THE WORD OF THE YEAR

 

There are awards for everything these days, especially during the transition from one year to the next. Merriam-Webster, the publisher of dictionaries and other language-oriented books annually select a “word of the year”, and for 2020, (in what might be the least surprising choice ever) “pandemic” topped their charts.  Meanwhile, the people over at the Oxford English Dictionary, while acknowledging that the use of the term “pandemic” had increased “57,000%” felt that 2020 was an “unprecedented” year and broke tradition to name an entire slate of “words of the year”.  These included “bushfires, Covid-19, WFH, lockdown, circuit-breaker, support bubbles, keyworkers, furlough, Black Lives Matter and moonshot”.  That’s quite a mouthful of words, but, then again, – it was quite a year.

One of the words Oxford noted as being substantially down in usage throughout 2020 was “Brexit”, which comes as somewhat of a surprise.  Of course, the reduced rate of usage is relative as one can imagine that during 2019 there may have been times when a sentence in your typical BBC report consisted of “Brexit [verb], [adjective] Brexit, Brexiteer, Brexit [verb] [expletive] Brexit”.

Now that Brexit is fully upon us one might expect to see similar peaks and troughs in usage of the “B” word as the finer details of its workings are developed.  Perhaps of even more importance will be some of the Brexit associated words that will come to the fore as everyone starts to incorporate the reality of a separate and distinct UK and EU into their respective commercial lives.  As the contest begins to choose which Brexit related term might become the 2021 “word of the year” an early favourite has emerged. 

That would be “EQUIVALENCE”.

You see, up to now much of what has driven the Brexit movement has been the urge to emphasise the differences between Britain and the rest of the EU.  You have heard about contrasts in language, culture, sovereignty concerns, unique relationships with Commonwealth partners and the United States, an unwillingness to defer to “Brussels” in multiple areas – all of which may or may not be legitimate but which, now that Brexit is a reality – become of less urgency.

What will remain (and increase) in importance will be the areas where the UK will attempt to show that they remain much the same as their former EU partners.  Areas where the standards under which the UK operates are substantially similar to and compatible with those of the EU and therefore should be viewed as (that word again) “equivalent”.

The various governments’ ongoing assessment of where the EU and UK retain (or build) equivalent standards will take up a significant amount of time and will evidence itself in a variety of forms.  It is well worth exploring in some detail what those will look like. The idea of “equivalance” in a legal or regulatory sense will arise in a variety of circumstances – but the concept will essentially be the same for each – it will be an attempt to answer some form of this question:

Can one view the laws, regulations, guidelines and principles under which the two jurisdictions operate as sufficiently compatible for each to acknowledge and accept the sufficiency of those standards?

So where will we find situations where this question arises – and how do we establish the answers when it does?  One place that will certainly give rise to queries concerning equivalence will be the field of financial services regulation.  Here are a couple of helpful examples of where regulators will be faced with determining “equivalence” in the very near future. 

First, let’s consider the topic of “outsourcing” – a key focus of European regulatory reform within just the past couple of years, and one which gives rise to many instances of cross border interaction.  If an EU based subsidiary of a UK parent company wishes to make use of the parent as a provider of outsourced services (such as for internal audit) – or if they wish to use a UK based company for other such remote services (e.g. cloud based storage), then the status of that relationship will likely have changed as the result of Brexit. There would have been, under a pre-Brexit EU based regime, minimal legal differentiation between an entity based in, say, Ireland and that same entity’s registered branch in the UK (and vice-versa).  Post-Brexit, with branches not being recognised by the EU as a viable means of establishment for UK based entities, and with only a temporary permissions regime in place in the UK itself, a split in recognised authority has taken place.  As many will be aware, a number of changes were made to many group structures to address this circumstance, particularly where a UK based parent had previously operated cross-border branches.  In those instances, parent structures were often re-located to a jurisdiction that retained EU membership (and thus passporting rights). The remaining UK entity now will offer its regulated services only to U.K. based customers. But what if that U.K. entity still offers certain “outsourced” services to the other group companies?  What if they still provide things like the group’s sanctions screening process, vendor management programme or IT security upgrades?  What if they receive those services from other group companies or 3^rd parties? When formulating their restructures did groups factor in the need to answer these questions (for both internal and external outsourcing)? What standards will apply, what will the contracts have to look like – where are the rules to be found?

For questions surrounding outsourcing the answer used to be relatively simple – you would look to the “EBA Guidelines on Outsourcing Arrangements” as a primary source.  The “EBA” is, of course, the European Banking Authority – a distinctly EU based organisation.  Post-Brexit that means that the answer (at least with respect to services touching in some way upon UK based entities) is not quite so straightforward.  Given that many groups had undertaken a restructure to address Brexit – had they also fully considered whether their outsourcing profile had changed?  Even if they had – was the EBA still the authority to look to when undertaking that analysis?  Did those standards maintain the necessary (here it comes) “equivalence”?

The simple fact is that in undertaking their restructures many companies continued to avail of services offered from their UK entity to the former branches, (or vice versa) without having fully considered the outsourcing implications.  Whereas it may have been possible, under prior legal structures, to posit that those services were not “outsourced” (due to the fact that they derived from the same legal entity), that likely will not be the case any longer.  A contract for outsourced services will certainly be required where a former EU branch is receiving those services from a now separate UK entity. I would posit that this may even be the case where an EU parent is receiving a service from a UK branch that is operating cross-border pursuant to the Temporary Permissions Regime (“TPR”).  The TPR is a mechanism by which the UK regulator becomes comfortable with the continued presence of an EU registered firm within the UK.  It does not necessarily have any impact on how an EU regulator would view the status of that (now non-EU based) branch.  The safe route would be to contract those services in a manner that complies with the EBA Guidelines, because, for now (and here comes that word again) those standards would still be seen as equivalent in the two jurisdictions. Indeed, indications are that UK regulators are quite keen to retain the equivalent standards for at least the mid-term.

This is evidenced by the fact that UK regulators (e.g. Bank of England, FCA and PRA) are currently stating that UK based entities should make every effort to adhere to guidelines like those espoused by the EBA on outsourcing "to the extent that they remain relevant when the UK leaves the EU”.  Such relevance will be retained for guidance that existed pre-Brexit (in this case January of 2021), but what if there are amendments or additions to that guidance post-Brexit? The FCA has noted that in such instances it will “clarify” whether the rules will continue to apply on an “equivalent” basis.  One would expect that there will be a significant bias in favour of retaining equivalence where possible – and this is quite possibly going to remain the case in most instances.  However, in certain other areas, (cloud outsourcing comes immediately to mind) the UK may decline to recognise the EU standard thereby creating an area of divergence.  Firms should build the monitoring of such “equivalence gaps” into their regulatory change management structures.

The question has arisen as to whether a regulator based, for example, in the EU would be much interested in what the contract of an entity they regulate says when that entity is the provider of outsourced services.  Although the motivation for review will be different it is relatively easy to envision why there may be such dual interest. Consider the case where EU based parent Company “A” derives a significant portion of its revenue from UK based subsidiary group Company "B". It would not be unusual for the UK subsidiary "B" to receive outsourced services from Parent "A" or another external provider and certain of those services may be "critical" when it comes to allowing "B" to function. While it may be the UK regulator who examines "B" as the recipient of those services, an EU based regulator would also have a prudential concern based upon the potential disruption of that channel or service.  After all - if "B" gets shut down due to inadequate outsourcing protections - there goes a huge chunk of "A's" revenue. Thus, it would not be surprising, under many existing group structures, to see both recipient and provider regulators evidencing an interest in reviewing outsourcing arrangements and retaining equivalent standards when doing so.

Where else might the concept of “equivalence” raise its head?  One intriguing area concerns the area of payment services, as such field was re-defined under the Payment Services Directives.  This EU legislation created a new type of entity (the “Payment Institution”) which was allowed to offer “payment services”, as defined in those laws.  Fully licensed banks (“Credit Institutions”) are similarly authorised to offer these services as well as the additional banking services that go along with that more expansive license.

Here is where things get interesting from an equivalence standpoint.  While a member of the EU, the UK, almost exclusively, allowed certain banks licensed in non-EU jurisdictions to open “3^rd country branches” in the UK.  So, under this approach, a large U.S. based bank could apply for the right to open a “branch” in the UK without meeting the prudential requirements associated with full “credit institution” status.  That “3^rd country branch” could operate in the UK but would not be eligible to passport any of its services to the rest of the EU.  It would probably be more than a mild understatement to say that this practice was looked on with skepticism from the rest of the EU.

The UK argued that it was within its rights to do this because they were able to establish, to their satisfaction, that the home state regulatory regime of the institutions so authorised were largely (you guessed it) “equivalent” to those that would apply in the UK.  A bank regulated in the United States was thus able to apply and receive branch status based upon that concept.

Presumably, if a U.S. based institution can avail of such 3^rd country branch status, a credit institution regulated in the EU, which has a regime structurally in line with all the UK could expect (since they belonged to that same regime until just one month ago), should be able to do the same. This appears to be the position the PRA is taking in the UK and, particularly for “wholesale banking”, the “3^rd country branch” approach will remain viable.

But what of “payment institutions” (and the related class of “e-money institutions”)?  Will the UK grant these smaller, less capital intensive, limited entities the same ability to establish a branch that currently exists for their larger, more complex cousins?  Logic would, seemingly, dictate that this be the case.  What merit is there in requiring separate legal entities (and attendant board structures, capital outlays, risk frameworks and duplicative reviews) for a type of business that was created out of thin air less than two decades ago by an EU based directive? 

Logic, alas, is not always the primary driver of regulatory oversight.  As of right now there does not appear to be significant movement afoot to establish 3^rd country branch status for payment or e-money institutions.  As the temporary permissions regime proceeds towards its conclusion it would seem likely – under that pervasive desire to achieve “equivalence” when possible – that such a movement will arise.  The ironic thing is that whereas the non-UK EU members despised the existence of the “3^rd country branch” pre-Brexit – it may become a favoured tool for maintaining ties between the two jurisdictions in this post-Brexit environment.

So, in conclusion, those who work in the field of regulatory change management would be well served to search out and understand the concepts surrounding “equivalence” over the next few years as the EU and UK engage in the dance surrounding their future relationship.  As standards evolve and relationships mature the equivalence concept will keep coming up - in areas as diverse a data protection or units of measure. Knowing when it has been achieved – and when it may no longer be present – will be a key to many future decisions.