The UK has finally reached an agreement regarding financial services regulation with the European Union (EU), five months after leaving the union. The memorandum of understanding will create a framework for voluntary regulatory cooperation and establish the Joint UK-EU Financial Regulatory Forum, which is a regulatory forum that will manage talks regarding issues surrounding financial services. Both sides have yet to sign the agreement, but it is the first tentative step towards London regaining access to the EU market it lost due to Brexit.
The primary objectives are to lower uncertainties and locate potential cross-border implementation issues. Both parties want to avoid regulatory arbitrage, unnecessary incompatibilities, and overlaps in rulemaking while providing each side the freedom to develop its financial system as it sees fit.
Although the UK and EU reached a last-minute Brexit agreement in December 2020, they chose to postpone any decisions regarding the financial sector until now. The financial industry is key to the UK economy, accounting for nearly 7% of GDP and 10% of the country's tax revenues, which amounts to around £76 billion.
However, a crucial issue that was not addressed in the agreement was equivalence. Equivalence, in this instance, is when the EU grants direct market access to a foreign firm if the EU believes the home market rules are similar to its standards. It also allows UK-based firms to operate in the union. There are currently 40 separate areas of activity in which the EU can agree to equivalence but has only granted two. On the other hand, the UK has granted EU equivalence in 17 areas. In comparison, the EU has 21 equivalences with the US, 19 with Japan, and 15 with Singapore.
The issue of equivalence is one of the more acrimonious issues between the two parties. The EU suspects the UK will weaken its financial regulations to grow its market at the expense of the EU's tighter regulations. At the same time, the UK believes that the EU is withholding equivalence for political and economic reasons.
Without equivalence, UK banking, trading, and processing operations will need to relocate into the EU. Additionally, UK financial institutions will need to run separate operations within the union to manage their European businesses. This will mean extra costs, complexity, and layers of processing that smaller firms may struggle with.
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