Extraterritoriality, equivalence, reciprocity? It’s all Greek to me!

Following the latest MEP discussions in Brussels can be quiet challenging at times. Not only was this particular session interrupted by protesters, but MEPs kept throwing in technical terms in regard to third country regulation that not everyone might be familiar with. So here is a quick guide to cut through all the mist.

Today, the access of third country firms to the EU markets is not harmonised under MiFID. Each Member State can introduce its own third country regime. The aim of MiFID II is to harmonise rules as follows. Third country firms are free to establish a branch within the EU and then are fully subject to EU regulation. It goes without saying that firms want to prevent this, as complying with multiple sets of regulation is a massive burden. Thus, firms from non-EU countries hope to apply for some form of waiver. This is called an extraterritoriality agreement, which exempts non-EU firms from local jurisdictions. In that regard, MiFID II proposes that if non-EU firms choose to trade only with professional investors, they have the opportunity to apply for the third country rule that exempts them from EU regulation, as long as their home country passes the equivalence and reciprocity tests.

Equivalence means that EU regulators would recognise a third country’s regime as being of a sufficiently comparable standard, without being identical. Unfortunately, the EU has not worked out the fine print and nobody knows which country is deemed equivalent and which is not. Thus, Mr Hoban, financial secretary to the UK Treasury, is worried that “from the moment that MiFID is passed and until equivalence decisions are taken, it would close the EU market entirely to any new third country firm, as well as choking off opportunities for our firms in some of the strongest and fastest-growing emerging economies.”

Reciprocity refers to the question of whether the third country treats the EU as equivalent in terms of their third country rules. This is a highly political issue, as some argue that we should not grant access to non-EU companies where our local firms cannot compete with them on their home turf. Others argue that we should be happy for any third country investor. This is not the time to be picky. If other countries choose to protect their markets from welfare creating competition, that is their choice. It should not stop the EU from embracing open competition.

The outcomes of those discussions are more than just uncertain. On the one hand, you have David Lawton, Acting Director at the UK’s FSA, saying “with a successful conclusion to international standard setting work, and with the necessary goodwill on both sides, I believe that we as regulators can define a system of regulation which is compatible with global derivatives market”. On the other hand, Gary Gensler, chairman of the Commodity Futures Trading Commission, stated that the US was vulnerable to risky activity in London. He said AIG had been hit by its financial products unit in London while Citigroup had been harmed by special purpose investment vehicles set up in the UK capital. “So often it comes right back here, crashing to our shores … if the American taxpayer bails out JPMorgan, they’d be bailing out that London entity as well.”

Thus, there is nothing left to say except that everyone may pick his side as he likes, but let’s all together hope for the best.

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