In response to a report and a resolution adopted by the European Parliament in 2018, the European Commission has issued a Communication on its approach to “equivalence” provisions in financial services legislation. These provisions are critical for third-country firms providing services into the EU and impact groups' capital requirements. Readers hoping for greater transparency in the decision-making process and for longevity of equivalence judgements will be disappointed. Also, the Commission states that the decision process for “high impact” third countries (those whose firms are likely to make intensive use of an equivalence determination) will involve the assessment of 'a more significant set of risks' to the EU.
Meanwhile, the UK regulators have announced that they are extending the use of their transitional powers in the event of a `no deal' Brexit, from June to December 2020. This will give firms 14 months longer to come into compliance with UK `on-shored' rules.
Firms should review any dependencies on presumed equivalence decisions in their Brexit risk assessments and contingency plans. They should also continue to factor in the possibility of a `no deal' outcome and, therefore, the sudden loss of passports and other critical measures, such as those relating to group capital requirements.
An `equivalence' decision requires a positive assessment of the third country's regulatory framework, which enables the EU to rely on the third country's rules and the work of its supervisor. There are around 40 equivalence provisions in EU financial services legislation and the Commission has to date taken over 280 equivalence decisions for more than 30 countries.
Today's Communication recognises that market participants, both EU and third-country, look for advantages in equivalence decisions:
However, the Communication does not indicate that the greater transparency and certainty sought by firms will be forthcoming. It notes that recent legislation (such as the new prudential rules for investment firms) include `improved' equivalence provisions, which emphasise that decisions need to be risk-sensitive, reflect closely the third country's regulatory and supervisory framework, and take into consideration the impact of third-country activities in the EU. They also underline that ongoing compliance with any criteria and conditions must be ensured.
The Commission further articulates these points to mean that there must be ongoing monitoring of a third-country's framework after an equivalence decision has been made, to ensure that `potentially serious divergences' are identified early and addressed. The Communication also explains that the assessment of a third country whose firms are likely to make intensive use of an equivalence decision will require a more significant set of risks to the EU to be assessed. No countries are named, but the UK and the US, for example, spring to mind.
Moreover, the Communication does not directly address the question whether equivalence assessments are outcomes-based or require line-by-line analysis of rules. Instead, the Communication refers both to assessments being outcomes-based and that they involve `a rigorous case-by-case assessment of third-country rules'. It also refers to other factors being part of the assessment, including tax transparency and anti-money laundering rules, for instance.
The Commission confirms that equivalence - both initiating an assessment and the decision itself - is in its gift, and that third countries and firms have no right to require that an assessment be undertaken. It also confirms that it has the right to suspend or withdraw an equivalence decision at any time. These statements are not surprising as an equivalence decision is a form of sovereign right.
The nub of industry concerns have been that the equivalence process is not transparent or time-certain, and that an equivalence decision might be suspended or withdrawn with insufficient notice for firms to make alternative arrangements or for markets to adjust (the recent developments relating to Switzerland compound such concerns). No assurances are forthcoming on either of these points.
UK regulators announce six-month extension to transition
The FCA has announced that in the event of a no-deal Brexit, it will extend the use of its transitional powers from June to December 2020, to take account of the extension of the Article 50 period to 31 October 2019. Firms will therefore have 14 months to come into compliance with UK `on-shored' rules, apart from some specific areas where the FCA do not think it is appropriate to grant transitional relief e.g. transaction reporting rules under MiFID II.
The PRA and the Bank of England have announced a similar extension, and are also consulting on rule amendments to fix deficiencies arising from Brexit and to make consequential changes in the light of the extension to the Article 50 period.
For more details on the regulators' transitional powers, see here.