Intermediate EU Parent Undertaking Requirement for non-EU G-SIBs

Introduction

On 23 November 2016, the European Commission published a package of proposals amending the Capital Requirements Directive and associated Regulation (CRD and CRR, together CRD 4), the Bank Recovery and Resolution Directive (BRRD) and the Single Resolution Mechanism (SRM) Regulation. The proposal aims at implementing global standards by the Financial Stability Board (FSB) and the Basel Committee on Banking Supervision (BCBS). According to the Commission, the requirement to set up an intermediate EU parent undertaking (EUPU) is intended to facilitate resolution proceedings. We think that this requirement can also be understood  as a response to the US requirement for an intermediate holding company (IHC) applying to US operations of non-US banks with more than USD 50bn of assets.

Scope of application

The proposal requires that non-EU globally systemically important banks (G-SIBs) which have two or more subsidiaries in the EU that qualify as credit institutions or investment firms must establish an EUPU. By contrast branches of non-EU credit institutions or investment firms will not be subject to and will not trigger this requirement.

The European Commission does not determine which banking groups or banks are qualified as G-SIBs. The requirement refers to the banks or banking groups included in the list of G-SIBs published by the FSB.

Impact

Reorganization of EU banking and investment activities

Non-EU G-SIBs must reorganize their European operations. They have to relocate their EU subsidiaries within their group structure so that one of them becomes the parent company of the other European institution(s) and thus qualifies as an EUPU. Alternatively, a new EUPU has to be established at the top of the corporate chain of undertakings in the EU.

The establishment of a new EUPU would require an authorization procedure. Under the current regime, an authorization procedure is only required for credit institutions and investment firms, but nor for (mixed) financial holding companies. However, an authorization requirement applying to (mixed) financial holding companies is also intended to be introduced through the proposal of the European Commission. The current proposal does not allow investment firms to act as EUPU as it does not explicitly include institutions which have obtained an authorization in accordance with Art. 5 MiFID. One might argue that this was a drafting error. However, since the ECB competences for supervision on a single entity level extend to credit institutions and (mixed) financial holding companies but not to investment firms, the exclusion of investment firms might also be intentional.

Consolidation

The introduction of an EUPU will trigger the regulatory consolidation of the European subsidiaries of non-EU GSIBs. This means that the EUPU or one of its EU subsidiaries will have to consolidate the entire EU subgroup (including its non-EU subsidiaries). This will, inter alia, include the consolidation for their own funds requirements, large exposure limits, liquidity requirements, leverage ratio, disclosure under Pillar 3, financial reporting or Pillar 2 requirements.

Recovery and resolution

Recovery and resolution planning would have to be undertaken at the level of the EUPU for the entire EU subgroup. Under the Commission’s proposal, TLAC (total loss absorbing capacity) and MREL (minimum requirement for own funds and eligible liabilities) would have to be held at the consolidated level of the EUPU for the entire resolution group. The Commission’s proposal defines resolution group as a resolution entity and its subsidiaries that are not resolution entities themselves and that are not subsidiaries of another resolution entity. The proposal furthermore requires resolution authorities, inter alia, to identify the resolution entities and resolution groups within a financial group and to consider appropriately the implications of any planned resolution action within the group to ensure an effective group resolution.

Requirements on an individual basis

In principle, all regulatory requirements would have to be complied with at single-entity level (individual basis) of the institutions and, additionally, on the consolidated basis of the EUPU. This would significantly increase the regulatory burden for the European operations of non-EU GSIBs.  Certain requirements such as recovery and resolution planning would by contrast not be applicable on an individual basis, but only on the consolidated basis of the EUPU. The same applies to disclosure requirements under Pillar 3 of the Basel Framework which would require compliance only on the consolidated level of the EUPU.

Competent authorities

If the EUPU is established (i) within the Eurozone or (ii) as a financial holding having its largest subsidiary in the Eurozone it may become subject to direct supervision by the European Central Bank (ECB), eg, (i) if the consolidated value of its assets exceeds EUR 30bn or (ii) if the EUPU was a financial holding company with credit institutions as subsidiaries in two Eurozone states and the cross-border activities exceed 20% of the consolidated balance sheet. In addition to this, the Single Resolution Board (SRB) may become the resolution authority.

Brexit

Following Brexit, the situation may become more complex if the UK ceases to be an EU Member State or EEA state and no other “soft Brexit” agreement is negotiated. Credit institutions or (mixed) financial holding companies located in the UK may possibly no longer be regarded as EUPUs. If the UK were no longer part of the EU, British G-SIBs would also have to be qualified as non-EU G-SIBs and therefore may be required to set up an EUPU in one of the continuing EU Member States.

Heinrich Nemeczek is a Research Fellow at the University of Mannheim (Germany). Sebastian Pitz is an Attorney-of-Law at Freshfields Bruckhaus Deringer LLP in Frankfurt am Main (Germany) in the field of banking regulation.