A glimpse at South Africa’s future “equivalence” for foreign financial market infrastructures and participants

South Africa’s financial regulators have taken a step towards further integrating with offshore financial markets.

Currently, most foreign financial firms that wish to do business in South Africa or with South Africans must apply for local licences, or obtain exemption from local supervision – an all or nothing approach. On 5 December 2019 however, the Financial Sector Conduct Authority (“FSCA”) published a number of draft documents that, once enacted, would set up the process for the FSCA (in concurrence with the South African Reserve Bank (“SARB”) and the Prudential Authority (“PA”)) to deem certain market infrastructure regulatory frameworks, and their enforcement, in other jurisdictions as “equivalent” to the regulatory frameworks established in terms of the Financial Markets Act, 2012 (“FMA”).

What is equivalence and what are its benefits?

In broadest terms, “equivalence” allows a regulator in country A to recognise, as equivalent, the regulatory environment (and its enforcement) in country B. Both countries’ regulators remain unrestricted and able to set their own standards, but market access to country A is provided to country B’s financial institutions so long as the regulatory outcomes in country B are broadly the same as those in country A. For example, equivalence in the European Union is a well-worn concept that has been used in financial services to give the European Union access to financial institutions from jurisdictions such as Japan, the United States of America and Canada.

A determination of equivalence would, therefore, allow the FSCA to confidently rely on a foreign market infrastructure’s compliance with its own (non-South African) regulatory framework, and in turn, allow the FSCA to grant licences to external market infrastructures and exempt them from certain South African requirements.

Equivalence serves important objectives in open financial markets. Some of the objectives of equivalence in the European Union, for example, include the balancing of the needs of financial stability and investor protection with the economic benefits of maintaining an open and globally integrated financial market, as well as establishing supervisory cooperation with third country partners. Equivalence has been considered to be an effective way to manage cross-border financial activity in a sound and secure prudential environment, while providing a wider range of financial products and services to local consumers. Equivalence also reduces compliance overlap and increases competitiveness.

Aim of an equivalence regime

From the view of South African regulators, the aim of establishing an equivalence regime would be to:

1. reduce or eliminate compliance overlaps while enhancing prudential supervision of cross-border activities,
2. lighten the regulatory burden that South African financial institutions face when trading with counterparties in equivalent jurisdictions, and
3. broaden the range of financial services available to South African financial institutions and investors

One of the draft documents published is titled “Draft Equivalence Framework for External Trade Repositories, External Central Counterparties and External Central Securities Depositories” (the “Draft Equivalence Framework”). It would apply only to the named market infrastructures, but is informative for all types of market infrastructures. It can likely be seen as the first indication of how the FSCA, SARB and PA might in the future construct South Africa’s equivalence regime in respect of a wider range of licensees, such as OTC derivative providers, authorised users and financial services providers.

Qualification process

Under the Draft Equivalence Framework, in respect of offshore trade repositories, central counterparties and central securities depositories wishing to qualify as external market infrastructures under the FMA, the process would involve an applicant’s submission of an application, supporting documents and payment of a substantial fee (proposed to be ZAR450 000). Thereafter, the FSCA would interact with the relevant foreign regulator and the foreign regulator would be required to complete a questionnaire, the FSCA would assess the results of the interaction and the questionnaire, and then the FSCA would determine, in concurrence with the SARB and the PA, whether the foreign regulatory regime is “equivalent” to the relevant regulatory regime in South Africa.

Key takeaways from the draft equivalence framework

The Draft Equivalence Framework also contains a few important takeaways for future external OTC derivative providers, external authorised users and external financial services providers.

1. An equivalence determination must be driven by an applicant. The FSCA, SARB and PA will not simply commence evaluating a list of jurisdictions for equivalence. An applicant may request a pre-application meeting to better understand the process, but must thereafter apply to the FSCA for an equivalence determination and pay a hefty fee of ZAR450 000.Thereafter the FSCA will make contact with the foreign regulator and request that the foreign regulator complete a questionnaire designed to assess the extent to which the relevant FSCA regulatory provisions appear in the foreign jurisdictions regulatory framework.Finally, the FMA then requires that the FSCA enters into a cooperation agreement with the foreign regulator, specifying, inter alia, mechanisms for exchanging information and notifying of breaches, etc., use of information for law enforcement purposes, confidentiality and procedures for cooperation. This equivalence investigation leading up to a cooperation agreement would be undertaken separately for each type of market infrastructure.This will no doubt be a long and involved process for both the FSCA and the applicant. No provision seems to have been made yet for the possibility of multiple foreign market infrastructures applying jointly for equivalence recognition of a single jurisdiction, nor of a foreign market infrastructure applying for equivalence recognition of multiple jurisdictions in a single application. Once a single party from a jurisdiction has paid for and driven the process, it would open the door for other applicants from that jurisdiction to apply for recognition as external market infrastructures without going through the entire equivalence recognition process.

2. The FSCA will look to the foreign jurisdiction’s licensing requirements, rules, regulations and supervision, taking into account relevant international standards and considering the systemic risk posed by the external market infrastructure to South African financial markets. In doing so, the FSCA will assess the extent to which the foreign jurisdiction’s requirements would satisfy South African regulatory requirements.Similar to regulations in the European Union, many of South Africa’s market infrastructure requirements, rules and regulations are based on standards set by international organisations such as the Basel Committee for Banking Supervision (“BCBS”) and the International Organization of Securities Commissions (“IOSCO”). This may smooth the path to equivalence recognition for jurisdictions that largely follow BCBS and IOSCO standards.

3. The FSCA acknowledges that establishing equivalence may involve “an intensive dialogue” with the regulatory/supervisory authorities in the jurisdictions of applicants. Prospective applicants will, therefore, likely want to communicate with their own regulatory authorities to determine whether the authorities will be willing to participate in the process, before commencing on what may become a long and expensive process.

The eventual entry of external market infrastructures and participants will be a substantial step forward for the prudential regulation of cross-border financial services, as well as the expansion of availability and competitiveness of products in South Africa’s financial markets. The commenting period for these drafts have passed, but further opportunities to comment in relation to equivalence for external market participants will come in due course.