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Skepticism around EU financial services deal, as UK says no to rule-taker role

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Skepticism around EU financial services deal, as UK says no to rule-taker role

Bank of England Governor Andrew Bailey has said a deal with the European Union on financial equivalence that left the U.K. as a financial regulatory rule-taker would not be worth having.

Bailey told parliamentarians that if the EU demanded that the U.K. follow its regulatory rules entirely in return for an agreement on equivalence, whereby it judges the U.K. financial rules equivalent to its own and so allows British banks access to the single market, that would be unacceptable.

"If the price is too high then we can't just go for it whatever. I strongly recommend that we don't become a rule-taker. If the price of that is no equivalence, then I'm afraid that will follow," said Bailey in an appearance before the Treasury Select Committee.

The U.K., which exited its Brexit transition period on Dec. 31, has signed a free-trade agreement with the EU but this focused on goods and did not cover financial services in a significant way. Prime Minister Boris Johnson said at the time that the U.K. had struck a good deal but on financial services accepted that the deal "perhaps does not go as far as we would like."

British banks previously operated across the EU via a passporting system, which allowed all lenders in the EU to sell services across the bloc's single market. But now that the U.K. has left the EU and is outside the single market, British banks are operating via their EU-based offices and not directly from London as before.

Equivalence

The EU is considering whether to grant the U.K. so-called equivalence status, which would allow some banking activity to be carried out from London across the EU. But that is a unilateral decision and any such status is likely to be limited and could be withdrawn at short notice.

"The current reliance of the EU on London as, now, an offshore financial center in a third country in which it has no regulatory authority is quite unique — it's a category of its own," said Nicolas Véron, senior fellow at the Bruegel think tank and the Peterson Institute for International Economics.

"I think there are very legitimate debates to be had from the risk management and financial stability perspective by the EU on the possibility that in certain scenarios the incentives for the U.K. authorities could significantly diverge from the incentives for the EU, in terms of how to define public interest, and that could lead to mismatches," he told S&P Global Market Intelligence.

In the final Brexit agreement, the two sides agreed to aim to reach a Memorandum of Understanding on financial services by the end of March. This is intended to establish a framework for co-operation.

Emma Reynolds, managing director of public affairs, policy and research at TheCityUK, the British financial services lobby group, said the memorandum is likely to be limited in scope.

"We're expecting that the MoU will deal with structured dialogue between the regulators. We are not expecting for there to be any big agreement on equivalence because the EU's equivalence decisions are unilateral," she told S&P Global Market Intelligence.

Arved Kolle, associate director of the Association for Financial Markets in Europe, said there might be an opportunity to provide more information on the equivalence process.

"There's a reference in the joint declaration to providing transparency and dialogue in the equivalence process; hopefully that will be reflected in the actual MoU — that will really help the market," he told S&P Global Market Intelligence. "But we'll have to see if the MoU will affect equivalence decisions."

Kolle also said an early decision by the EU on share-trading and derivatives-trading obligations would be welcome. EU rules currently oblige EU firms to trade shares on EU trading venues and some classes of over-the-counter derivatives on EU trading venues or their third country equivalents.

A 'non-event'

Others are considerably less sanguine that a deal is in the offing. Bruegel's Véron said the EU had no incentive now to rush its decision on equivalence, while the MoU was likely to be insignificant.

"The MoU is a non-event. The only deadline which is real here is the one for clearing [the EU has given an 18-month extension for EU firms to use UK clearing houses]," he said.

The debate on clearing will become active quite soon but they can always extend the deadline, he said.

"The MoU will probably be something like what exists between the EU and the U.S. and a number of other jurisdictions, which we know from experience doesn't have a lot of impact in constraining EU decision-making," he said.

Nor is a decision from the EU on equivalence likely to be all-encompassing for banks, said Véron. There are about 40 equivalence processes, and even together they don't cover the full scope of financial services, he said.

"Now that the Jan. 1 deadline has passed that there is no incentive for the EU to rush the equivalence process. Taking everything together, including the reluctance of the U.K. to commit to a medium-term course [on regulation], I don't expect anything to happen any time soon," he said.

Trading in shares, derivatives

Since the EU does not recognize British financial regulatory systems as equivalent to its own, nearly €6 billion of euro-denominated share trading has moved away from London to EU-market places and primary exchanges. But London-based clearing for EU firms trading in derivatives has been granted an 18-month extension by the EU.

Conor Lawlor, director of Brexit, capital markets and wholesale at UK Finance, which represents British banks, said an MoU would help build regulatory dialogue but a decision on equivalence was vital.

"Both the U.K. and the EU should continue to work together to reach all appropriate equivalence determinations as soon as possible. This will enable consumers and businesses on both sides of the Channel to benefit from open and integrated capital markets," he said via email.

The U.K. has already granted equivalence to EU firms operating in Britain post-Brexit, doing so in November 2020.

Instead, the MoU is likely to focus on ensuring transparency between the two sides over regulatory affairs, said Reynolds, and so reducing the risk of inadvertent divergence on regulations. She said there was likely to be divergence between the two regimes, however.