The intermediary parent undertaking: Only a minor aspect of the draft RIG?

At the end of April 2020, the Federal Ministry of Finance (BMF) opened a consultation on a draft bill for a law to reduce risks and strengthen proportionality in the banking sector (RIG-E). The act would implement the so-called EU banking package and is intended to strengthen the capital and liquidity requirements for banks in line with international standards, in order to reduce risks. It would also implement an international standard on Total Loss-Absorbing Capacity (TLAC) and strengthen the principle of proportionality for small and medium-sized banks.

The RIG-E also provides, in a new Section 2g KWG, for the establishment of a joint EU Intermediate Parent Undertaking (IPU). This would become necessary if the registered office of a parent undertaking is outside the European Economic Area (EEA) and the parent undertaking has not less than two subsidiaries in the EEA which are CRR institutions. This will only be relevant if the total asset value within the EEA of the third-country group, including third-country branches, exceeds EUR 40 billion. Section 2g KWG-E is to implement Art. 21b CRD V. The background to the provision is that the European legislator wanted to ensure that multiple CRR institutions, including investment firms, are consolidated within the EEA. Third-country branches would however not be included in the consolidation.

Investment firms are only eligible as IPUs if the group consolidated in the EEA does not include credit institutions.

This seemingly bureaucratic provision on setting up an IPU has drastic consequences for the companies concerned. Shareholdings in the CRR institutions must either (a) be grouped under one of those institutions, which would then also have to qualify as a financial holding company, or (b) a separate financial holding company, domiciled in the EEA, would have to be established to hold the shareholdings. If a financial holding company needs to be created, it would need to be "approved" in accordance with Section 2f KWG-E, i.e. it would need to undergo an approval procedure similar to the license procedure under Section 32 KWG. RIG-E provides a transitional provision in this respect in Section 64a KWG-E. However, Section 64a KWG-E not only provides an ambitious timetable, it also contains an unsuitable relevant date: it would make sense to set the relevant date for calculating the threshold value at a point in time immediately after the Act enters into force (instead of retroactively to 27 June 2019). Furthermore, it is completely unclear whether companies and assets in the United Kingdom should still be included in the calculation of the balance sheet total of a group in the EEA. Institutions which had activities in the UK on the proposed relevant date, but which do not reach the relevant thresholds within the EEA as it is after Brexit, would be subject to a particularly heavy burden. If this intentional, the legislator should at least have to justify this additional burden.

Institutions with parent companies in the USA, Japan and Switzerland are particularly affected, as institutions from these countries have the highest number of relevant units in the EEA. If no agreement is reached between the European Union and the UK in the Brexit negotiations, parent companies domiciled in the UK will have to comply with the same requirements as other third-country parent companies.

The number of parent companies concerned is likely to be limited due to the de minimis clause. In the EEA it is currently estimated that around 20 parent companies would be affected.

The practical consequences:

Firstly, the right location must be found for the IPU; this is similar to the site selection for Brexit relocation projects.

The next question to be asked is how the transfer should be carried out, taking into account legal, accounting and tax considerations, and/or whether units can be further amalgamated, for example by merging and creating branches.

The Japanese cases are particularly interesting because Japanese supervisory law still separates commercial banking from dealing in financial instruments under the Financial Instruments and Exchange Act (1948); a merger of these differing business areas would be incompatible. Although the wording of Section 2g KWG-E takes this separation into account, it is still unclear how the preferential provision is to be applied in practice and how coordination between the relevant supervisory authorities is to take place.

In addition, in the case of share transfers, the relevant national ownership control procedure must be followed, including the involvement of the ECB. Anyone who has ever had to follow such a procedure, for example under Section 2c of the German Banking Act (KWG), knows the time and resource requirements entailed. The RIG-E does not provide for any simplifications in this respect, although they would be appropriate. This is because all the companies to be consolidated would already have been subject to owner control at the formation stage, and the ongoing supervision of these institutions ensures that such control is maintained.

Possibly, the exemption under Sect. 16 par. 2 of the Ownership Control Ordinance (InhKontrV) could be activated and provide a remedy; BaFin, the German National Competent Authority, would be the responsible law maker for any amendment of the InhKontrV.

How is this IPU approach to be assessed overall?

Section 2g KWG-E must be viewed in the international context of “ring-fencing”, i.e. the desire to segregate certain business areas in various regards, such as resolution, or capital and liquidity resources.

The advantage from the point of view of European supervision is clear: it will be easier for the Single Supervisory Mechanism (SSM) and the Single Resolution Mechanism (SRM) to monitor a group of companies that is confined to Europe under company law and - in times of crisis - to resolve it more easily. What is striking but consistent here is that third-country branches are not included in the IPU regime, with the consequence that these branches would not have to be consolidated in the EEA. As a consequence, the ring-fencing remains incomplete. It remains to be seen whether the large third-country branches, such as those maintained in particular by institutions from Japan, China and South Korea, will be included in a ring-fence in a further legislative step.

The Dodd – Frank Act (2010) including Regulation YY (2014) was the American model for the European law maker. To master the European framework, the US practice for Dodd – Frank will be helpful and instructing.

The European approach is part of the trend towards de-globalisation, which aims to strengthen host state supervision. In this context, the largely harmonised EEA would be seen as an association of host states which, through subsidiarity, can counteract the trend described above. Nevertheless, even if the IPU could improve European supervision, the measure must be seen as a step backwards compared to the global standardization of supervision started in the 1970s.

Germany has not imposed a legal obligation to transfer shareholdings except for during the war and in the immediate post-war period. Could welcome further harmonization and the pursuit of an improved European market lead us to seal ourselves off from the rest of the (third-country) banking world? Serious legal literature claims to recognize the danger of “Balkanisation in Banking”.

The fact that this is hardly ever discussed in Germany may be due to the fact that only an indirect effect can be expected here. Nevertheless, it would be wrong to treat the IPU requirement as only an afterthought. Rather Ovid's ironic words, used pathetically far too often, are once again in demand: "(...) Principiis obsta! Sero medicina parata (...)" (Fend off the beginnings! Otherwise medicine will come too late).

This acticle was published in German language in Börsenzeitung, June 20, 2020: "Neue Hürden für Auslandsbanken"
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