Brexit: Swiss case shows UK-EU equivalence not guaranteed
In a dispute that has clear implications for the United Kingdom, the European Commission has allowed the European Union equivalence arrangement for Swiss stock markets to expire. In the event of Brexit, the UK would need to pursue an equivalence relationship for the City of London with the EU.
The EU-Swiss dispute was a result of the failure to agree on a framework agreement by the EU’s deadline. Switzerland retaliated by barring the trading of Swiss-listed companies’ shares on EU platforms.
In December 2018, the European Commission told the Swiss government it had drafted a new framework agreement – an overall accord designed to replace 120 bilateral deals regulating trade relations between the two sides – which required agreement by the end of June 2019. At the time of writing, an agreement was still yet to be reached.
The punishment for the lack of agreement was the loss of ‘equivalence’. This refers to the EU’s power to grant market access to financial firms from non-Member States if it concludes that the country’s home rules are equivalent or very close to EU rules. The Commission has taken over 280 equivalence decisions with regard to over 30 countries so far.
Equivalence is one of our main tools to engage with third countries in financial services. It’s mutually beneficial because it enables us to have a robust cooperation with our partners
Vice-President, Euro and Social Dialogue, European Commission
‘Equivalence is one of our main tools to engage with third countries in financial services,’ says Valdis Dombrovskis, Vice-President for the Euro and Social Dialogue at the European Commission, in a statement setting out the Commission’s equivalence policy with regard to non-EU countries. ‘It’s mutually beneficial because it enables us to have a robust cooperation with our partners and to open up our markets to non-EU market players and vice versa.’
The EU Markets in Financial Instruments Directive (MiFID II) and Markets in Financial Instruments Regulation (MiFIR) introduced a so-called share trading obligation, which requires EU investment firms wishing to trade in listed shares to do so only on an appropriately regulated trading venue. This means EU investment firms can trade shares on Swiss trading venues only if the European Commission recognises the equivalence of the Swiss regulatory framework.
Benjamin Leisinger, Vice Chair of the Mergers and Acquisitions Subcommittee of the IBA Securities Law Committee and a partner at Homburger, believes that ‘Equivalence has been used as a bargaining chip to pressure the Swiss Confederation into signing up to this framework agreement.’ He says that ‘It would provide for a mechanism to update certain bilateral treaties in the case of any change in EU laws and to implement such changes dynamically in Swiss law.’
The EU and Swiss decisions did not have a substantial impact when they came into force, at least not obviously, however. ‘The trading volumes on the SIX Swiss Exchange went up slightly, implying that the EU trading venues and the broker dealers trading on those venues respect the ban,’ says Leisinger. ‘If they trade in Swiss shares, they go to the SIX Swiss Exchange. Either they are themselves direct participants or they use their banking network to trade via direct participants at the SIX.’
According to a SIX spokesman, trading volumes on that market rose by about 20 per cent in July compared to June. Normally, trading is substantially below normal levels due to the holiday season, but July 2019 turned out to be the strongest July since 2008.
This does not mean the two sides will not deal with the situation. ‘It’s still important, not because it has practical implications, but rather because if there is equivalent legislation, as is undoubtedly the case in Switzerland, then not getting this recognition is a bit odd,’ Leisinger says. ‘Equivalence seems to be a political tool, not only a technical and legal one.’
The implications of the dispute are not lost on those tracking the UK’s plans to leave the EU, which will turn the UK into what the EU calls a ‘third country,’ like Switzerland. ‘It is very clear that the EU is tightening up its approach to equivalence and I expect this is with at least one eye on Brexit,’ says Michelle Kirschner, a partner in the Financial Services Regulation practice at Macfarlanes. ‘There are many areas where the EU is doing this. Another one relates to the substance requirements for firms setting up a presence in the EU as part of their Brexit plans.’
In late July, the European Commission repealed equivalence decisions for Argentina, Australia, Brazil, Canada and Singapore in the field of credit rating agencies. According to the Commission, ‘These jurisdictions could no longer meet the standards set by the EU Credit Rating Agencies Regulation after its amendment in 2013.’
All these moves may partly be a way of warning the UK that equivalence, or anything else for that matter, is not guaranteed, says Michael Huertas, Co-Head of Dentons’ Financial Institutions Regulatory Practice Group in Europe. ‘However, not granting financial equivalence to the UK is likely to lead to a response similar to that of Switzerland but with worse consequences,’ he says. ‘EU issuers could lose direct access to Europe’s second-largest exchange, and EU market participants subject to the European Market Infrastructure Regulation’s clearing obligation could lose access to some of Europe’s key clearing houses.’
Liquidnet, a global institutional investment network, has said that ending equivalence would damage EU funds more than those in the UK. This is because at European trading venues, ‘one per cent of activity is European to European, under a quarter is European to UK and international trading’ and more than three quarters of activity occurs ‘without interaction with an EU [Member State]’.
It seems unlikely the European Commission would choose the same approach in Brexit negotiations. ‘The UK stock market is approximately twice the size of Switzerland’s market, and UK clearing houses are and will continue to be a core part of Europe’s trading infrastructure,’ says Ramona von Riedmatten, a lawyer at Swiss firm Lenz & Staehelin.
In Switzerland’s case, she adds, ‘an unlimited extension of the stock exchange equivalence is the preferred solution and best for all parties involved’.