EU Capital Requirements Regime: Third-country branches under CRD VI

Background and sources

• As in general with CRD VI in terms of supervisory powers, sanctions and environmental, social and governance risks, the prudential objective with regard to the introduction of third-country branches (TCBs) is to further harmonise the supervisory framework and, ultimately, deepen the internal market for banking activities.
• Although TCBs are already established within the EU, they are not subject to uniform regulatory standards, but to widely differing national provisions. In addition, the national competent authorities (NCAs) have neither the necessary supervisory instruments nor sufficient data to adequately monitor the specific risks.
• Such fragmented regulatory landscape creates risks to financial stability and market integrity in the EU, which are to be adequately addressed through a harmonised framework for TCBs introduced by CRD VI. Such a framework includes common minimum requirements for licensing, prudential standards, internal governance, supervision and reporting.
• The key provisions on TCBs are the new Article 21c in conjunction with Articles 47 to 48s of CRD VI. While Article 21c sets the requirement for establishing a TCB (including the reverse solicitation exemption), the Articles 47 to 48s cover the various material requirements for both TCBs and NCAs.
• Unlike the majority of the other revisions in CRR III and CRD VI, the TCB framework is not based on Basel IV, but driven solely by the European legislator underlining the legislative in-tent behind the new regime: transparency and protectionism, tightening and harmonising the EU regulatory framework for regulated banking services.
• Please also see our detailed Q&A paper on TCBs and their requirements available here.

Key changes

• Article 21c of CRD VI introduces a significant change by imposing a ban on third-country institutions providing core banking services (specifically, lending, guarantees, commitments, and deposit-taking) into the EU on a cross-border basis, i.e. without a physical presence.
• CRD VI does not explicitly define what is meant by the provision of a service "in(to)" a Member State. Rather, the geographical scope is subject to further interpretation by the European Supervisory Authorities (ESAs). It is to be expected, though that this will be rather restrictive (solicitation test rather than characteristic performance method).
• Third-country institutions are to be required to establish TCBs in each relevant Member State (because no passporting will be allowed), or one EU subsidiary duly licensed as a credit institution (allowed to use passporting rights). The provision of cross-border investment services under MiFID (i.e. in particular those under Annex I Section A of MiFID) remains unaffected and is subject to MiFID/MiFIR market access rules.
• The scope of application includes all types of entities that offer core banking services and would therefore be considered a (credit) institution (including financial sector entities) if they were established in the EU. Insurance companies and funds are excluded.
• National waivers, such as those used in Germany by US and Swiss banks, would have to be removed with the introduction of Article 21c of CRD VI.

Requirements

• Articles 47 et seq. of CRD VI provide for substantial requirements in terms of day one li¬censing and ongoing compliance.
• A TCB requires a licence from its NCA, which is linked to a number of minimum requirements. All TCBs within the EU must fulfil these requirements.
• Accordingly, the licensing requirement generally also applies to existing branches of third-country institutions. It is at the discretion of the respective NCA to grandfather existing licences that were granted 12 months or more before the application of the CRD VI (where the local minimum requirements already correspond to those of CRD VI).
• TCBs are not allowed to provide cross-border services to other Member States, unless it is intragroup or by way of reverse solicitation, as there is no EU passport available for TCBs.
• CRD VI categorises TCBs into two classes (class 1 and class 2) based on the size, nature and scope of their business.
• Class 1 branches are, for example, those for which the locally booked assets in the previous year amount to EUR 5 billion or more or which accept retail deposits that make up at least 5% of total liabilities or exceed a total of EUR 50 million. All others are categorised as class 2 branches, which are subject to less strict regulatory requirements.
• In case of equivalence of a third country determined by the Commission, branches whose head office is located in such an equivalent country would be categorised as qualifying branches and automatically fall into class 2.
• CRD VI provides that NCAs may require TCBs in their Member State to "subsidiarise", i.e. to apply for a fully-fledged banking licence as a subsidiary.
• This "subsidiarisation" is to be applied in particular if the TCB (i) provides prohibited cross-border services, (ii) is classified as systemically important, (iii) the total amount of assets of a third-country group within the EU is at least EUR 40 billion, or (iv) the amount of assets of the TCB in the relevant Member State is at least EUR 10 billion.
• CRD VI sets a number of requirements for TCBs in a staggered approach in line with the two classes introduced. These include, in particular, capital, liquidity, internal governance, outsourcing management, booking and record-keeping requirements as well as reporting obligations. The requirements only form the minimum floor. Each Member State may impose even stricter requirements.
• Available exemptions include interbank services, intragroup services, reverse solicitation and grandfathering of certain existing contracts. Services provided ancillary to MiFID services (in Annex I Section A) by third-country institutions are excluded from the scope. This exemption also includes any accommodating MiFID ancillary services linked to the provision of trading of financial instruments or private wealth management and could include, for example, the custody of financial instruments.

EBA technical standards

• Articles 47 et seq. of CRD VI provide for substantial powers for EBA and Commission to draft and adopt regulatory and implementing technical standards (RTS/ITS).
• Such RTS and ITS are expected e.g. on the equivalence of a third country's banking regulatory framework for the purpose of determining qualifying TCBs, detailed information on li-censing and capital requirements, on internal governance and risk controls, on booking requirements, on reporting frequency and templates, on the SREP and on the colleges of supervisors.

Timeline

• The timeline depends on when the legislation is published in the OJ, expected in spring 2024. After publication, there will be an 18-month transposition period for Member States to implement CRD VI into national law, followed by a further 12-month transitional relief for TCB provisions.
• The new rules (including licensing) are therefore expected to apply from autumn 2026 allowing the affected institutions to adapt and comply with the regulatory changes.
• The reporting obligations will come into force 12 months earlier.
• There are some grandfathering rules for existing contracts that were entered into at least six months before the end of the transitional relief (probably in the second half of 2025) to pre-serve client rights allowing those contracts to continue being serviced cross-border.

Practical impact

• It is to be expected that the new TCB requirement will not lead to the establishment of a large number of new branches in the EU. The TCB practically comes only with downsides, namely complex licensing and ongoing compliance obligations, but no genuine upsides, in particular because no passporting is available. Instead, the framework serves to force third-country institutions with a duly licensed subsidiary into the EU.
• Other options for avoiding a TCB include the migration of existing business to non-credit institutions or EU group companies or the use of exemptions.
• The application of the reverse solicitation exemption will, however, be closely monitored by all EU agencies as well as NCAs and is already under increased scrutiny. Information obligations are provided for in order to be able to prove the client's own initiative. It will not be possible to establish or continue a sustainable business model based on reverse solicitation.
• What should remain possible, however, are structures found primarily in corporate lending, whereby a duly licensed EU subsidiary (or a non-group regulated EU entity) is used as a lender of record entity, but the (credit) risks are transferred back-to-back to the third-country parent company to accommodate the different allocation of resources in terms of capital, liquidity, large exposure, but also personnel and expertise; the same applies to genuine fronting models, whereby regulated EU entities act as day one lenders and then assign the receivables to third-country entities. However, both such structures are being scrutinised by some NCAs in the aftermath of Brexit.