EU treaties and legislation aim to guarantee the Single Market’s four freedoms of goods, services, people and capital.
This means goods and some services from one member state can be sold in another. In the case of financial services, this is known as a 'passport'.
The four freedoms are supported by the harmonisation of rules across all the member states, the prevention of discriminatory practices and the provision for mutual recognition of standards.
Mutual recognition involves both sides recognising each other’s standards or regulatory regimes. But if only one side recognises the other’s standards or regulatory regimes, this is termed ‘equivalence’.
According to the EU, after Brexit the UK has two options: it could either continue to benefit from the four freedoms if it becomes part of the European Economic Area (EEA) or it could seek equivalence decisions from the EU, which would allow some access to the Single Market.
The UK has ruled out EEA membership and hopes that there can be agreement on the mutual recognition of standards or regulatory regimes, either in general or in specific sectors. For example, the UK has called for mutual recognition of data protection frameworks in order to allow the free flow of data after Brexit.
However, the EU’s Chief Negotiator, Michel Barnier, says that mutual recognition will not be possible in light of the UK’s decision to end free movement of people and to end the jurisdiction of the European Court of Justice (ECJ), which enforces the Single Market's rules. He says that the best the UK can hope for are equivalence decisions, in areas where EU legislation allows this.
If the EU granted equivalence to the UK in a specific area, the EU could decide unilaterally to withdraw the equivalence. That is why equivalence decisions are a riskier basis for operation than mutual recognition.
Because the EU will also want access to UK markets after Brexit, the UK has argued that mutual recognition of regulatory frameworks will be the best route. But even if the EU is open to agreeing mutual recognition in some areas, Michel Barnier says that mutual recognition with the EU will restrict the UK’s scope to set its own regulatory standards.
If the UK wants to be able to vary its standards from EU ones, equivalence decisions provide some scope to do this. Equivalence decisions are based on an assessment of the results of regulatory regimes, rather than the similarities between different regulatory regimes.
What is the scope for equivalence decisions?
Equivalence decisions are provided for in EU legislation. For example, around a quarter of financial services legislation provides for equivalence. This means that while some areas of investment banking and insurance could achieve equivalence, retail banking and reinsurance cannot.
Because the UK is a member of the Single Market, it might be possible to agree equivalence in areas beyond those currently provided to those outside the EU. This would require new EU legislation or a treaty.
The EU makes equivalence decisions by 'implementing acts' which are akin to secondary legislation in the UK.
The procedures are different for different areas but the decisions are based on proposals by the European Commission, with input from committees of experts or EU regulators, and then subject to approval by the Council of the EU.
Take data for example. The Commission makes a proposal, which is considered by a committee of data protection experts from member states - the national equivalents to the Information Commissioner’s Office in the UK. The Commission’s proposal then requires the approval of the Council of the EU by qualified majority and is then considered by the College of Commissioners.
Decisions about data adequacy are based on whether equivalent data protection law and rules are in place and wider aspects that include: the rule of law; respect for fundamental rights and freedoms; relevant legislation (particularly around security and public bodies' access to data) and the scope for judicial redress.
The process of granting equivalence to other countries is similar for financial services, although this varies for different pieces of legislation. An important difference in financial services is that while the EU might grant equivalence to a particular country, in sometimes necessary for individual companies to get additional approval from EU regulators.
Who ensures that equivalence is maintained?
Equivalence can be withdrawn unilaterally by the EU. In 2015, the ECJ found data equivalence with the US to be invalid following a challenge by an Austrian citizen through the Irish High Court. A new - more restricted - equivalence decision was put in place by the EU shortly after this.
EU legislation provides for equivalence, and the equivalence decisions themselves do not establish a procedure for maintaining this equivalence. But as with the procedure for approving equivalence, the Commission is likely to play an important role.
How long do equivalence decisions take?
Equivalence decisions can be made rapidly – as in the case of US data equivalence – or they can take several years, particularly where they form part of wider trade negotiations.
As part of the Solvency II legislation to harmonise insurance regulation, the EU provided equivalence to several third countries pre-emptively when the legislation came into effect. This could be a useful approach for Brexit negotiations.