Not Equivalent (Yet?): The Current EU Third Country Regime for Credit Institutions and Incoming Changes

Abstract

As part of the European Commission’s ‘Banking Package’, introducing a series of amendments to the key legal sources of EU banking regulation, a comprehensive proposal for the treatment of third country branches of credit institutions (i.e., branches of institutions licensed by non-EU jurisdictions seeking authorisation in an EU Member State) has been presented. If and when ultimately adopted, this new framework will, for the first time, harmonise the applicable authorisation procedures and substantive conditions for authorisation hitherto left exclusively to the discretion of EU Member States. Under the new regime, the equivalence of third country regulatory and supervisory approaches with EU banking regulation will play a role, albeit a limited one. While taking up, and refining, approaches that have been present in a range of Member States for some time already, the new framework will require others to fundamentally change their existing regimes. The new amendments will be of particular relevance for the future regulatory relationship between the United Kingdom and the European Union, since a bespoke arrangement for continuing access of UK financial intermediaries to the EU markets has not been achieved, and UK credit institutions wishing to continue to operate within the EU other than through legally separate and independently capitalised subsidiaries have to rely on authorisations as third country branches. Against this backdrop, the present paper presents a functional analysis of the incoming regime in light of experiences made with regard to the existing landscape of diverging national laws.

1 Introduction

In comparison with other subsectors of financial markets, where access to EU jurisdictions based on the concept of ‘equivalence’ has been a feature of European financial regulation for some time,¹ the regulatory treatment of branches of (non-EU) third country credit institutions (hereafter referred to as ‘third country branches’, or ‘TCBs’) clearly stands out. In comparison with the establishment of legally independent subsidiaries, the establishment of branches would often be the more attractive option, as it would come with substantially less costs, not just in organisational terms but also in order to avoid complex solvency requirements applicable to independently authorised subsidiaries that would otherwise tie up a substantial amount of capital not available to other parts of the third country institution. To date, the applicable regulatory framework, included in the Capital Requirements Directive (‘CRD IV’),² has been confined to extremely rudimentary requirements, leaving the admission of third country branches largely to the discretion of each particular Member State. While the authorisation of third country branches by individual Member States under this framework facilitates access only to one specific national market and does not cover the provision of services or the establishment of further branches in other Member States, the European Commission has been authorised to negotiate agreements with third countries governing market access to all EU national markets on the basis of reciprocity.³ Substantive conditions for market access and ongoing supervision and the procedural frameworks for the ongoing cooperation between host and home jurisdictions in this regard have remained largely unharmonised, however. This will change with the adoption of a Commission proposal for a reform of European banking regulation published in 2019,⁴ which anticipates the replacement of the existing regime with a comprehensive new framework for the treatment of third country branches within the EU.⁵

Notwithstanding this recent proposal, which is still in the legislative process, it is certainly peculiar that the current regime can, to a large extent, be traced to the very beginning of European harmonisation in the field of banking regulation, and has hardly been changed since its introduction in the First Banking Directive of 1977.⁶ Both against the backdrop of equivalence regimes for other sectors and in view of the potential adverse implications of the presence and activities of non-EU banking institutions within the internal market, which will be discussed in more detail below, the reasons for this long-term legislative diffidence—and the apparent indifference as to these implications—are difficult to determine. During the early stages of the harmonisation of European financial regulation in the 1970s, the absence of more detailed provisions, not uncontroversially, appears to have been justified on the grounds of subsidiarity: in view of the limited geographical dimension of activities of third country branches within the then European Economic Community, the Member States rather than the European legislator were considered to be best placed to regulate market access and ongoing supervision.⁷ Whether or not this justification reflected genuine motives remains a matter of speculation, of course, and it is at least conceivable that aspects of subsidiarity may have conveniently lent authority to at least some Member States’ preference to keep in place existing, and beneficial, idiosyncratic arrangements with third country jurisdictions that otherwise might have been impaired by incoming European harmonisation. Be that as it may—during the political negotiations in relation to the Second Banking Directive of 1989, the need for a more detailed third country regime was taken up again, but the final version of that Directive left things unchanged and merely referred to the existing provisions established by the First Banking Directive of 1977,⁸ while the Commission undertook to further monitor the situation and, if deemed necessary, initiate further legislation in this regard.⁹ Given this state of affairs at the end of the 1980s, the fact that these provisions essentially remained untouched—throughout a series of comprehensive reforms of European banking regulation—until 2019¹⁰ appears all the more surprising.

One possible explanation, which is that the assumption that the economic dimension of the problem could be negligible, certainly has to be ruled out, at least on the basis of the most recent figures, according to which the role of TCBs has grown substantially in recent years: according to a report on the treatment of third country branches published by the European Banking Authority (‘EBA’) in 2021, a total number of no less than 106 TCBs, distributed across 17 Member States, were active within the EU as of 31 December 2020. The aggregate amount of total assets held by these TCBs was recorded to be EUR 510.23 bn, 86% of which being concentrated in only four Member States (Belgium, France, Germany and Luxembourg).¹¹ At the same time, the report, responding to a legislative mandate introduced in 2019,¹² also notes a significant increase of TCBs following the United Kingdom’s exit from the European Union, indicating that the problems associated with the presence of such branches have increased disproportionately in recent years. While the UK is not the largest source of third country branches within the UK, it nonetheless has jumped to the second rank in this regard post-Brexit.¹³ Brexit, in other words, illustrates at least why, after decades of legislative inactivity, the treatment of third country branches has finally, and abruptly, entered the limelight: with the separation of the UK from the EU, the existence of such branches has ceased to be a problem limited to individual Member States only—perhaps as far as the economic role of individual branches within the respective host market is concerned, but certainly (and probably more importantly) also from a political economy perspective. As will be discussed in more detail below, while bilateral arrangements between individual Member States and third country jurisdictions may have been an appropriate framework to facilitate limited market access on a case-by-case basis,¹⁴ they are unlikely to yield satisfactory solutions, acceptable across the internal market as a whole, in a landscape where the relationship between the EU and what used to be its most important financial market pre-Brexit has to be restructured comprehensively. So, whatever the reasons why the European legislator had been dormant for decades, Brexit and its impact on the regulatory relationship between the UK and the EU clearly has triggered (and, arguably, necessitated) a reorientation also with regard to the treatment of third country branches of credit institutions within the EU.

Against this backdrop, the present paper analyses the incoming regulatory regime, as anticipated by the 2021 Commission proposal¹⁵ on the basis of recommendations developed in the 2021 EBA Report,¹⁶ in the light of existing arrangements for third country branches of credit institutions and, to some extent, in comparison with the ‘equivalence’ regimes for other sub-sectors already in place. The remainder of the paper is organised as follows: Sect. 2 first presents an analysis of the current legal framework, in the form established in 1977 (as amended). Section 3 then moves to assess the incoming regime, starting with a functional analysis of the merits of, and challenges presented by, market access for third country branches to the internal market. Section 4 concludes.

2 The Status Quo: Legal Requirements for the Treatment of Third Country Branches in the CRD IV (and Its Predecessors)

2.1 The Legal Framework…

As noted before, the current legal framework for the treatment of third country branches in EU banking regulation was established as early as 1977, by Art. 9 of the First Banking Directive of 1977,¹⁷ which subsequently was incorporated, first, into the consolidated Banking Directive of 2012,¹⁸ then into the recast Banking Directive of 2006,¹⁹ and finally into Art. 47 of the CRD IV. Just as in 1977, Member States under this regime have been free to authorise the establishment of third country branches of credit institutions within their territory, and to define the conditions for market access autonomously. The only substantive restriction to be observed in this regard is the principle that host jurisdictions are not allowed to treat TCBs more favourably than branches of credit institutions domiciled and authorised by other EU Member States.²⁰ For all third country branches authorised in a Member State, Art. 47(1a) CRD IV (introduced in 2019)²¹ sets out a number of minimum reporting requirements to be imposed at least annually.²² Finally, Member States authorising third country branches to operate within their territory are required to notify the European Banking Authority (‘EBA’) of such authorisations, subsequent changes to the authorisation, the total assets and liabilities and the name of each TCB.²³ While Recital 23 of the CRD IV states that ‘rules governing branches of credit institutions having their head office in a third country should be analogous in all Member States’, conditions for market access and the legal arrangements for the ongoing supervision of the operation of TCBs within EU Member States have, to date, never been harmonised.

As an alternative to bilateral agreements between individual Member States and third country jurisdictions, the European Commission, ever since the First Banking Directive, has had the mandate to negotiate

agreements concluded with one or more third countries, … to apply provisions which accord to branches of a credit institution having its head office in a third country identical treatment throughout the territory of the Union.²⁴

Just as for bilateral arrangements, however, neither substantive requirements nor the applicable procedural framework were specified further.

2.2 … and How it Has Been Used

To date, comprehensive agreements between the EU and third countries that would have facilitated comprehensive market access for third country branches of credit institutions pursuant to Art. 47(3) CRD IV (and its predecessors)²⁵ have not materialised. Other than with regard to technical equivalence decisions pertaining to the recognition of third country supervisory regimes for the calculation of capital requirements for EU institutions under the CRR,²⁶ regulatory and supervisory arrangements in third country jurisdictions have not been considered at European level, and market access to third country branches of credit institutions has been decided exclusively at Member State level.

As far as the prudential (and procedural) conditions for authorisation are concerned, the general prohibition, in Art. 47(1) CRD IV, to treat TCBs more favourably than branches of EU institutions²⁷ can certainly be interpreted as realigning the relevant conditions with those applicable to EU branches (which are subject to the general CRD/CRR regime). Still, as documented by the EBA Report on the treatment of third country branches published in 2021, Member States have used their residual powers to broadly similar ends, but with substantial differences in both conceptual and technical terms. While all national approaches appear to be based, in one way or another, on the substantive framework for prudential regulation established by the CRD IV and CRR²⁸ regime, significant differences exist with regard to both the scope and the intensity of regulatory requirements applied.²⁹ The majority of Member States appear to treat third country branches as entities similar to subsidiaries, with solvency, liquidity and organisational requirements calibrated individually as if such branches were separate legal entities.³⁰ Other Member States emphasise the legal nature of branches as dependent entities and focus more on the respective third country institution.³¹ In a majority of Member States, third country branches have benefited from generous exemptions from, or reductions in, capital requirements,³² while, in particular, organisational requirements applied to them remain extremely heterogenous and, in general, far more flexible than in the case of subsidiaries.³³ While all Member States have required prior authorisation for the establishment of third country branches and have reached a high degree of convergence with regard to certain core authorisation requirements derived from the CRD IV/CRR regime (other than capital requirements),³⁴ differences exist, in particular, with regard to determinants outside the respective EU jurisdiction, e.g., the relevant institution’s position under the home country deposit guarantee regime³⁵ and the soundness of the relevant third country institution.³⁶ Moreover, differences have also been observed with regard to (a) determinants for the decision whether or not to open up the domestic market to third country branches in the first place,³⁷ (b) the host jurisdictions’ assessment of supervisory standards and practices in the relevant home jurisdictions (which are taken into account by the vast majority of Member States as determinants for the authorisation of TCBs),³⁸ and (c) the scope of authorised activities,³⁹ and in terms of the applicable supervisory approach and relevant regulatory framework for the ongoing supervision of TCB activities.⁴⁰

2.3 Preliminary Conclusions

While an in-depth assessment of the findings reported above would be outside the scope of the present paper (and, besides, to some extent redundant in view of the detailed analysis presented by the EBA Report), a few preliminary conclusions may nonetheless be drawn. It is not just obvious that the recognition of third country branches, to date, has remained a national rather than a European matter. As evidenced by diverging regulatory concepts and strategies, but also—and in particular—by different national approaches to the fundamental question whether, and for what reasons, to authorise TCBs in the first place,⁴¹ the provision of market access to third country branches reflects, at least in part, policy choices different from those governing the general framework for the licensing of new market participants or, indeed, the recognition of branches of EU institutions based on the authorisation granted by another Member State. Unlike with regard to newly established intermediaries or new branches of EU institutions under the ‘European passport’ regime, which requires mutual recognition of national bank licenses across the EU as a whole,⁴² third country branches will not necessarily be authorised automatically because they satisfy general prudential requirements, to a large extent harmonised under the CRD IV/CRR regime and other applicable regulations, in the interest of providing a ‘level playing field’ for all intermediaries operating within the Internal Market. Instead, the authorisation of TCBs by any one Member State will, in the first place, reflect that Member State’s own individual assessment as to whether or not the operation of such branches will be beneficial in economic terms.⁴³ As a consequence, host country authorisation decisions and the ongoing supervision of TCBs by individual host countries can thus be expected not to take into account the implications of TCBs’ activities beyond their own territories and, in particular, in other EU jurisdictions.⁴⁴ These preferences probably also shape the regulatory treatment of third country branches, which, while broadly based on the general regulatory framework for authorised credit institutions, frequently appears to follow a nuanced approach. Particularly the readiness of Member States to provide for exemptions and reductions in regulatory requirements, arguably, reveals the assumption that, given their limited role within the respective host market, the treatment of TCBs can be relaxed. At the same time, it is certainly noteworthy that the vast majority, in the absence of harmonised criteria in European law in that regard, have come to apply their own assessments of home country equivalence as determinants for the authorisation of TCBs,⁴⁵ indicating an awareness that the risk profile of TCBs inevitably depends on the quality of home country supervision. However, the ongoing cooperation with the relevant home jurisdictions is characterised by substantial differences in terms of both legal basis and intensity.⁴⁶ At the same time, considerations about the equivalence of third country regulatory and supervisory approaches have always been just one (and not the most important) determinant for Member States’ authorisation policies.⁴⁷ And interestingly, Member States have taken different approaches to the role of reciprocity for the authorisation of TCBs, with only some Member States making authorisation conditional on market access for their domestic intermediaries in the respective home jurisdiction.⁴⁸ Taken together, these differences appear to suggest that—despite a high-level convergence with regard to the calibration of regulatory requirements—Member States’ policies relating to the treatment of third country branches are by no means identical conceptually.

3 A Fresh Start: The Incoming Regime from a Functional Perspective

3.1 Functional Aspects: Economic Costs and Benefits of Third Country Market Access and Their Implications

In principle and at a very abstract level, the case for the admission of third country branches is as straightforward as the relevant regulatory objectives to be pursued by host jurisdictions in this regard. For host jurisdictions, third country branches may be beneficial in various respects, in particular by facilitating foreign direct investment and by supporting foreign enterprises willing to invest within the host market or domestic enterprises willing to invest abroad. They may also be a welcome provider of financial innovation (but that could, of course, turn out to be a mixed blessing, especially where such innovations come with new, insufficiently controlled risks). As has been argued with a view to the UK’s exit from the European Union, such advantages may also be present in relation to the operations of institutions authorised in London within the EU-27.⁴⁹

At the same time, depending not just on the respective TCB, its size, market share and risk profile as such, but also on the structure of the domestic market and its interlinkages with the TCB, activities of third country branches can come with undesirable effects on regional financial stability. Significantly, depending on the regional scope of activities carried out by the TCB, spillovers into markets other than the host jurisdiction as such are also conceivable,⁵⁰ which is particularly relevant in view of potential arbitrage effects currently caused by varying national authorisation standards.⁵¹ Moreover, the presence of TCBs may come with adverse consequences for domestic intermediaries, especially where such TCBs benefit from lighter regulatory requirements in their respective home jurisdictions.

Against this backdrop, any regime for the treatment of third country branches within the EU must satisfy a rather complex matrix of requirements—and balance an intricate mix of potentially conflicting interests. Host jurisdictions generally will seek to preserve a high level of autonomy (and flexibility) not just in terms of the decision whether to authorise TCBs at all, but also with regard to the definition of the requirements for market access both initially and on an ongoing basis, in accordance with their own assessment of the respective TCBs’ risk profile and potential implications for domestic market structures. As a rule, they will also seek to protect their domestic constituents by establishing effective means of control over the TCB’s domestic activities, which usually will require a minimum reliance on the relevant third country supervisors and a certain minimum level of cooperation with them. In many cases, host jurisdictions will also seek to use their authorisation regimes as leverage in negotiations with third countries so as to accomplish market access for their own constituents in the respective foreign markets, by making authorisation conditional on the principle of reciprocity. These interests, as indicated above, may help to explain the existing legal framework for the treatment of third country branches, where decentralised decisions remain the rule, although national approaches to assessing the risks of TCBs have converged to some extent. At the same time, the potential for spillover effects of TCBs’ activities into other EU markets, which may materialise in consequence of an outright failure of the third country institution (e.g., resulting from the exposure of counterparties in jurisdictions other than the host jurisdiction), but also as a result of an unauthorised outreach of a TCB into another EU jurisdiction, clearly militates in favour of further convergence of applicable prudential requirements and supervisory approaches. In this regard, a centralisation of equivalence assessments with regard to home jurisdictions’ prudential requirements and supervisory arrangements, as well as the negotiation of cooperation agreements with third country jurisdictions may be preferable to decentralised decisions by individual Member States not just because a European institution (the European Commission, EBA, or indeed both) may be better placed to carry out relevant assessments than individual Member States, but also because it is in a stronger negotiation position vis-à-vis the respective third country authorities.

An effective harmonised third country regime for credit institutions should take these—rather complex—considerations into account and balance the underlying interests fairly and effectively. This overarching aim is also reflected in the recommendations made in the EBA Report of 2021, which identifies the following policy objectives to be pursued by incoming regulation:⁵²

• a. Preserving the openness of the EU financial market to foreign players, acknowledging their beneficial contribution to the local economy and to international trade and finance;

• b. Ensuring that the same third countries are treated equally across the EU;

• c. Ensuring the application of a minimum harmonised regulatory approach in order to avoid arbitrage opportunities across the EU;

• d. Ensuring the safe and prudent management of TCBs in accordance with proportionate regulatory requirements and supervisory practices in order to maintain financial stability;

• e. Ensuring adequate monitoring and supervision of TCBs’ activities via the appropriate transparency of TCBs’ operations and reporting requirements in order to capture and mitigate the associated risks;

• f. Ensuring that the rationale for the requirement on TCGs to set up one or more IPUs is not circumvented by an unbalanced distribution of activities between TCBs and subsidiaries within the EU.

3.2 The Incoming Regime to be Established Under the Commission Proposal of 2021

3.2.1 A Two-Tiered Approach: ‘Class 1’ and ‘Class 2’ TCBs

If and when ultimately adopted, the proposed reform of the CRD IV,⁵³ based largely on the recommendations presented by the EBA Report in 2021,⁵⁴ will, in a new Title VI of that Directive, for the first time establish a comprehensive harmonised framework for the treatment of third country branches within the EU. Based on a harmonised definition of the term⁵⁵ and citing concerns about ‘risks to the financial stability and market integrity of the Union which should be properly addressed through a harmonised framework on third country branches’,⁵⁶ the new framework fundamentally relies on the categorisation of TCBs into two groups, namely ‘class 1’ TCBs (which are deemed riskier and hence require stricter regulation) and ‘class 2’ TCBs (which are smaller and therefore less risky and hence do not merit similarly strict regulatory requirements).⁵⁷ TCBs will be allocated to ‘class 1’ if they, alternatively,

• a hold a total value of assets in the relevant Member State equal to or higher than EUR 5 billion, as such branches are deemed to pose a greater financial risk on account of their size and complexity; or

• b regardless of their size, are authorised to accept deposits or other repayable funds from retail customers, where the amount of such deposits or funds is equal or higher than 10% of the total liabilities of the TCB or higher than EUR 100 million, because their potential failure is deemed to have the potential of affecting depositors’ confidence in the safety and soundness of the host Member State’s banking system and thus affect financial stability as a whole.⁵⁸

Additionally, TCBs that do not satisfy the conditions for ‘qualifying third country branches’ as specified by a new Art. 48b CRD IV will also be allocated to ‘class 1’.⁵⁹ Pursuant to Art. 48b(1) CRD IV (as proposed), this classification generally requires that

• a the respective ‘head undertaking’ (i.e., the foreign legal entity seeking to establish the branch) is established in a country that applies prudential standards and a supervisory oversight at least equivalent to the CRD IV/CRR regime;

• b the supervisory authorities of the TCB’s ‘head undertaking’ are subject to confidentiality requirements defined in the Directive; and

• c the relevant third country jurisdiction complies with EU money laundering legislation.⁶⁰

Art. 48b(2)–(4) CRD IV (as proposed) then specifies a framework for the recognition of third country equivalence (and conformity with confidentiality requirements) by the Commission with the assistance of EBA, which incorporates the procedural framework for so-called examination procedures specified in Art. 464(2) of the CRR in conjunction with Art. 5 of Regulation (EU) No 182/2011.⁶¹ Pursuant to Art. 48b(4) CRD IV (as proposed), EBA shall keep a public register of third countries and third country authorities determined to be equivalent by these standards.

Significantly, in the future, Member States will be required to classify each new application for authorisation according to the categories described above and, in this context, request the Commission to make an equivalence assessment of the respective third country if it has not already done so. Pending this assessment, the applicant will have to be treated as a ‘class 1’ TCB. Effectively, the incoming Directive—in combination with the proposed authorisation regime to be discussed below—thus restricts the Member States’ discretion not just with regard to the conditions for authorisation but also with regard to equivalence assessments, which in the future will be centralised at European level,⁶² as is the case under other equivalence-based third country regimes.⁶³ Importantly, however, the equivalence of the relevant third country’s regulatory and supervisory arrangements will continue to play a rather limited role, and a positive equivalence assessment (in addition to the third country institution’s own safety and soundness) will remain only one, but not the decisive, determinant for authorisation of branches.

3.2.2 A Harmonised Framework for Authorisation and Harmonised Prudential Requirements

Reflecting the two-tiered approach to the treatment of TCBs discussed above, Title VI, Section II of the CRD IV (as proposed) then defines a harmonised framework for the authorisation of third country branches and applicable conditions for authorisation. While the authorisation requirement as such, set out in Art. 48c(1) CRD IV (as proposed), essentially replicates authorisation requirements already established in national laws,⁶⁴ at least some of the harmonised authorisation requirements certainly are new.

As a minimum, in the future, authorisation will require that the third country institution, in its home jurisdiction, holds a license for the activities to be carried out within the host jurisdiction,⁶⁵ and that the host jurisdiction’s competent authority has access to all relevant information and can effectively coordinate its supervisory activities with the third country supervisor.⁶⁶ Moreover, TCBs should not be authorised if there are grounds to suspect they might be used for money laundering activities.⁶⁷ Authorised TCBs will be expressly prohibited to conduct authorised activities within an other EU Member State on a cross-border basis, except where such activities are provided on the basis of reverse solicitation or for intragroup liquidity purposes with other TCBs or subsidiaries of the same group in other Member States.⁶⁸

While Art. 48d CRD IV (as proposed) defines corresponding conditions for the refusal or withdrawal of an authorisation, Arts. 48e-48i CRD IV, arguably a core element of the proposal, then introduce harmonised substantive prudential requirements. Given the differences in residual capital requirements established in the national laws of the Member States to date,⁶⁹ the new harmonised ‘capital endowment requirement’ defined in Art. 48e will certainly require at least some Member States to fundamentally reform existing approaches. Under this new regime, ‘class 1’ branches will, in the future, have to hold a minimum endowment of 2% of the branch’s average liabilities (and a minimum of EUR 10 million), while ‘class 2’ branches will have to hold a permanent endowment of EUR 5 million. In all cases, the endowment will have to be held in cash or liquid debt securities of high quality in an escrow account with a credit institution unaffiliated with the TCB, or with the central bank of the respective host Member State.⁷⁰ In addition to liquidity requirements determined by national laws, Art. 48f CRD IV (as proposed) then defines minimum liquidity requirements for TCBs which, for ‘class 1’ TCBs, will be determined by reference to Part 6, Title I of the CRR and Commission Delegated Regulation (EU) 2015/61.⁷¹ ‘Qualifying third country branches’ as specified by Art. 48b CRD IV may be exempted fully from the liquidity requirement.⁷² While all TCBs will be required to have at least two qualified directors and comply with a number of organisational requirements set out in the CRR⁷³ and additional organisational duties stipulated in the CRD IV,⁷⁴ ‘class 1’ TCBs, in addition, may be required to ‘establish a local management committee to ensure an adequate governance of the branch’.⁷⁵ Finally, Arts. 48i, 48l and 48m CRD IV (as proposed), respectively, stipulate specific booking and reporting requirements.

3.2.3 Supervision and Cooperation with Third Country Authorities

In a series of technical and, in part, highly convoluted provisions, Arts. 48n–48s CRD IV (as proposed) complement the harmonisation of substantive prudential standards with a harmonised framework for the ongoing supervision by host countries’ competent authorities, as well as for cooperation with the respective home authorities. Specifically, host jurisdictions have to comply with an obligation to review and evaluate, on an ongoing basis, TCBs’ compliance with the applicable prudential requirements and applicable money laundering law, which will be specified further in EBA guidelines in due course.⁷⁶ Art. 48p(1) and (2) CRD IV (as proposed) sets out a range of supervisory powers to be allocated to host competent authorities, while paragraphs (3) and (4) require a regular assessment of financial stability risks caused by systemically relevant TCBs, to be carried out by a lead competent authority within the EU,⁷⁷ and remedial action to address such risks which may take the form of both additional prudential requirements and changes to organisational structures or business models. Significantly, in this context, Member States will have the power to require third country institutions to operate through fully authorised subsidiaries rather than branches if they determine that such branches are systemically relevant.⁷⁸ Finally, Arts. 38q and 48r CRD IV (as proposed) establish a framework for the cooperation between EU competent authorities supervising TCBs and subsidiaries of the same third country group through colleges of supervisors, while Art. 48s defines a mandate for the EU to conclude agreements with third countries in order to facilitate the consolidated supervision of such groups.

3.2.4 The Proof of the Pudding Is in the Eating? Equivalence in Practice: A Preliminary Assessment

Given the absence of harmonised requirements for the treatment of third country branches in EU law on the one hand, and the potential adverse implications of diverging national standards on the other hand, the incoming regime is certainly to be welcomed as a substantial step forward. In view of the economic relevance of TCBs within Europe in general and the concentration of TCBs in some Member States in particular,⁷⁹ there is certainly a strong case for harmonisation that moves away from the existing approach, and arguments supporting continued subsidiarity would ignore the potential implications of TCBs for EU financial markets as a whole. It is worth noting in this context that the Commission proposal essentially takes up the recommendations made in the 2021 EBA Report,⁸⁰ which, in turn, build on a careful and nuanced analysis not just of the status quo in the national legislation of Member States, but also of relevant supervisory approaches and the empirical situation of TCBs across the EU as a whole. The new regime clearly implements elements of third country regimes building on the concept of regulatory and supervisory equivalence established in other areas of financial regulation. At the same time, the new regime takes into account that the size and relevance as well as the scope of activities carried out by TCBs of credit institutions within Europe and, ultimately, their systemic relevance differ substantially, which necessitates a differentiated and flexible approach. While it certainly requires—to some extent, fundamental—changes to established national approaches with respect to both authorisation requirements and the ongoing supervision, Member States, under the new regime, will retain a high level of discretion whether or not to authorise third country branches in the first place. While they will have to step up existing supervisory arrangements to ensure that TCBs’ activities are confined to their respective territories, this consequence is to be welcomed in order to contain the risk of spillovers of risky and/or illegal behaviour into other Member States. And although the new regime certainly is more complex than existing arrangements, there is, prima facie, little reason to doubt that it can provide a robust, reliable and efficient framework not just to provide market access for foreign institutions, but also to contain the potential risks associated with it.

Notwithstanding this rather positive preliminary assessment, it is an open question whether the new regime will provide improved opportunities for the market access of third country institutions and, thus, facilitate a genuinely new approach to their treatment under the laws and regulatory policies of the Member States. Precisely because, if and when ultimately adopted, the authorisation and supervision of TCBs will remain, by and large, a matter of national discretion, a comprehensive and consistent common policy in this regard will continue to be absent, and Member States will remain entirely free to determine if, and for which activities, TCBs will be authorised within their territories. Generally speaking, the authorisation of third country branches, under the new regime, will likely remain a matter of case-by-case decisions and facilitate the operation of a limited range of activities rather than comprehensive market access for branches offering a broad range of banking services within the respective Member State.

These considerations are of particular relevance as far as the future relationship between European banking markets (and supervisors) and institutions (or subsidiaries of third country institutions) authorised within the UK are concerned. To be sure, equivalence-based concepts of mutual market access had been expected, and advocated, to provide the basis for wholesale ongoing access to European financial markets for UK-licensed institutions following the UK’s exit from the EU.⁸¹ Given the limitations discussed before, however, it would seem rather unrealistic, for the time being, to expect the new regime—in the absence of an even more comprehensive, bespoke UK/EU arrangement that would have been preferred (probably even more unrealistically) by some authors⁸² and, indeed, by the UK government⁸³—to provide the basis for a comprehensive overhaul of the regulatory relationship between banking supervisors within the EU and their counterparts in the City of London. Particularly because the authorisation of third country branches will be restricted to individual Member States, applicant UK institutions cannot hope to accomplish comprehensive, Union-wide access as a result, so that the authorisation of a separate subsidiary within an EU Member State, which may then benefit from the passporting regime pursuant to Art. 33 CRD IV across the EU as a whole, remains the only available option in that regard.⁸⁴

These limitations may appear disappointing from the perspective of the UK in particular and third country institutions in general, although future market access of UK institutions on the basis of the reformed regime will not just depend on the Member States’ willingness to authorise them, but also on the UK’s ongoing preservation of ‘equivalent’ regulatory and supervisory standards (which may be jeopardised if and to the extent that UK reforms will move away from existing standards, e.g., in the course of a liberalisation of the UK prudential regime). At any rate, there are certainly reasons not to be overly generous as far as market access is concerned. Leaving aside concerns about potential competitive advantages for TCBs vis-à-vis domestic intermediaries, the operation of third country credit institutions, given the complexity of banking services and the risks associated with them, arguably warrants a cautious approach—more cautious perhaps than in the case of more specialised intermediaries or services, whose impact on domestic constituents, especially in the event of a failure of the institution, is likely to be more limited. To be sure, the new regime will address such concerns, in particular through the harmonised capital endowment and liquidity requirements.⁸⁵ However safe the respective funds are kept within the host jurisdiction, though, the very fact that they are owned by the third country institution rather than the branch itself, which is not legally separate, may create enforcement problems in the event of an insolvency, where foreign insolvency practitioners and/or resolution authorities may assert claims in relation to these assets, which may at least obstruct domestic enforcement proceedings carried out in the host jurisdiction. Against this backdrop, it is certainly to be welcomed that host Member States will have the express authority to demand systemically relevant third country branches to reorganise as subsidiaries.⁸⁶ In the absence of robust and reliable cooperation agreements with the respective home jurisdictions also with regard to the cross-border coordination of insolvency or resolution procedures, this should facilitate the effective ring-fencing of domestic assets located within host countries, and thus provide an effective basis for the protection of domestic stakeholders.⁸⁷ These considerations, however, clearly illustrate the functional limitations of third country market access in the first place: the most effective protection of domestic constituents can be accomplished only vis-à-vis subsidiaries of foreign banks, not with regard to their branches.

4 Conclusions

With the ‘Banking Package’, a comprehensive reform proposal for the overhaul of key elements of EU banking legislation, the European legislator is likely to enact an extensive overhaul also of the existing framework for the treatment of third country branches within the EU. While the authorisation of such branches has hitherto been left more or less exclusively to the discretion of the Member States, which were free to define applicable prudential requirements and supervisory approaches, the new framework will provide a comprehensive harmonisation of authorisation procedures and substantive conditions for the authorisation. Given the residual differences between national laws so far and their potential negative consequences, this step is to be welcomed. Whether the adoption of the new framework will improve market access for third country institutions remains to be seen, however, but such market access will, in all likelihood, continue to be granted on a case-by-case basis by individual Member States and be restricted to their respective territories. Given the risks associated with incoming third country institutions, this is understandable and commendable. As far as the future relationship between the EU-27 and the UK is concerned, however, the expectation that the new regime could facilitate a basis for comprehensive market access for UK institutions certainly appears overoptimistic.