK institutions would not be able to access the EEA market to provide several services, including consumer activities such as deposit-taking and mortgage lending.  The European Commission also has the discretion, giving 30 days notice, to withdraw an equivalence determination. 

 

It is hoped that the above will contribute to a better understanding of the ongoing negotiations and any eventual legal framework regarding a crucial sector of the British economy.