CRD VI: Third country branches and subsidiaries

Rationale

The Commission reported that according to the European Banking Authority (EBA) the largest 15 third country banking groups have a significant footprint in EU banking markets and more than three quarters of their EU assets are held via third country branches. The Commission is concerned that this presents a source of financial stability risk for the EU. These concerns are on the basis that there is little or no harmonisation as to how these third country branches are authorised or prudentially regulated nor are there cooperation arrangements between supervisory authorities to comprehensively monitor branches and subsidiaries of the same third country group.

The proposal

The Commission proposed, per Articles 48j and 48k of the draft Directive amending the CRD IV, that in relation to third country branches with assets equal to or larger than EUR 30bn in one or more Member States, Member State competent authorities (NCAs) will need to assess whether those third country branches are systemically important for the Member States where they are established, and the EU. Where NCAs conclude that the assessed third country branches are systemically important, they will be able to require the third country parent group to convert its third country branches into subsidiaries or, alternatively, impose other requirements provided these are deemed sufficient to address financial stability concerns (for example restructuring of the third country branches’ assets or activities, introducing additional prudential requirements).

EU legislative process

On 14 December 2023, the Commission published an update on the Banking Package stating that it had been agreed, endorsed by the Council of the EU and European Parliament and will be implemented in EU law.

With the decisions taken by the Council and European Parliament preparatory bodies, the legal texts have now been published on the Council’s website (CRR text and CRD text) and on the European Parliament’s website. Although still subject to legal revision and to a final vote in the Plenary, the texts provide transparency about the agreed new rules.

The co-legislators have stated that the regulation amending the CRR will apply on 1 January 2025. The directive amending the CRD IV will need to be transposed by Member States.

The provisions regarding the requirement to establish a branch and subsidiary are set out in the directive amending the CRD IV. The references below relate to the version of the amending directive published on the Council’s website last December.

Requirement to establish a branch

The newly proposed Article 21c(1) of the CRD IV foresees that, in the future, third country firms must establish a physical presence within the EU Single Market if such firms intend to provide core banking services to EU-domiciled clients and counterparties. The provision of core banking services is defined in the activities referred to in points 1, 2 and 6 of Annex I to the CRD IV.

The requirement to establish a branch in the EU will not apply to cases of reverse solicitation, which is where a client or counterparty approaches an undertaking established in a third country at its own exclusive initiative for the provision of banking services or banking services closely related to those originally solicited. In addition, the requirement to establish a branch does not apply to cases of interbank and interdealer transactions and MiFID investment services will be out of scope of core banking activities. Member State national regimes that have banking monopolies like in France are likely to amend their provisions to take into account these requirements as part of their CRD VI transposition. The reverse solicitation mechanism is aligned with MiFID II (for investment services).

Member States are to ensure that NCAs have the power to require credit institutions and branches established in the relevant Member State to provide them with the information they require to monitor the services provided at the own exclusive initiative of the client or counterparty established or situated in a Member State where such services are provided by undertakings in third countries that are part of the same group. This will entail organizational requirements for relevant institutions to ensure such solicitation from clients (or potential clients) is duly tracked and evidence is kept in internal records.

By 12 months from the date the directive amending the CRD IV enters into force the EBA will review whether any financial sector entity in addition to credit institutions should be exempted from the requirement to establish a branch for the provision of banking services by third country undertakings. Based on that report, the Commission shall, where appropriate, submit a legislative proposal to the European Parliament and to the Council.

Authorisation conditions

The third country branch authorisation conditions include that when authorised a third country branch may only conduct the authorised activities within the Member State it is established. There is a prohibition on the third country branch offering or conducting the same activities in other Member States on a cross-border basis (a subsidiary in one of the Member States is therefore required for passport purposes across the EU / EEA). The only exception to this prohibition relates to intragroup funding transactions concluded with other third country branches of the same head undertaking and for transactions entered into on a reverse solicitation basis.

Management body

Article 91 of the CRD IV which deals with the management body is being updated and now includes, among other things, that they have independence of mind. In addition, the management body should receive adequate human and financial resources for their induction and training, including on environmental, social and governance risks and impacts and on ICT related risks. This section essentially incorporates EBA guidance on fit and proper requirements.

Booking requirements

NCAs will require third country branches to maintain a registry book which will allow the branch to keep a comprehensive and precise record of all the assets and liabilities booked or originated by it. The registry book shall provide all necessary and sufficient information on the risks generated by the third country branch and on how they are managed.

The branch’s policy on booking arrangements is to be regularly reviewed and updated. Such policy is to be documented and approved by the relevant governing body of the third country branch’s head undertaking.

The EBA is to develop technical standards which further specify the booking arrangements which includes the methodology to be used by a third country branch to identify and keep a track record of the assets and liabilities booked by it. The EBA will submit these technical standards to the Commission within 18 months of the amending directive entering into force.

NCAs will also require third country branches to provide them with an independent written and reasoned opinion on the implementation of and on-going compliance with the requirements.

Branch classification

Third country branches are to be classified as either class 1, where they are deemed riskier, or, otherwise, as class 2 where that are small and non-complex and do not pose a significant financial stability risk.

A third country branch will be classified as class 1 where any of the following conditions are met:

• The total value of the assets booked or originated by the third country branch in the Member State is equal to or higher than EUR 5 billion, as reported for the immediately preceding annual reporting period.
• The third country branch’s authorised activities include taking deposits or other repayable funds from retail customers, provided that the amount of such deposits and other repayable funds is equal to or higher than 5% of the total liabilities of the third country branch or the amount of such deposits and other repayable funds exceeds EUR 50 million.
• The third country branch is not a ‘qualifying third country branch’ in accordance with Article 48b.

A third country branch that does not meet one of the conditions above will be categorised as class 2. Classification as class 1 or 2 can be updated by NCAs. Where a class 2 third country branch starts to meet one of the above conditions, it  shall be considered as class 1 only after a period of four months from the date on which it started to meet those conditions.

Classification as a class 1 or class 2 third country branch has certain ramifications. For instance from a prudential perspective class 1 and class 2 third country branches have a different minimum capital endowment and also a different liquidity coverage requirement. There are also different requirements concerning internal governance and risk controls. Class 1 third country branches are to be included within the scope of colleges of supervisors of third country groups in the EU. Where such a college does not exist already, NCAs are to set up an ad hoc college.

Establishing a subsidiary

Per Article 48j of the amending directive, NCAs shall have an explicit power to require on a case-by-case basis that third country branches be converted into a subsidiary and apply for an authorisation as a credit institution at least where:

• The third country branch has engaged in the past or is currently engaged in the performance of prohibited cross-border services.
• The third country branch meets certain systemic importance indicators set out in Article 131(3) of the CRD IV or is considered as systemically important per Article 48k and poses significant risks to the financial stability in the EU or in the Member State where it is established.
• The aggregate amount of the assets of all third country branches in the EU which belong to the same third country group is equal to or higher than EUR 40bn or the amount of the third country branch assets on their book in the Member State where it is established is equal to or higher than EUR 10bn.

Per Article 48k, a third country branch will be subject to an assessment of systemic importance where all branches in the EU that belong to the same third country group have an aggregate of assets in the EU equal to or higher than EUR 40bn (in the Commission’s original proposal it was EUR 30bn). This is based on either:

• on average for the immediately preceding three annual reporting periods; or
• in absolute terms for at least three annual reporting periods during the immediately preceding five annual reporting periods.

The asset threshold of EUR 40bn does not include assets held by the third country branch in connection with central bank market operations entered into with ESCB central banks.

Before exercising the power to require a subsidiary the NCA will consult the EBA and other NCAs where the third country group has established other third country branches or subsidiary institutions.

Colleges

NCAs supervising third country branches and subsidiary institutions of the same third-country group are to cooperate closely and share information with each other. NCAs are to have written coordination and cooperation arrangements in place. As mentioned above, class 1 third country branches shall be subject to the comprehensive supervision of a college of supervisors.

United Kingdom

Obviously, the EU’s proposals have significant ramifications for third country banks operating in the EU including those from the UK.

From the UK perspective whilst the Prudential Regulation Authority (PRA) is finalising its rules to deal with the outstanding Basel III reforms it has not followed suit with the Commission’s proposals for branches and subsidiaries. The PRA’s approach to branch and subsidiary supervision for international banks remains as set out in Supervisory Statement 5/21 and the Financial Conduct Authority’s Approach to International Firms. Perhaps this approach should come as no surprise given the UK Government’s commitment to openness which it feels attracts international investment.