The EU’s Banking Package nears the finishing line: third-country branches not out of the woods yet

Relevant to: Board members, executives, risk and finance leads, heads of legal entity structure.

At a glance:

• In March, the European Parliament and the Council of the European Union began finalising the EU’s flagship Banking Package via trilogue negotiations, which we expect to run until H2 2023.
• This is our third blog in a series analysing the implications of the Package and proposed revisions to the EU’s Capital Requirements Regulation and Directive (known as CRR3 and CRD6). Our first two blogs focused on the implementation of Basel standards and the new requirements for how banks manage ESG risks. This blog evaluates the proposed new rules regulating the provision of cross-border banking services into the EU and connected requirements for third‑country branches (TCBs).
• Cross-border services: the Commission’s original proposal amounted to an outright ban on the provision of cross-border services into the EU, requiring services to be conducted from a branch in the relevant Member State (MS), save in the case of “reverse solicitation”. The Council’s position maintains the status quo for banks entirely, unless a bank undertakes both deposit-taking and lending in a MS. The Parliament’s proposal sits in the middle, requiring banks to establish a TCB in each MS where they provide a range of core banking services unless the transaction is interbank, intragroup, interdealer[1], in respect of reverse solicitation or is exempt (see Table 1 below). Large Investment firms (deemed “class 1”) treated as credit institutions will be required to set up a TCB for underwriting and dealing on own account in a MS under all three texts.
• New requirements for TCBs: the Parliament proposes higher TCB capital endowments, but also a higher hurdle before giving MS the power to make TCBs subsidiarise. The Council removes this hurdle entirely and gives national competent authorities (NCAs) more discretion.
• Our overall assessment is that while there is likely to be some improvement (relative to the Commission’s original proposal) on third‑country banks’ ability to provide services into the EU on a cross-border basis, the costs of maintaining a TCB in the EU will rise, particularly if a TCB is deemed to be systemically important.
• Banks will have 18 months from adoption to prepare for most provisions in the legislation, and then either an additional 12 (Parliament) or 24 (Council) months to implement the new TCB requirements.

Part I – Background to the EU Banking Package

The Commission’s CRD6 proposal amounts to an outright ban on the provision of cross-border services from a third country into the EU, and would establish a uniform and onerous regulatory framework for TCBs. As we have flagged previously, if adopted these proposals would significantly alter the costs and benefits of doing business in the EU.

The Council agreed its General Approach (GA) in response to the Commission’s proposals on 8 November 2022². More recently, the European Parliament’s ECON Committee voted to adopt the Parliament’s proposed amendments to the Commission’s proposal, setting out its own position.

Interinstitutional negotiations (known as “trilogues”) began in early March 2023. We expect them to last until the second half of 2023, with legislators potentially adopting the final text by the end of the year.

Part II – Key Issues in CRD6 for provision of services into the EU

Cross-border services

• The Commission essentially proposes a ban on all cross-border CRD Annex I activities (including deposit‑taking, lending and FX, securities and derivatives trading), with the exception of business done via reverse solicitation. In contrast, the Council proposes largely retaining the status quo (although the combination of deposit‑taking and lending services rendered cross-border into the same MS would still need TCB authorisation as seen in the below section).
• The Parliament’s proposal sits in the middle. While it maintains the cross-border services ban, it introduces some important new exemptions in addition to reverse solicitation. These include transactions that are interbank, intragroup, interdealer or that would be a MiFID II service (MiFID II has its own regime for cross-border transactions, so this proposal would essentially maintain the status quo for transactions exclusively within its scope).

The table below summarises the differences between the three proposals in relation to cross-border activities that will trigger a TCB authorisation.

Table 1: Key activities that will require a TCB

TCB Authorisations

• The Commission’s proposal subjects new TCBs, as well as those 92 TCBs³already active within the EU, to fresh authorisation by the relevant NCA against a new set of harmonised requirements (discussed below) if they conduct any Annex I activities.
• The Council’s proposal limits the need for TCB authorisation to banks providing both deposit-taking AND lending activities in the same MS. In addition, under the Council’s proposal, NCAs may decide that the authorisations of TCBs granted two years before CRD6 has effect (so six months preceding its adoption) can remain valid provided they comply with the new minimum requirements (discussed below).
• The Parliament’s proposal rescopes this requirement to those carrying out any one of a smaller subset of “core banking” CRD Annex 1 activities (see Table 1).
• Large Investment firms (deemed “class 1”) treated as credit institutions are required to set up a TCB for underwriting and dealing on own account into a MS under all three proposals. However, in the same way as banks, they are allowed to provide “investment banking” Annex 1 activities (including non-own account trading) cross-border without a TCB under the Parliament’s proposal.

TCB Categorisation

• The Commission’s proposal creates two new “classes” of TCBs that are not judged to be systemically important. Class 1 TCBs are those with total assets greater than or equal to €5bn, or those taking retail deposits. All other TCBs would be Class 2. Both the Council and Parliament largely maintain this approach, although the former proposes that retail deposit‑takers should only become Class 1 when those deposits exceed 10% of the total liabilities of the TCB or €100mn.

New Requirements for TCBs

• TCB Capital: The Commission proposes that Class 1 TCBs should have a capital endowment equal to 1% of the TCB’s liabilities (subject to a minimum of €10mn), and Class 2 TCBs a fixed capital endowment of €5mn. The Council doubled the Class 1 endowment to 2%, and the Parliament tripled it to 3%. In addition, the Parliament sets the minimum capital endowment for Class 2 TCBs at 0.5% of the branch’s liabilities, with a minimum of €5mn.
• Other requirements: Amongst other requirements, all three proposals mandate TCBs to:
  • maintain sufficient liquid assets to cover liquidity outflows for a minimum of 30 days;
  • have at least two individuals subject to NCA approval directing the businesses within the MS; and
  • maintain a registry book enabling them to track all the assets and liabilities logged within the TCB for risk management information purposes.

TCB “Systemic Importance” class

• In addition to Class 1 and 2 TCBs, the Commission’s proposal introduces a new “systemic importance” assessment triggered when a TCB’s assets exceed €30bn4 . The MS would then evaluate the TCB via certain indicators (i.e size, interconnectedness, substitutability, and complexity of the TCB’s activities amongst others that will be developed by the EBA later). If a TCB is deemed systemically important under these indicators, MS may:
  • require the TCB to subsidiarise, or restructure so it ceases to be systemically important;
  • impose additional requirements, including Pillar 2 capital add-ons for both branches and subsidiaries;
  • defer imposing any additional requirements for a period of no more than 12 months, subject to the supervisor conducting a reassessment of the TCB’s systemic importance within the 12-month period.
• The Council’s proposal removes the €30bn trigger, so the powers can be used at any point, while the Parliament’s proposal increases the €30bn trigger to €40bn. This is potentially significant as only three TCBs exceeded the €30bn threshold as of end-2020 according to the EBA.

Part III – What do the differences between the Commission, Council and Parliament proposals mean for firms?

The outcome of trilogue negotiations will alter the costs and benefits of doing business in the EU via cross-border service provision. Banks taking deposits and lending cross-border into the same MS (as well as class 1 investment firms dealing on own account or underwriting cross-border) will need a TCB to do so under both the Council and Parliament’s proposals, while the latter would extend this requirement to a wider range of “core banking” Annex 1 activities.

Depending on the eventual rules, banks should consider how best to reorganise their EU‑wide operating structure. This may include evaluating the costs and benefits of setting up/expanding their existing TCBs in each MS (some of which will be more profitable than others), transferring business to an existing (or new) EU subsidiary able to passport across MS or ultimately ceasing business in that MS.

If the Parliament’s position on cross-border services prevails, banks intending to continue providing those non-exempt Annex I activities into a MS under the “reverse solicitation” exemption should ensure they have adequate policies, procedures and controls in place to ensure compliance.

We expect CRD6 to have a significant impact on EU TCBs, regardless of which approach is eventually taken. While the majority of TCBs held less than €1bn of assets (as of end-2020) and would fall well below Class 1’s €5bn threshold – there were 35 TCBs with assets exceeding €3bn. More significantly, half of the 106 TCBs are classed as universal banks (and could therefore take retail deposits) or retail banks. As a result, many TCBs will have to hold capital equivalent to either 2% or 3% of total liabilities depending on whether the Council’s or Parliament’s position prevails. This may mean that banks will need to sacrifice the efficiency and benefits of using TCBs and shrink branch balance sheets or transfer business to subsidiaries (14 third country banks have a TCB and subsidiary in the same MS).

At the very least, the three largest TCBs collectively accounting for almost €146bn in assets, may be judged “systemically important” and potentially being required to subsidiarise. If the Council’s position prevails, potentially all TCBs are in-scope depending on NCA discretion.

Part IV – Next steps

We expect trilogue negotiations on the Banking Package to run until the second half of 2023, and likely conclude before the end of the year. Both the Council and the Parliament’s proposals provide for an 18-month transposition period for CRD6. While most provisions will begin to apply one day after this period ends, the Council then prescribes an additional 24-month transitional period for application of the new TCB requirements vs 12 months proposed by the Parliament. Therefore, we expect the new authorisation requirements to apply between late 2025-2026. These dates create a relatively short implementation timeframe for third‑country banks to prepare for and comply with the new rules.

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Reference :

¹While the interdealer exemption is referred to in the recitals section of the Parliament’s text (and is therefore its intention), it is arguable whether the underlying legislative text has this effect, as it refers to “credit institutions” (banks) only. Whilst the term “dealer” is widely used commercially, there is some uncertainty around its legal scope including whether it includes MiFID regulated investment firms. If the final legislation excludes “interdealer” transactions, then we expect that it will need to define “dealer”.

²You can read our analysis here, comparing the GA with the Commission’s original proposal.

³Accurate as of June 2021.