Membership vs access: Why words have meaning for the future of UK financial services and the Single Market
by Inline Policy on 26 Jul 2016
Some of the UK political instability following the EU Referendum in June is beginning to dissipate. A new Prime Minister, reshuffled Ministerial teams, and reshaped Government machinery are in place. A timetable of sorts for the next steps is beginning to form, ie. no triggering of Article 50 to commence the departure negotiations, during this calendar year, but likely early in 2017. What is still concealed in opacity is any inkling of what the UK position might be in the parallel discussions on a future economic and co-operative relationship with the EU.
This does not have to be in place on the date of UK cessation of its EU membership but it is highly desirable if that does occur, lest reliance has to be had on WTO rules when the UK may not yet have established separate trading schedules from the EU on that organisation (is 'on' correct?). It is in the interests of investors and traders, the self-employed and workers alike, that as seamless a transition as possible happens to secure jobs, ensure on-going flows of inward investment, and for the long-term stability of tax receipts and the public finances.
With the UK having a current account deficit approaching 7% of GDP, the UK’s trade surplus in services exported to the EU running at approximately £6bn between Q4 2015 and the end of Q1 this year, and nearly half of inward investment flows to the UK going into financial services, certainty for financial services operating in the UK is critical. Income tax receipts stemming from financial services employees in the UK amount to some £18bn per annum, with approximately a third of that attributable to staff in the investment banking, wealth and asset management sectors.
What Brexit means for the financial institutions and agencies of the EU
The words being used by politicians and analysts in relation to their preferred vision for access for UK goods and services within EU markets sound interchangeable, but within them are hugely important distinctions. One word you won’t hear is influence, since when the UK’s membership of the EU ceases, with it goes its presence in the EU institutions upon which it is currently represented – the European Council, the European Commission, the European Parliament, Council of the European Union, Court of Auditors and the European Court of Justice. In terms of rule-making, this means that the UK will no longer participate in the making of EU legislation. It would also lose membership rights of and influence within the European Banking Authority (EBA), and the European Securities and Markets Authority (ESMA), which may result in a tilting of EU regulatory standards and approaches towards a less UK-friendly model in financial services. Initiatives such as the Capital Markets Union and the liberalisation of securities markets will continue, but it is questionable who will pursue the issues of Single Market deepening with the vigour exemplified by the United Kingdom within the EU up to now.
Membership of the Single Market v Access – what are the differences?
On the Single Market there is a huge difference between the terms “membership” and “access”. Membership implies a formal relationship of the kind characterised by that which the three European Free Trade Association-European Economic Area (the EFTA-EEA) states have with the EU, involving the applicability of the EU acquis communautaire in those areas to which they are party, namely, the Single Market, energy and environmental policy, skills and education co-operation, labour market policy, state aid and competition policy. The major areas where the acquis does not apply to Norway, Iceland and Liechtenstein are over the Common Agricultural Policy, the Common Fisheries Policy, and the common external tariff. This means these three states may conduct their own external trade policies, and are subject to customs checks for entry into the EU markets for their goods (although these are in the nature of spot checks). The three EFTA-EEA states have full participation in relation to the Single Market via the EEA Agreement, and there are agreed methods of dispute resolution, combined with a supranational Treaty and competition law enforcement body (the EFTA Surveillance Authority) and a supranational court (the EFTA Court) heavily influenced by EU rules on the making of its own judgments on disputes brought by member states.
The Norway model permits full passporting rights for Norwegian-based financial institutions and firms to export services into other EU/EEA states without restrictions or barriers, having secured a licence from the home state. In this way, the right of establishment for Norway-based firms and of the free flow of capital are the same as they are for EU states under the EU Treaties. A recent EU legislative proposal to be adopted by the EEA Joint Committee will extend the scope of the EU financial supervisory institutions and their decisions and rules to the three EFTA-EEA states too.
Bilateral option within EFTA – Swiss model
Other arrangements, such as that between another EFTA state, Switzerland, afford a large measure of participation in the Single Market. Similar to the EEA model, Switzerland adopts those elements of the relevant acquis into its own legal system, providing for rules over Single Market access for goods, and in a more limited way, for services. As full passporting rights are not available for financial services under the Swiss-EU bilateral agreements, Swiss financial firms must establish sizeable legal subsidiaries or alternative entities within the Single Market, with their own staff, management and capitalisation structures, in order to engage in cross-Single Market trade in services.
Bilateral options for third countries outside of EFTA
In relation to non-EEA states seeking access to EU services markets, the gatekeeping role of the European Securities and Markets Authority (ESMA) becomes crucial under several EU Directives in determining through its technical standards whether the regulatory systems of third countries outside the EU are deemed as “equivalent”. Recently, ESMA published its advice on the application of the Alternative Investment Fund Managers Directive on awarding qualified passporting rights to funds and managers in a dozen states to sell and market services across the EU, including the US and Canada. It considered factors such as investor protection, competition, market disruption, and handling systemic risk, finding no difficulties in declaring equivalence under the Directive to entities based in Japan, Canada and Switzerland, but being more restrictive in its assessment in relation to the US and Australia among others. ESMA had previously authorised central counterparty equivalence for these states for over-the-counter (OTC) derivative trading as permitted by the European Market Infrastructure Regulation (EMIR) and the Capital Requirements Regulation (CRR).
Regulation on Securities Financing Transaction and the replacement of MiFID by a new Directive (MiFID2) and Regulation (MiFIR), applicable to all financial instruments, due to come into force by 3 January 2018, will ease matters somewhat.
The divergence and regulatory costs for third countries outside the EU/EEA for offering services will be lowered as a result. Nevertheless, the EU member state involved may still require the investment firm to offer services from a regulated branch established in that member state, as opposed to offering services from outside the Market as a third country firm. The firm must be authorised by its own third country jurisdiction for all of the services it seeks to provide in the Single Market, but must also comply with governance rules stemming from the EU Capital Requirements Directive. Additionally, however, where a third country firm seeks to provide services to retail or opted-up professional clients in more than one member state (other than the one in which it obtains authorisation) it must either attain authorisation in each individual member state or follow individual member state rules on market access for retail or opted-up professional clients.
Slightly different standards apply where the third country firm is offering services to eligible counterparties and per se professional clients. If the EU Commission has adopted a decision that prudential and business conduct standards for eligible third country firms are equivalent in terms of MiFID2 and CRD requirements, if the firm is supervised in the home country for those specific services, and ESMA and the home country regulator have co-operation agreements, then trade in services to this category of counterparty or client is permissible.
Where no equivalence decision has been reached by ESMA at a state level or the national regulator on an individual firm basis, a third country firm may offer investment services to eligible counterparties and per se professional clients in a state within the Single Market as long as it complies with the requirements of that member state’s national law. Third country firms may also offer services where the client in the Single Market area initiates contact with them and requests the service directly. It can be seen therefore that even if ESMA and national regulators applying their technical standards permit the UK to have regulatory equivalence under these rules, it cannot be compared to the full passporting, free flow of services, and right of establishment, which apply to those countries signing up to the four freedoms of the Single Market either through the EU Treaties, the EEA Agreement, or in Switzerland’s case, by bilateral accords recognising the EU acquis.
The equivalence principle in order to access EU markets in financial services is a continual obligation, requiring on-going compliance with relevant EU legislation in order that financial and regulatory systems retain that equivalent character. The obligation is predominantly on the third country – it has no influence over the content of the EU rules, only the duty to mirror them through the terms of its own national law in order to retain access for its firms. There is provision for member states to create appeal procedures whereby third country firms could seek redress in a tribunal against any decision made against them.
Important decisions on the UK’s negotiating position on a future relationship with the EU lie ahead – their impact upon the future market access for financial services may be profound indeed.
(Photo via Flickr, CC BY-ND 2.0)