European Union: The New EU Law On Intermediate Holding Companies For Third-Country Banking Groups

Non-EU banking groups ("non-EU groups") with large EU operations will be required to establish an EU intermediate parent undertaking ("IPU") according to the final changes to the Capital Requirements Directive ("CRD 5") package.1 CRD 5 will enter into force 20 days after it is published in the Official Journal of the European Union, which is likely to be in Q2 this year, and will apply 18 months thereafter. The new rules are similar to U.S. Federal Reserve requirements for certain non-U.S. banking organizations to establish an intermediate holding company ("IHC") in the United States. Non-EU groups will need to hold EU bank and investment firm subsidiaries through one, or at the most, two EU IPUs. Each EU IPU will be subject to capital, liquidity, leverage and other prudential standards on a consolidated basis.

This note discusses the key obligations and impacts for non-EU groups and their restructuring plans, with a particular reference to U.S. and U.K. groups. We also discuss the potential interactions between Brexit and these new requirements for U.K. sub-groups.

The final text of the IPU rules differs substantively from the original proposals published by the European Commission in November 2016.2 Four significant, and welcome, changes it introduces are:

  • The new exception3 to the single IPU requirement, allowing the possibility for a non-EU group to establish two IPUs where:

    • having a single IPU would be incompatible with a mandatory requirement for separation of activities according to the laws of the third country or rules of the third-country supervisory authority; or
    • resolvability would be 'less efficient' than if there were two IPUs, according to the relevant EU resolution authority's assessment.
  • Change to the scope of the requirements as G-SIBs are no longer automatically in scope.
  • Changes to the threshold, which has been increased from €30 billion to €40 billion of assets in the EU; and
  • Deferral of the compliance date for existing non-EU groups. Non-EU groups already operating in the EU will have three years from the date that CRD 5 applies to establish their IPU structures. The Commission had proposed two years. CRD 5 will apply 18 months after it enters into force. The uncertainty around the timing of Brexit muddies this provision—we discuss this in more detail below.

Large non-EU headquartered financial groups will need to analyze how to comply with the new EU IPU requirements—in particular, any new governance or other prudential requirements—and remain in compliance with their home country's rules. Such groups will also need to consider how to structure their operations, including evaluating whether only one EU subsidiary is needed. For some groups, it may be easier to change the scope of their activities or reduce their balance sheets in the EU to ensure that they fall below the relevant threshold such that the new IPU rules do not apply to them.

According to the Commission, the EU IPU rule is intended to ensure that the EU operations of non-EU groups are sufficiently capitalized so, if the group fails, there is enough capital locally to absorb the losses of the group's European operations. It also fills a gap by providing the Single Resolution Board with the requisite resolution supervisory tools for those firms established in the Eurozone. However, it is widely regarded as retaliation to the Federal Reserve's requirement for non-U.S. banking organizations above a certain asset threshold to establish a U.S. IHC. That U.S. requirement resulted in many large EU-headquartered banks undertaking major restructurings at significant cost to maintain (non-branch) access to the U.S. market. The Federal Reserve's IHC rule was widely viewed as addressing the capital position of large U.S. broker-dealer subsidiaries of non-U.S. banks because such broker-dealers were not otherwise subject to a risk-based and leverage capital regime administered by U.S. prudential banking regulators. By contrast, the large EU broker-dealer subsidiaries of U.S. bank holding companies are currently subject to Basel-based capital requirements and so the same rationale for the EU rule, whilst asserted, is elusive. Moreover, the Federal Reserve's rule may be revisited in its anticipated rulemaking to apply tailored legislation to non-U.S. banking organizations.

The EU IPU Requirement

Where a non-EU group has two or more banks or investment firms established in the EU, it would need to set up an intermediate EU parent undertaking above those entities. A non-EU group is one that has at least one subsidiary EU bank or large EU investment firm in its group and the parent entity is established in a non-EU country.

Non-EU groups within scope of the EU IPU rules are those that have a total value of assets of more than €40 billion in the EU. The threshold is higher than the €30 billion originally proposed by the European Commission. However, it is still lower than the U.S.'s equivalent $50 billion threshold. The total value of assets for purposes of the EU test takes into account: (i) the assets of the group's EU bank and investment firm subsidiaries; and (ii) its EU bank and investment firm branches (even though branch assets are not required to be moved into the EU IPU). This is in contrast to the U.S. IHC rule, which looks only at U.S. non-branch assets because only non-branch assets are subject to being placed under the U.S. IHC.

Each EU IPU would need to obtain authorization as either a bank under CRD 5, or alternatively be approved as a financial holding company under related new provisions bringing financial holding companies directly within the scope of the EU prudential regulation regime.[4] The IPU may alternatively also itself be an investment firm authorized under the Markets in Financial Instruments Directive ("MiFID II") and subject to the Bank Recovery and Resolution Directive if either: (i) none of the third-country group's EU entities is a bank; or (ii) it has to be an investment firm to comply with a third country's mandatory separation requirements. Regardless of the type of entity, this will trigger an authorization process for the EU IPU which will become subject to the direct supervision of the relevant national regulator or the European Central Bank (if the IPU is established in the Eurozone).

The amendments allowing two IPUs will be welcomed by U.S. groups that have separate bank and non-bank sub-groups and that must comply with U.S. restrictions on the activities that each can undertake. This change will also allow U.K. banking groups to comply with the new U.K. ring-fencing rules once the U.K. has left the EU.

The diagrams below illustrate at a high level the structures that will or will not be permitted under the EU IPU rules.

Examples of permitted structures

Timing and Brexit

CRD 5 includes a transitional provision for non-EU groups that already have large EU operations on the date that CRD 5 enters into force.5 These groups will have three years from the date that CRD 5 becomes applicable to establish an EU IPU.6 This transitional provision is relevant to the timing of Brexit because the requirement to establish an EU IPU will only become applicable after the U.K. is scheduled to leave the EU, either in a "no deal" scenario or if an agreement is reached. If Brexit is delayed, this situation may change, depending on the extent of the delay.

Issues for Non-EU Groups (excluding UK Groups)

Where the U.K. has left the EU by the time CRD 5 applies, the U.K. subsidiaries of a non-EU group will not need to be taken into account to determine whether the group is within scope of the IPU requirements. Likewise, the U.K. branches of a non-EU group will be irrelevant for the threshold calculation. In the event that Brexit is delayed and the U.K. is still an EU Member State when CRD 5 enters into force, then U.K. subsidiaries and branches would need to be factored in, but only for such time as the U.K. remains an EU Member State. In the delay scenario, to avoid a situation where a group would only be within scope of the EU IPU rules until the U.K. leaves the EU, non-EU groups would be reliant on the Commission or individual EU Member States passing legislation allowing their U.K. entities to be ignored for these purposes for the interim period.

Issues for UK Groups

Once the U.K. leaves the EU, U.K. groups fulfilling all the EU IPU conditions would be in-scope and would need to set up an EU IPU. In the event of a no deal or an agreed Brexit, the transitional provisions would apply to these groups, giving them time to structure themselves appropriately. However, if there is a Brexit delay, it is unclear whether the transitional provisions would apply to U.K. groups, although one would hope that they would to avoid uncertainty and risks to financial stability.

Non-UK Groups and UK Legislation Post-Brexit

The U.K. has prepared draft legislation7 that would give HM Treasury, in a no deal scenario, powers to implement and make amendments to a specified list of financial services "in flight" legislation. This refers to EU financial services legislation that is out of scope of the European Union (Withdrawal) Act 2018 because it will not be "operative" before exit day. Only legislation with an implementation date falling in the two years after the U.K.'s exit is covered. CRD 5 is within scope of this draft legislation. However, to our knowledge, the EU IPU requirements are not part of the U.K.'s financial services policy.

Possible Future EU Amendments

The European Commission is required, within a set number of years of CRD 5 becoming applicable, to review the EU IPU rules and report on whether the rules reflect "best international practices." This will likely include comparisons with the U.S. IHC rules and a consideration of the post-Brexit environment.

EU Bank Branches of Third-Country Groups

The new EU IPU obligation does not require subsidiarization of the EU operations of non-EU groups that are conducted through EU branch offices. The ECB advocated the extension of the requirements to third-country branches regardless of whether a non-EU group operates in the EU partially or exclusively through branches and called for existing branches exceeding a certain threshold to be reestablished as branches of the IPU.8 The ECB's extension proposals were not adopted. However, the final text does require, within two years of CRD 5 entering into force, the European Banking Authority to report to the European legislative bodies on the treatment of third-country branches under relevant national laws of member states. The report must consider the extent to which those national laws differ across the EU, whether any such difference opens the door for regulatory arbitrage and whether it would be appropriate to introduce further harmonization, in particular, on the treatment of significant third-country branches.

Use of Two IPUs and the US Bank/Non-Bank Issue

Large U.S. bank holding companies operate in the EU through direct branch offices of their home country subsidiary FDIC-insured banks as well as through locally incorporated bank subsidiaries of those banks and, importantly, through broker-dealer subsidiaries that are often (but not always) owned by the bank holding company through a corporate chain separate from the FDIC-insured bank. There are strict limitations on transactions (including loans and other funding transactions) between the FDIC-insured bank (and its subsidiaries) on the one hand and its bank holding company parent and sister companies on the other. There are also limits on the securities underwriting and dealing activities of a broker-dealer subsidiary of a U.S. bank, which can make it impractical or difficult to operate a large broker-dealer as a direct or indirect subsidiary of a U.S. bank. Thus, the largest U.S. bank holding companies operate their large U.S. broker-dealer subsidiaries as sister companies of their FDIC-insured banks and often do the same with their non-U.S. broker-dealer subsidiaries.

Moreover, the swap push-out provisions of the Dodd-Frank Act (as amended) prohibit U.S. banks (and their subsidiaries) from engaging in certain types of structured finance swap transactions. It is to be expected that U.S. institutions subject to these requirements will be able to establish two IPUs, one for the bank chain and another for the non-bank chain.

Comparison Between the US IHC Rules for Foreign Banking Organizations ("FBOs") and the EU IPU Rules

This table sets out the main differences and similarities between the existing U.S. IHC rules for FBOs and the incoming EU's IPU rules.

U.S. IHC RULES FOR FBOS EU IPU RULES FOR THIRD-COUNTRY BANKING GROUPS
Scope Despite different capital requirements regimes in the U.S. for banks and broker-dealers ("b-ds"), the U.S. IHC rules for FBOs brought some b ds into the bank capital rules by making the IHCs subject to bank capital rules on a consolidated basis and requiring the b-ds entities to become subsidiaries of such IHCs (which increased costs). Applies to non-EU banking groups with two or more banks or investment firms established in the EU.
Threshold U.S. non-branch or agency assets of US$50 bn or more. It is possible that this threshold may be raised in light of other recent increases in prudential thresholds in the United States. A non-EU group that has two or more banks or investment firms established in the EU and that has total EU assets of at least €40 bn (bank and investment firm subsidiaries and branches).
Applicable to all foreign G-SIIs No, not automatic. No, not automatic.
Single IHC/IPU requirement Yes, subject to certain exceptions. Yes, subject to an exception allowing for two IPUs where a third-country's laws require this (see exceptions).
Form of IHC/IPU An IHC is typically a U.S. corporation or limited liability company. No particular form is mandated, but an IHC must be governed by a board of directors or managers that has rights, powers, duties, etc. similar to those of a company chartered as a corporation under U.S. law. No particular financial activity license is required but often is a financial holding company (FHC) under U.S. law. The IPU must be either an EU authorized bank or an approved financial holding company or mixed financial holding company. A derogation allows for the IPU to be an investment firm authorized under MiFID II where: (i) none of the EU entities are banks; or (ii) two IPUs are allowed and the second IPU needs to be an investment firm to comply with the ultimate parent's home country laws.
Ownership interests / transfer requirements Yes. Ownership interests in virtually all U.S. bank and non-bank subsidiaries must be transferred to the U.S. IHC. U.S. branch and agency offices of non-U.S. banks do not need to be transferred, rolled up or otherwise "subsidiarized." All bank and investment firm subsidiaries must be owned by the new EU IPU. There is no subsidiarization, transfer or roll-up requirement for EU branches of non-EU banking groups.
Exceptions U.S. Federal Reserve may allow alternative ownership structures if applicable home-country law prohibits the FBO from controlling its U.S. subsidiaries through a single IHC or where the activities, scope of operations or structure of the U.S. subsidiaries justify an alternative structure. Limited availability.[9]  National regulators may allow two IPUs to be established where a single IPU would be "incompatible with a mandatory requirement in accordance with the rules of the third country where the ultimate parent undertaking of the third country group has its head office." More commonly expected.
Other requirements A U.S. IHC must comply with U.S. Basel III leverage capital requirements, capital planning, stress testing, liquidity requirements and risk management requirements, such as establishing a risk committee. Dependent on whether the EU IPU is authorized as: (i) a bank; (ii) an investment firm; or (iii) a financial holding company.

Footnotes

1 The text of CRD 5 was agreed between the European Parliament and the Council of the European Union on February 15, 2019. This client note is based on that version of CRD 5 as amended by the text of the new Investment Firm Directive, which was agreed between the two legislative bodies on March 19, 2019 (and which confirms that change to the definition of "institution" in the Capital Requirements Regulation will not affect the scope of the EU IPU requirements). There may be minor drafting changes as the text is vetted by technicians and translated prior to its publication, but the legal position should be unaffected by this.

2 On November 23, 2016, the European Commission published legislative proposals to amend the Capital Requirements Directive and the Capital Requirements Regulation as well as other key pieces of EU banking legislation.

3 This derogation was suggested by the ECB in its Opinion on amendments to the Union framework for capital requirements of credit institutions and investment firms (CON/2017/46), OJ C 34, 31.1.2018, p. 5.

4 New Article 21a, CRD.

5 CRD 5 enters into force 20 days after it is published in the Official Journal of the European Union.

6 CRD 5 will enter into force 20 days after it has been published in the Official Journal of the European Union. The European Commission had proposed a delay of two years after the revised CRD entered into force. However, according to HM Treasury, the U.K. government succeeded in securing an extension to that deadline. See the letter from HM Treasury to the head of the European Scrutiny Committee.

7 At the time of writing the draft Financial Services (Implementation of Legislation) Bill is being considered by the U.K. Parliament and the provisions are therefore subject to change. The progress of the Bill can be tracked here. HM Treasury published a Policy Note explaining the purpose of the Bill.

8 ECB Opinion on amendments to the Union framework for capital requirements of credit institutions and investment firms (CON/2017/46), OJ C 34, 31.1.2018, p. 5.

9 On February 14, 2018, the U.S. Board of Governors of the Federal Reserve System used its authority for the first time and approved the establishment by Deutsche Bank AG of a second U.S. IHC to hold its asset management business pursuant to Regulation YY. You may like to view details of the approval.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Similar Articles
Relevancy Powered by MondaqAI
Morrison & Foerster LLP
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Morrison & Foerster LLP
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Mondaq Free Registration
Gain access to Mondaq global archive of over 375,000 articles covering 200 countries with a personalised News Alert and automatic login on this device.
Mondaq News Alert (some suggested topics and region)
Select Topics
Registration (please scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions