CRD VI and the New EU Third-Country Branch Regime: Harmonization Means Restricted Access
In Short
The Situation: The European Union ("EU") banking legislation has been substantially reviewed and provides notably for a new regime applicable to cross-border activities from non-EU jurisdictions.
The Result: Third-country firms will have to set up branches in the EU, which will be subject to organizational and prudential requirements, in addition to enforcement actions from EU regulators.
Looking Ahead: Even if reverse solicitation is still applicable toward EU customers, non-EU financial institutions will have to carefully review and monitor their business in the EU to consider the necessity to set up an EU branch. This will enter into force on January 11, 2027.
Existing European banking regulation, essentially provided for in Directive 2013/36/EU (and Regulation (EU) n°575/2013 for prudential aspects), did not exhaustively address the extent to which core banking services will be provided from a third country (i.e., a non-EU Member State). It was left, to a certain extent, to each Member State to consider any specific local regime of exemption for those services provided on a cross-border basis.
This lack of harmonization has been considered detrimental to the proper functioning of the European capital market and led to Directive (EU) 2024/1619 of May 2024 ("CRD VI"), which amended Directive 2013/36/EU as regards supervisory powers, sanctions, third-country branches, and environmental, social, and governance risks. It has now been mandated that any institution willing to offer core banking services within the EU shall set up a branch within the Member State where it wishes to offer its services and be specifically authorized.
This means, potentially, the abrogation of any local existing regime of exemption that could benefit a third-country institution when offering core banking services to European clients.
The new regime sets forth (i) in a new article 21.c the conditions under which a branch has to be set up and authorized in an EU Member State; and (ii) in new Title VI prudential rules to be complied with by such branches.
When Must a Branch Be Set Up in the EU?
The new regime applies to the provision on deposit-taking and financing transactions (including guarantees and commitments) for customers within the EU. However, these activities, when relating to financial services and as listed in Annex I Section A of Directive 2014/65/EU on markets in financial instruments, are not covered.
This obligation does not apply where the covered services are offered to a client within the EU at its own and exclusive initiative, but do apply if the client is solicited by an agent acting on behalf of that third-country institution.
No European passporting will be acknowledged to such branches.
Third-country branches will be classified as class 1 if (i) assets booked or originated locally exceed EUR 5 billion; and (ii) it receives deposits exceeding EUR 50 million, or which amount exceeds 5% of the total local liabilities. Otherwise, it will be classified as class 2. However, some class 2 country branches will also classify as a qualifying third-country branch (with reduced liquidity and reporting obligations).
Minimum Conditions for Being Authorized
Once the competent local authority has entered into arrangements with the relevant third-country authority supervising the institution willing to establish a branch in the EU, an authorization may only be granted if the following conditions are met:
- Maintenance of a minimum capital endowment of (i) 2.5% of class 1 branch average liabilities or (ii) 0.5% of class 2 branch average liabilities; such capital may be constituted with cash or liquid instruments, governmental bonds, or immediate and unrestricted other instruments, and shall be held in escrow with a local credit institution;
- Maintenance at all times of encumbered and liquid assets to cover liquidity outflows over a minimum period of 30 days;
- Appropriate governance (two individuals directing the business and certain key functions in place) and risk management on place (reporting line to management of head office, management of outsourcing arrangements, monitoring of intra-group risk exposure), with a third party assessing on a regular basis compliance with these requirements; and
- Booking for tracking purposes of all assets and liabilities originated (or solely booked) at branch level.
Some reporting must also be made to the relevant local authority in respect of regulatory and financial information relating to the branch, but also to the head undertaking. This will notably enable local authorities reviewing and evaluating the financial and prudential situation of the branch (supervisory review and evaluation process).
Should the branch be of a systemic importance, local competent authorities may require the head office to apply for a proper authorization of a subsidiary.
Specific Powers to Be Acknowledged to Local Authorities
Finally, local authorities shall be acknowledged of proper enforcement powers against such branches to require, notably: (i) compliance with CRD VI provisions and local laws applicable to them and (ii) that material risks are covered and managed in a sound and efficient manner. These powers may lead to require the holding of excess capital endowment, and meeting other specific liquidity requirements, to restrict or limit the scope of their business or of their counterparties, or to make specific public disclosures.
Three Key Takeaways
- Providing core banking services into the EU requires at least the setting up of a branch in the jurisdiction where targeted clients are, without benefitting, however, from any passport into other EU Member States.
- An authorization will have to be obtained from a relevant regulator with minimum capital endowment, sufficient liquid assets, and proper governance.
- Local authorities will enjoy wide powers to enforce any measure ensuring compliance with new applicable rules.
