The UK’s Brexit Process has raised many questions on the future City of London - Continental Europe (ie the EU) relationship.
There is much debate about which side depends more on the other, yet undoubtedly, any loss of institutions and people from the city will weaken the city’s overall importance and weaken the UK’s tax take from the city. This debate around the relationship is now centred on the concept of ‘Equivalence’ and I wonder if this is a waste of time.
To recall, currently the principal route of cross-Europe institutional banking & finance is through ‘passporting’, the simplified concept of ‘if it’s OK for one EU country, then it can be done throughout the EU from the home country’. Passporting has been written off as dead post Brexit, with the best effort towards status quo depending on ‘Equivalence’. Sounds simple? But what is ‘Equivalence’? This concept is largely ‘as long as my regulation is equivalent to yours and the reverse, we accept each other’s regulation, and allow market access, thus, it appears almost as passporting by a different name – but no, it is not that simple.
For one, the concept of equivalence is a temporary, yet rolling one – and it inherently has many judgments and, indeed, whims embedded. Obviously, anything short of perfectly identical will require a judgement of equivalence. And, even when rules are the same, their implementation may not be identical or interpreted that way.
Equivalence certainly offers a decent solution to less competitive situations or perhaps among equals; for example, if the US has a financial futures market in Florida oranges that the EU doesn’t have, equivalence saves the EU from coming up with a regime if it accepts the US regulation on Florida oranges futures and allows Florida orange futures to be directly marketed in the EU from the USA. Note, there is not much of a concept of protectionism as there are no Florida oranges in the EU and this is likely to be a small business.
Is this the real reason behind the equivalence regime to date? If both the EU and US have equivalent markets, equivalence could provide competitive pricing pressures? I don’t know if that really works, but it is certainly easier when competitive aspects don’t arise. Yet, it’s hard to argue that the ability to relatively quickly withdraw equivalence recognition doesn’t suggest some sensitivity to underlying competitive aspects as much as changing regulation. It would also be foolish to say that competitive interests don’t influence regulatory rules.
I like to explain the equivalence concept or process in a fun example about cheese.
Let’s leave taste aside and note that there is limited Italian produced cheese in the USA and much less of the reverse. In the USA, Wisconsin Parmesan and New York Mozzarella might imply a larger opportunity for Italy but perhaps the USA also views a great opportunity to sell Monterey Jack from Milan to Sicily. The USA and Italy both have government oversight of cheese production and no one seems to suffer fatal attacks so they decide on equivalence (forget the EU). One year down the road, someone notices that a small Italian artisan cheese imported to the USA is not pasteurised and there is a health scare – and by the way, Italian Parmesan sales to the USA have tripled – will the USA withdraw equivalence due to the pasteurisation issue not being equivalent? Rejoice Wisconsin Parmesan? Let’s say Monterey Jack pizza has hit it off in Naples and a challenged Italian Mozzarella maker notices that the USA uses an industrial process that isn’t regulated in Italy. Time to challenge equivalence?
I don’t want to cheese off the new governments in Washington or Rome, but changing governments, regulators, and economic interests certainly imply depending on equivalence is a bit of a charade. Ultimately, the EU will get more tangible presence and jobs, but the marketplace looks likely to become less efficient with a cost to both sides.
The large USA banks with substantial employee presence in Asia seem to be facing a similar geographic dilemma as their USA industrial counterparts. The new USA administration is focusing on employers with off-shore labour related to the provision of domestic service. This may have started with the production of auto parts or air-conditioners in Mexico and has now reached bank call and IT centres in Asia.
What’s a bank to do? I’m trying to imagine a New York bank making the decision to increase its overall costs by moving the off-shoring on shore and then trying to obtain business in the ‘high growth’ market where they have just de-camped and unemployed thousands. With their larger domestic footprints, USA banks might have to give up on some Asian opportunities in the near future. Perhaps some good news for the few UK and EU banks with capabilities in those parts of the world?
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