Equivalence in Financial Services

This chapter provides a conceptual framework for the regulation and supervision of financial services in a domestic, one-country environment. The financial industry plays a fundamental economic role in modern societies, by funding the real economy, matching savers with investors, and providing a system of payments. However, financial service providers may be systemically important actors, whose activities can endanger not only their shareholders, but also the rest of the economy. Financial regulation plays a fundamental role by forcing financial actors to internalize the negative externalities they produce.

The scope of this chapter is to explore the globalized nature of systemic risk, and the legal strategies that domestic authorities employ to address cross-border externalities. The chapter starts by describing the risks arising from cross-border finance, distinguishing between banking and non-banking activities. Thereafter, we describe the difficult choice public authorities face when confronted with the problem of how to regulate globalized finance. Despite the international nature of the industry, an international law of finance does not exist; finance is rather regulated by non-binding principles and standards produced by Transnational Regulatory Networks (TRNs). Though useful, TRNs cannot deliver international harmonization, leaving each regulator with a difficult choice on which regulation to apply to market operators coming from other jurisdictions (our rules or their rules?). One option is to impose local rules to foreign actors, a model called domestic treatment. Alternatively, public authorities can allow foreign providers to operate in their territory according to their home regulation, a model called mutual or unilateral recognition. We outline the different advantages and disadvantages of each approach from a financial stability viewpoint.

The global financial crisis first and the sovereign debt crisis thereafter have fuelled a constitutional mutation in the EU financial governance. The member states of the European Union have pooled together their financial sovereignty at an unprecedented level, transferring many of their regulatory powers to the EU. The EU architecture, previously geared exclusively towards market integration, is now also equipped to achieve (and preserve) EU financial stability. This chapter has the ambition to summarize the European system of financial regulation and supervision. In line with the scope of the present book, the chapter focuses on the non-banking sector, and it is organized as follows. The first part provides a bird’s eye view of the history of EU financial regulation. The second and third sections describe the main pillars of the EU financial governance, namely the single rulebook and the European System of Financial Supervision. Finally, we analyse the role of the European Securities and Markets Authority (ESMA) in the supervision of non-banks and market infrastructures.

Equivalence is the legal mechanism employed by the EU to manage cross-border financial integration with third countries, namely those countries that are neither part of the European Union nor the European Economic Area (EEA). Under equivalence, the European Commission can assess whether the regulation of a third country is equivalent to EU regulation, granting market access to financial firms established in that jurisdiction. The chapter provides an historical overview of equivalence under EU law, from the financial crisis until Brexit. It explains the legal procedure that the European Commission must follow to adopt equivalence decisions, disciplined by the EU Treaties and EU financial legislation, and the different role played by equivalence in the banking and non-banking sector. Finally, the chapter outlines the accountability practises through which the European Parliament and the Council can control how the European Commission implement equivalence frameworks established under EU law.

The chapter provides an analytical framework to assess the effectiveness of EU equivalence frameworks, identifying which conditions they should meet to prevent as extensively as possible potential risks triggered by foreign actors. We find that, to be effective, equivalence frameworks should delegate ESMA with the supervision of third-country institutions, applying a different supervisory approach according to the systemic relevance of each entity. We call this methodology “macroprudential” because it is tailored to the systemic impact of each market actors. While small operators can provide services in the EU following their local regulation, systemic players should be subject to EU regulation, to preserve the level playing field within the Union.

The chapter conducts a cross-industry review of the equivalence frameworks established under EU securities legislation; assessing the procedures and conditions according to which non-banks and market infrastructures established in a third country can operate in the European Union. The chapter describes not only market access conditions and procedures, but also how EU authorities—the European Commission and the ESMA—have implemented each framework, checking whether they can be considered effective from a prudential perspective. We analyse the cross-border regulation of the following market actors: credit rating agencies, benchmarks, trading venues, investment firms, investment funds, central securities depositories and trade repositories.

The present chapter analyses the regulation and supervision of Central Counterparties (CCPs) in the European Union. The European Market Infrastructure Regulation (EMIR) establishes a regulatory framework for EU and non-EU CCPs to operate in the Internal Market, offering clearing services to EU clearing members and trading venues. While EU CCPs are subject to EMIR requirements, enforced by national authorities, Third-Country CCPs (TC-CCPs) can access the EU only if the European Commission considers their home regulation to be “equivalent” to EMIR. The chapter is organized as follows. First, it examines the relationship between central clearing and financial stability, outlining the centrality of CCPs for the post-crisis financial system and their nature of “too-big-to-fail” market infrastructures. Second, it analyses the regulatory and supervisory framework for CCPs established in the European Union and third countries. Thereafter, it describes the most recent reform of the framework for TC-CCPs (the EMIR 2.2 regime), where ESMA and the ECB are given enhanced powers to supervise systemically important TC-CCPs. Finally, the chapter concludes by assessing whether the equivalence framework for TC-CCPs can be considered effective from a financial stability perspective. The chapter finds that further improvements would be necessary to fully protect EU financial stability from potential risks.

The present chapter concludes the book by proposing a wide-ranging reform of the equivalence system. We argue that the EU legislator should harmonize the various third-country frameworks established under EU legislation, strengthening ESMA’s capacity to supervise third-country entities operating in the Internal Market. This approach would establish a clear legal basis for EU regulation and supervision of foreign-based institutions while streamlining an overly complex system and providing the third-country industry with a single point of access into the Internal Market. The chapter is organized as follows. First, it summarizes the shortcomings of equivalence frameworks we have identified in the previous chapters. Second, it outlines how the EU equivalence regime and ESMA should be reformed to centralize the supervision of third-country entities. Thereafter, the chapter investigates whether our reform proposal would be compatible with EU constitutional law and the jurisprudence of the European Court of Justice, as well as feasible from a political perspective.