Does the agreement of a Memorandum of Understanding (MoU) for financial services (FS) signal that the future of the EU-UK relationship will become more “pragmatic”? Will there eventually be a series of regulatory equivalence and market access decisions that provide investors and businesses with more options to do business between the UK and the EU? What are the prospects for meaningful cooperation and trade in the medium (3-5 year) term?
In 2020, many had hoped the EU-UK Trade and Cooperation Agreement (TCA) would include some trade principles for FS, after the two sides had signalled (in the Withdrawal Agreement of November 2019) that they would work towards assessments of regulatory equivalence by mid-2020. But ultimately, the parties only agreed to work towards an MoU about FS regulatory cooperation, outside the main treaty, by March 2021. A commitment to equivalence assessments had been replaced with a forum for joint discussion of regulatory issues.
This means that short term progress on FS issues will depend on the tone set by political developments in the wider EU-UK negotiations. While that situation continues to generate headlines, progress in FS is unlikely.
But will the “positive” atmosphere described between FS officials involved in the MoU talks translate to a productive joint working group in the medium term, and perhaps a more cooperative overall approach?
Unfortunately, that seems unlikely, too.
The UK had wanted “a more comprehensive set of equivalence decisions… and responded to the Commission’s questions about UK plans for regulatory divergence a year ago. Where equivalence goes now is up to the European Commission,” said Katharine Braddick, Director General for Financial Services at Her Majesty’s Treasury to a recent public event.
What is the EU’s position?
On 19 January, the European Commission launched its open strategic autonomy (strategic autonomy) strategy for FS in the EU, arguing the EU must not be dependent on financial markets in third countries. It says “the withdrawal of the United Kingdom (UK) from the EU … strengthens the need to further deepen the Union’s capital markets.”
It goes on, in more detail, to say “euro-denominated contracts cleared and settled by central counterparties outside the EU ... raise financial-stability concerns in the case of a future crisis requiring liquidity in euro or other Union currencies.” and so recommends that “[EU] clearing members reduce their exposures to UK CCPs”. In this context, any regulatory equivalence decisions or liberalisation of EU-UK trade in FS is positioned as undermining the declared strategy.
In the coming months, the European Commission will need to make some important regulatory policy decisions that will tell the world a lot about the urgency of its ambitions for strategic autonomy.
How will the EU apply its strategy?
In the coming months, the European Commission will need to make some important regulatory policy decisions that will tell the world a lot about the urgency of its ambitions for strategic autonomy:
1. Temporary equivalence for UK CCPs
There is no bigger indicator than the decision about the temporary equivalence provided for UK CCPs that expires in June 2022. A Commission-ECB task force has been encouraging the industry to migrate trading from these UK CCPs to the EU, and the Commission is expected to report on this activity after the summer. Changes would cause very large impacts for EU firms required to close out and move positions, so a clear direction is needed from the European Commission well before the existing temporary permission expires.
The European Commission has also asked ESMA (the European Securities and Markets Authority) to prepare a report about the financial stability implications of UK CCPs for the EU. The contents of that report, also expected in the autumn after the new ESMA Chair is in place, should provide important indications about EU thinking and the policy direction.
Another major policy area to watch is the delegation of fund management activities. Delegation describes a widely used business model where funds are marketed in one jurisdiction with the underlying portfolio management activities contracted (“delegated”) to a specialist firm in another jurisdiction.
As part of the EU’s review of its Alternative Investment Fund Managers DIrective (AIFMD), ESMA and the European Commission consulted on whether the rules around activities which could be delegated to third countries needed to be significantly tightened, again citing Brexit as raising risks over which EU regulators have no control.
Legislative proposals for a revised AIFMD are expected later in 2021. These will be scrutinised carefully by EU member states with significant fund management industries. Other third countries (including the US and in Asia) will also be watching carefully, to understand the spillover impacts for fund management activities delegated to their jurisdictions.
Hopes for cooperation?
EU decisions could have significant negative impacts, especially for EU firms and users. The nature of the EU’s decisions, therefore, will say a lot about the politics of strategic autonomy, and whether the political benefits of the strategy are judged sufficient to outweigh the evident costs and risks.
A hard line from the European Commission on CCP equivalence and delegation decisions in the short term would suggest that wider hopes for future cooperation are limited.