Unintended Consequences: Third Country Equivalence

When you would ask someone a year ago about their opinions on third country equivalence, you'd probably get a glassy stare, including from me! Looking at the speed at which it has become a hot topic it must be pretty important.

What is it about? It’s about the possibility that the European Commission considers the supervisory structure and regime in non-EU countries as equivalent. This is a formal decision by the EC that will result in the possibility of exchanges (e.g. CME) or Investment Firms of that third country to do business in the EU. (article)

The need for equivalence is inspired by business opportunities. However, the assessment whether or not to take a decision in favor of equivalence is based on regulation. This is certainly a different perspective.

Is it new? No, National Competent Authorities (NCAs) have so far recognized certain countries as equivalent. These have been bi-lateral actions of the NCAs in the EU and non-EU country.

So why is it important? One problem is that MIFID II specifies that any foreign instrument listed in Europe should be traded on a European exchange if there is no equivalence decision. Another problem is linked to Direct Electronic Access (article). Other problems are linked to clearing, OTC derivatives, etc.

An example might clarify why it's so important: So let’s say that the EC does not recognize the US regime as equivalent. As a consequence US shares listed on an exchange in Europe must be traded in Europe. Everybody will understand that the client is best served by trading e.g. Apple in the US. The idea is not only ridiculous but also dangerous. There will be no best execution!

The impact of non-equivalence is not to be underestimated. It affects all assets classes, all investors and all exchanges. The bilateral agreements now in place between NCAs and non-EU countries are often limited to derivatives. The key words here are "derivatives" and "bilateral". I'm not sure if the US and other jurisdictions are waiting for a form of extraterritorialism of EU rules. They like to make up their own mind. Certainly Trump does, in his own special way. And yes, this might be the way UK licensed firms could continue to do business when Brexit is finalised. 

More info:

EPRS: Understanding equivalence and the single passport in financial services

EP Briefing: Third-country equivalence in EU banking legislation