Road to CRD 6 - common rules for third country branches now finalised

For the first time, CRD 6 will provide for a requirement to establish a TCB for third country firms before commencing or continuing the following activities:

• any of the activities referred to Annex I points 2 and 6 of the CRD (i.e. lending and guarantee business) by an undertaking established in a third country that would qualify as a credit institution or a Class 1 investment firm if it were established in the Union;
• taking deposits by an undertaking established in a third country.

Importantly, the following activities will not be in scope:

• the provision of MiFID services (including accommodating ancillary services such as related deposit-taking or lending in the context of the provision of investment services);
• the provision of banking services on a reverse solicitation basis, i.e. where a client or counterparty approaches the third country undertaking at its own exclusive initiative; and
• interbank and interdealer transactions.

Notably, CRD 6 will require that the exercise of these exemptions takes into account compliance with the European AML/CFT rules.

The authorisation requirement will generally also apply to already existing TCBs. However, NCAs may decide with respect to TCBs whose authorisations were granted 12 months before the application date of the CRD 6 that these authorisations shall remain valid.

Against this background, there seems to be no room for (new) national exemptions that grant third country firms the possibility to provide banking or financial services without requiring an authorisation if they meet certain requirements and are subject to equivalent supervision in their home country, such as currently the case in Germany. However, in order to preserve clients’ rights acquired under existing contracts the obligation to establish a TCB shall not apply to existing contracts that were entered into before the date of application of this requirement (cf. Article 21c (5) CRD 6). It seems to be not entirely clear if this means that third country firms that currently act on the basis of those national exemptions may continue to benefit from these going forward.

CRD 6 will also provide for a new classification of TCBs depending on the risk that they pose to financial stability and market integrity of the EU and the Member States (cf. Article 48a). The risk classification will have an impact on the application of the applicable prudential and governance requirement (see summary below). Member States shall classify TCBs as Class 1 where those branches meet any of the following conditions:

• The total value of the assets booked or originated by the TCB in the Member State is equal to or higher than EUR 5 billion;
• The TCB’s authorised activities include the taking of 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 TCB or the amount of such deposits and other repayable funds exceeds EUR 50 million; or
• The TCB is not a qualifying TCB. Qualifying TCBs are branches (i) whose head office is subject to regulation equivalent to the requirements stipulated in the CRD, (ii) whose third country regulators are subject to equivalent confidentia­lity requirements and (iii) whose head office is domiciled in a third country which is not regarded as high-risk for AML purposes. 

The above conditions are to be understood as alternatives. The fulfilment of one of these conditions would be sufficient to qualify the TCB as a Class 1 TCB. In any other cases, the TCB would be classified as Class 2. Class 2 TCBs should, there­fore, typically be smaller and non-complex branches that do not pose a significant risk to financial stability. Qualifying TCBs will always fall within the Class 2 categorisa­tion. 

A TCB will be required to obtain an authorisation in the Member State where it is established. Unlike an EU passport, the authorisation of a TCB will be limited to the Member State where it is established. In other words, TCBs authorised in one Member State will be prohibited from offering or conducting its activities in other Member States on a cross-border basis, except for intragroup funding transactions concluded with other TCBs of the same head undertaking and for transactions entered into on a reverse solicitation basis.

TCBs will be subject to the minimum regulatory requirements set out in Articles 48e to Article 48i. These requirements include:

• A minimum capital endowment of 2.5 % of the TCB’s average liabilities for Class 1 TCBs and 0.5 % for Class 2 TCBs. The requirement is to be fulfilled with cash, cash assimilated instruments or debt securities;
• Minimum liquidity requirements which will require TCBs to maintain unen­cumbered and liquid assets sufficient to cover liquidity outflows over a minimum period of 30 days. Class 1 TCBs will need to comply with the Liqui­dity Coverage Ratio (LCR);
• Appointing a minimum of two persons in the relevant Member State who effectively direct the business activities of the TCB and who are fit and proper;
• Compliance with the internal governance, remuneration and risk management function requirements applicable to credit institutions, with stricter require­ments for Class 1 TCBs;
• Implementation of reporting lines to the management body of the head office;
• Proper management and monitoring of their outsourcing arrangements;
• Ensuring adequate resources to identify and properly manage their counterparty credit risk if TCBs engage in back-to-back intragroup transactions;
• Conclusion of an SLA where the head office provides critical or important functions for the TCB;
• Maintaining a “registry book” enabling TCBs to track and keep a comprehensive record of all assets and liabilities booked or originated by the TCB in a Member State and managing these assets autonomously. Whether this requires that all transactions that have been initiated by the TCB will also have to be booked in the branch, is not entirely clear. The EBA may shed some light on this aspect since it has been mandated to develop regulatory technical standards to specify the TCB booking arrangements.
• Maintaining policies on booking arrangements. 

NCAs may waive the liquidity requirement and certain reporting requirements for Qualifying TCBs.

While the above requirements would apply equally to all TCBs in the EEA, Member States may apply to TCBs the same requirements that apply to credit institutions instead of the specific TCB requirements (cf. Article 48a (3a)). For TCBs in Germany and other jurisdictions that already treat TCBs like credit institutions, most of the requirements set out above should therefore have only limited impact.

NCAs shall have an explicit power to require on a case-by-case basis that TCBs are converted into a subsidiary and apply for an authorisation as a credit institution at a minimum where one of the following cases applies (cf. Article 48j):

• The TCB has engaged in the past or is currently engaged in the performance of prohibited cross-border services; 
• The TCB is considered as systemically important 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 TCBs in the Union which belong to the same third country group is equal to or higher than EUR 40 billion; or
• The amount of the TCB’s assets on their book in the Member State where it is established is equal to or higher than EUR 10 billion.

However, with respect to the latter two alternatives, NCAs shall take additionally into account whether the TCB may be regarded as systemically important before requiring a third country firm to establish a subsidiary. The criteria to be considered include, among others, the size of the TCB, the complexity of its structure and business model and its degree of interconnectedness within the EU. As such, exceeding the EUR 40 or 10 billion thresholds will not automatically result in the requirement to establish a subsidiary, especially not if the TCB is located in a larger Member State such as Germany or France where a balance sheet of EUR 10 billion generally should not result in a qualification as ‘systemically important’. 

Furthermore, the above-mentioned asset threshold of EUR 40 billion shall not include the assets held by the TCB in connection with the central bank market operations entered into with ESCB central banks (i.e. the ECB, German Central Bank, Banque de France, etc.).  In other words, this exclusion ensures that deposits held with central banks shall per se not be taken into account when assessing whether a TCB qualifies as systemically important.