The EU Provides a Small Reminder to non-EU Countries on ‘Equivalence’

In this post, we will review a recent action by the EU that takes into account credit rating regulation, as well as Brexit. It was only last week when we reviewed the most recent regulatory manoeuvrings in relation to credit rating agency regulation, and yesterday it was announced in the business media that the EU have taken another step. However, whilst that step is having very little effect, it is being seen as a direct warning shot to the British as the new British Prime Minister, Boris Johnson, continues to reiterate that the UK will be leaving the EU on the 31^st October, with or without a negotiated exit deal.

Rather than regulatory amendments, the EU has taken the unprecedented step of stripping five particular countries of its market rights. On the basis that the EU has warned Canada, Brazil, Singapore, Argentina, and Australia that, for the past 6 years, the rigour of its regulation of credit rating agencies is not equivalent to that of the EU’s regulation of the industry, the EU has decided to withdraw equivalence provisions. The technical impact of this is that European clients can no longer utilise the ratings of agencies based in those particular countries. A vice-president of the Commission, former Latvian Prime Minister Valdis Dombrovskis, stated that the decision set ‘some kind of precedence for monitoring adherence’ and that ‘if they, during several years, chose not to update their legislation, then we had to take the decision to withdraw equivalence’. However, the reality of the EU’s rules have been made clear by those affected, with the ‘endorsement’ regime seemingly coming to the rescue. The endorsement regime allows agencies stationed within the EU to vouch for the ratings of a satellite agency. With credit rating agencies being spread across the globe, the effect therefore is minimal, if not non-existent. Canadian rating agency DBRS stated that the decision ‘will have no impact on our business’, because they will ‘continue to issue ratings from our US and Canadian credit rating agencies that can be endorsed by our EU registered CRAs and therefore used for regulatory purposes in the EU’. In the immediate aftermath of the decision, the exact same sentiment can be seen coming from those within Singapore’s marketplace as well. This is because, seemingly paradoxically, the targeted countries are still seen as meeting the criteria to endorse credit ratings for regulatory usage, although does consist of a different process.

So, the effect is minimal at best. Onlookers such as Professor Lawrence Loh of National University Singapore, have stated that the real effect is that the rulings have two consequences. The first is that it is a warning shot to third-party countries that, with a new EU Parliament forming, there will be plenty of new rules being developed and that the bloc expects adherence in exchange for access. The second, and related point, is that this action may be seen as a warning shot to the UK, with Loh suggesting that the ongoing Brexit saga is vitally important in relation to the concept of ‘equivalence’. The Financial Times seemingly agrees, suggesting that an equivalence deal ‘may be the best the City can get’ from any negotiations between the two parties. There is an obvious downside for the British party in this process in that, under the equivalence regime, the EU can remove it at a moment’s notice. Bloomberg suggests that this system is all that will be offered by the EU and that, in the face of such a precarious threat, British firms are well ahead with plans to move more than $1 trillion into the Eurozone and thereby safeguard their assets. Dombrovskis has moved to calm these fears, arguing that whilst the UK will only be offered the equivalence regime in a negotiation, the reality suggests that the EU are extremely cautious in removing equivalence rights, with it being noted that 6 years elapsed since the EU raised these regulatory issues with the third-parties targeted this week.

The reality is important here however. On one side the EU is, quite rightly, seeking to protect itself from what may become a predatory race-to-the-bottom financial centre sitting right on its doorstep in the wake of a no-deal Brexit. With the British political establishment seemingly marching into the arms of a waiting President Trump, the EU must seek to protect itself. For the UK, the story is very different. There is a belief since Boris Johnson came to power that the EU has no choice but to give into the UK’s demands as they want the money that will be owed in the so-called ‘divorce bill’ – this is not true. The reality is that the EU holds the upper hand in these negotiations and the UK faces either a. having to accept the equivalence regime for entry, which makes a mockery of the claims that Brexit will mean a re-establishment of ‘British Sovereignty’, or b. leave without a deal and subject itself to, potentially, one of the largest instance of capital flight the modern would have seen. For business, there is no loyalty to a jurisdiction – at all. They serve the ideal of profit, and that ideal will see, and is seeing, businesses flock to Europe in order to protect their access to what is a much larger and more significant marketplace than the British economy. This move looks unsubstantial at first, but it is a clear reminder to the British – the penalty for becoming a regulatory cesspit in the wake of Brexit will be severe.

Keywords – Brexit, EU, credit rating agencies, regulation, @finregmatters