This article was originally posted on the Financial Institutions Hub blog.
On 9 July 2020, the European Commission published a Communication to the European Parliament, the Council, the European Economic and Social Committee and the Committee of the Regions entitled “Getting ready for changes: Communication on readiness at the end of the transition period between the European Union and the United Kingdom”. The Communication aims to highlight the main areas of inevitable change and to facilitate readiness and preparations by stakeholders, especially in light of the Commission’s views that “[n]egotiations so far have shown little progress” and that “broad and far-reaching changes … will arise under any scenario”. The Communication raises some key points for UK financial services firms, which we highlight below.
Given the UK’s decision to approach financial services arrangements by prioritising regulatory autonomy over preserving market access, in the absence of more robust services provision in any future trade agreement, equivalence frameworks will become the key mechanism by which access to UK and EU markets will be facilitated. These equivalence frameworks are available under the current EU regulatory framework in only a limited number of areas, including, for example, in relation to central securities depositories (CSDs) and central clearing counterparties (CCPs). However, in most areas, such as insurance, commercial lending or retail banking, equivalence will not provide market access but instead offer more limited relief provisions relating to prudential requirements or reporting.
Under the Political Declaration, both the EU and the UK were to have endeavoured to conclude their respective equivalence decisions by the end of June, and the Commission sent questionnaires to the UK covering 28 equivalence areas. According to the Commission’s Communication, by the end of June, the UK had returned only four completed questionnaires, and therefore the Commission could not complete its assessments. The UK, on the other hand, has stated that it has completed its own equivalence assessments of the EU, and has pushed back on the Commission’s criticism, noting that the EU’s questionnaires comprised over 1000 pages, 248 of which were sent to the UK at the end of May. Clearly, the issue is not as straightforward as either the EU or UK might otherwise indicate, with the EU taking a technical, “detailed and granular” forward-looking approach to equivalence and regulatory divergence, while the UK remains focused on outcomes-based assessments through determinations “about here and now … based on the self-evident symmetry” between the UK and EU.
The equivalence framework relating to investment firms is of particular interest. Although an equivalence framework is technically already present in the Markets in Financial Instruments Regulation (MiFIR) for investment firms providing services to professional clients, the Investment Firms Directive (IFD) and Regulation (IFR) will implement certain changes to that regime from mid-2021 which tighten assessment requirements and oblige the Commission to undertake a “detailed and granular assessment” of the third country’s prudential, organisational and business conduct requirements. These changes introduced by the IFR were drafted with the post-Brexit equivalence regime in mind, and it is likely that the Commission will want to rely on them rather than the MiFIR equivalence framework, which could potentially create a time lag between the end of the transition period and the date on which UK investment firms can make use of the MiFIR equivalence framework in order to provide services in the EU on a cross-border basis.
CCP and trading venue equivalence
The Commission confirms in its Communication that it has identified only one area – CCPs – which may present financial stability risks, and is therefore considering the adoption of a time-limited equivalence decision for UK CCPs. This would allow EU CCPs to further develop their capacity to clear relevant trades in the short and medium term and EU clearing members to reduce their systemic exposure to UK market infrastructure providers. The Commission also confirms that it will be adopting implementing measures under EMIR 2.2 that will determine the degree of systemic risk of third-country CCPs and the necessary measures to strengthen the supervision of those CCPs, as well as the possible need for further measures to mitigate those risks.
From the perspective of UK CCPs and their EU27 clearing members, ensuring that there is certainty around continued access to clearing services post-Brexit will be key, so in this sense it is unfortunate that the Commission has not yet stated explicitly that there will be transitional relief, and what that transitional relief will look like. However, the promise of a transitional arrangement will come as a relief to many, particularly given that the alternative could have involved UK CCPs being required to rush through applications for post-Brexit status under EMIR 2.2. This would be no easy feat for UK CCPs given that the necessary EMIR 2.2 technical standards have not yet been finalised; indeed, on 9 July 2020 ESMA published a letter on certain aspects of the technical standards for the Commission’s consideration. It seems likely that if the Commission does grant temporary equivalence for UK CCPs, we will see some certainty on this point by September this year since, otherwise, LCH in particular will need to begin taking steps to “off-board” EU27 clearing members.
Unfortunately, the Commission’s Communication makes no mention of temporary equivalence for UK trading venues, which may well complicate compliance with the derivatives and share trading obligations for EU27 firms that trade on UK trading venues.