Equivalence in the area of financial services: An effective instrument to protect EU financial stability in global capital markets?

Abstract

The article investigates whether the main EU regulatory mechanism for managing cross-border trade in financial services with third countries, the EU equivalence regime, is compatible with the post-financial crisis objective of protecting financial stability. Equivalence allows third-country financial firms to operate in the internal market on the basis of their home country regulation if this is equivalent to EU law. There are three different procedural safeguards to avoid financial stability risks: a) ex ante assessment of third countries’ regulation to ensure regulatory compatibility between the EU and the third country; b) ex post withdrawal of market access if cross-border liberalization triggers a “race to the bottom”; and c) direct supervision of systemic third-country entities to prevent them from becoming vectors of cross-border systemic risk. The article argues that those safeguards are ineffective in protecting the internal market from external risks. It proposes two alternative reforms. First, the EU could replace equivalence with a system of substituted compliance, following the US model where foreign financial firms must register with local authorities and follow host country regulation. Alternatively, the EU could reinforce the assessment, withdrawal, and supervisory procedure by harmonizing the current patchwork of different