Governance and Supervision Series: our second blog

In the previous blog, we wrote about the CRD-requirement for international banks outside the EU  (called Third Country Groups or TCG’s) to establish an Intermediate Parent Undertaking (IPU). Or, in a nutshell: the obligation to consolidate TCG entities in the EU to establish the EU Headquarter of the bank. In this blog, we will dive into some important considerations for setting up an IPU in the EU. For example: to branch or not to branch? 

An important consideration is, obviously, in which country the TCG prefers to establish the EU Headquarter or ‘EU Hub’. The choice for a specific country has impact on operations, clients, licences, tax, governance but also the culture and history of the bank should be taken into account. The location of the IPU should fit with the strategy and culture of the bank – and with the people running the bank. Another important topic is the legal form of the IPU. Some banks prefer a branch-driven model with branches in the countries the bank is operating in. Other banks prefer to operate through subsidiaries. We will not go into the details of ‘subs’ but we will describe the pros and cons of branches in this blog. 

There is a difference between ‘regular branches’, that are owned by the EU subsidiary, and Third Country Branches (TCB’s) that are directly owned by the TCG. Regular branches are subject to the supervisor of the home country of the subsidiary. TCB’s are subject to the home supervisor of the TCG; the local European (host) supervisor of the TCB has limited authorities. There are no direct activities, and as a result a licence is not required for both branches; a notification to the local supervisor is sufficient. To compare: subsidiaries are subject to the local supervisor and are licensed entities.

There are no harmonized rules for TCB’s in the EU yet. TCB’s are treated differently across the EU. However, it is expected that the European Commission will move towards a set of harmonized rules bringing TCB regimes closer to the one of subsidiaries. EBA has issued a report in 2021 about the treatment of TCB’s and has identified an increasing trend in the use of TCB’s by TCG’s as a form of accessing and operating in the EU market. However, as a consequence of having the lead supervision with the home supervisor of the TCG, the local supervisors lack oversight. In addition, a divergence of national rules may lead to regulatory arbitrage. Therefore, EBA considers harmonisation of national rules on TCB’s to be necessary in terms of effective cooperation with third country home authorities, the scope of authorisation, prudential requirements (notably capital, liquidity and internal governance), AML/CFT aspects, reporting, booking arrangements and recovery plans. CRDVI will include detailed rules for TCB’s. We will discuss CRDVI in one of our next blogs.

To remind us of the IPU-angle in this story, the following is important. The assets of all the TCG’s branches (both regular and TCB’s) in the EU are included in the calculation of the total assets for the threshold for an IPU (EUR 40 billion). However, these TCB’s are not required to move under the umbrella of the IPU! They can remain direct branches of the TCG and continue to be supervised by the home supervisor of the TCG.

However, our experience is that the ECB and national supervisors in the EU prefer fully licensed subsidiaries with regular branches rather than stand-alone TCB’s or ‘non-licensed activities’. As soon as it is a subsidiary, the regulator requests a different level of transparency and implied responsibility. Therefore, our advise would be to include TCB’s in the IPU as regular branches. The aim of an IPU is to prevent unnecessary complexity of the overall structure. According to the EBA Guidelines on Internal Governance, institutions should avoid setting up complex and potentially non-transparent structures. The more complex and opaque the organizational and operational structure, and the greater the risks, the more intensive the oversight of the structure should be.