8 minute read 19 Feb 2024
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How will the Swiss banks navigate upcoming EU branch requirements under CRD VI?

Authors
Silvia Devulder

Partner, Head Legal Romandie in Financial Services | EY Switzerland

Focusing on Legal Derivatives & Capital Markets topics, including the IBOR transition. Speaking five languages, playing tennis and enjoying family time with my boys.

Darko Stefanoski

Partner, Law Leader in Financial Services | EY Switzerland

His heart belongs to two places: one is Macedonia, where he has his roots, and the other is Switzerland, where he was born and lives.

8 minute read 19 Feb 2024
Related topics Banking and capital markets Financial Services Law
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The CRD VI, a landmark piece of EU financial regulation, will introduce changes that will have far-reaching implications for Swiss banks operating in the EU.

In brief

  • How will CRD VI impact the Swiss banks providing certain core banking services in the EU?
  • What exemptions from the requirement to establish new branches in the relevant Member State(s) are foreseen?
  • What will change for currently operating EU branches of Swiss banks?

The proposed amendment to Directive 2013/36/EU (the Capital Requirements Directive or CRD) is part of a legislative package that also includes amendments to Regulation (EU) No 575/2013 (the Capital Requirements Regulation or CRR).

Among other changes, CRD VI will introduce a requirement for non-EU (third country) banks to establish a branch in the EU Member State of the client to whom certain core banking services are provided on active solicitation basis, so called third country branch (TCB) requirement. The TCB authorisation procedure and minimum regulatory requirements under which TCBs will be allowed to operate in the EU will be harmonised to level the playing field and prevent regulatory arbitrage. Swiss banks, as third country banks, will need to review their cross-border market access and rethink their strategy to protect or grow their EU business.

The legal text of CRD VI endorsed by the co-legislators in December 2023 will now be submitted to the European Parliament Plenary and to Council for adoption, after which legal texts will be published in the Official Journal of the EU. At the time of this article, the proposal is awaiting EU Parliament's position in 1st reading, indicatively scheduled to 22nd April 2024.

Given the transitional period of 12 months following the 18 months transposition period of the Directive, the compliance date is currently expected in 2027.

Background

According to end-of-year data for 2020, there were 106 third-country branches operating across 17 Member States in the EU, with assets topping €510 billion. This trend of increased TCB activity indicates a growing preference for TCBs as a way to enter EU banking markets.

A key challenge in managing TCBs is the scattered regulatory landscape resulting from the lack of a universal regulatory framework. This scenario creates potential blind spots for market risks and, possibly, regulatory arbitrage situations, where TCBs could bypass EU banking requirements if their home country's regulations are less stringent.

To address these risks and to ensure financial stability and market integrity, the creation of a harmonized regulatory framework for TCBs is proposed. This would involve implementing explicit authorization procedures, formulating minimum regulatory requirements, establishing regular reporting protocols, and enforcing ongoing supervision for TCBs. Such a framework would also subject TCBs with assets over €30 billion to regular assessments concerning their potential risk to financial stability.

Despite the potential costs associated with adherence to this new framework, the overall transitional and compliance costs for re-authorization could be mitigated over a 12-month transitional period, following the 18-month transposition period of the Directive. This regulatory alignment progression will bring the EU's requirements for TCBs in line with international standards and ensure greater market stability.

Impact for Swiss banks

Against this context, the revised CRD VI framework will require that third-country banks established outside of the European Union (EU), such as Swiss banks, establish a branch within the EU Member State to provide certain core banking services to clients domiciled in that Member State.

The core banking services covered by the branch requirement include the services defined in points 1, 2, and 6 Annex 1 to Directive 2013/36/EU:

1. Taking deposits and other repayable funds.

2. Lending including, inter alia: consumer credit, credit agreements relating to immovable property, factoring, with or without recourse, financing of commercial transactions (including forfeiting).

6. Guarantees and commitments.

However, there are several exemptions mitigating the impact on Swiss private banks providing services to EU clients.

Reserve solicitation exemption

Under the current proposal, an exception to the EU third-country branch rule is made for reverse solicitation, whereby the client approaches the third-country bank independently for service provision. In such a case, the regulatory requirement for the third-country bank to establish a branch in the Member State is no longer applicable.

For an action to qualify for a reverse solicitation exemption, as currently proposed, the initiative to establish the provision of service must come exclusively from the client. It must not be induced or influenced in any manner by the service provider. 

Also, an initiative by a client would not entitle the third-country undertaking to market other categories of products, activities, or services beyond those that the client has initially sought, unless this is done through a third-country branch established in a Member State.

Moreover, if a third-country undertaking solicits clients or potential clients in the EU via an entity acting on its behalf or having links with the third-country undertaking, then such a service cannot be deemed as one initiated solely by the client.

Understanding and navigating the subtleties of reverse solicitation is crucial, as failure to conform to the requirements can lead to regulatory scrutiny and reputational risks. EU bodies have stressed that reverse solicitation should be interpreted narrowly to preserve the integrity of EU financial markets and to protect consumers. This also minimizes regulatory arbitrage, where firms could potentially try to circumvent the stricter EU regulation by influencing EU clients to use the reverse solicitation route.

MiFID II Investment services exemption

For certain types of investment services, an exemption from the requirement for third-country credit institutions to establish a branch in a Member State is proposed.

This includes cases of interbank and interdealer transactions.

Furthermore, the branch establishment requirement in the EU does not apply to third-country credit institutions providing investment services and activities listed under Annex I, Section A of Directive 2014/65/EU, commonly known as MiFID II. This implies that any associated ancillary services, such as providing trading of financial instruments or private wealth management services, can also be offered without the need to establish a branch.

The exempted investment services and activities mentioned under Annex I, Section A of MiFID II include:

  1. Reception and transmission of orders related to one or more financial instruments
  2. Execution of orders on behalf of clients
  3. Dealing on one’s own account
  4. Portfolio management
  5. Investment advice
  6. Underwriting of financial instruments and/or placing financial instruments on a firm commitment basis
  7. Placing financial instruments without a firm commitment basis
  8. Operation of a Multilateral Trading Facility (MTF)
  9. Operation of an Organised Trading Facility (OTF)

However, exercising this exemption should be done considering compliance with MiFID II, Anti-Money Laundering and Counter-Terrorist Financing rules.  It is also important to note that this exemption should not be misconstrued as a general pass to operate freely in the EU without regulatory oversight. Regardless of the provision utilized, third-country credit institutions are required to adhere to the European Union's financial market regulations to maintain market integrity and protect consumers.

Impact on currently operating TCBs of Swiss banks

Under the proposed new framework, TCBs currently operating in the EU may in some cases need to be re-authorised and face additional requirements.

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  • Authorisation

    The establishment of TCBs is subject to an explicit authorisation procedure and minimum requirements. 

  • Minimum regulatory requirements

    1. Maintain a minimum capital endowment, calculated as a percentage of the branch’s liabilities for larger and riskier TCBs (class 1) or a fixed amount for smaller TCBs (class 2);
    2. Comply with a liquidity requirement, which for class 1 TCBs must be the same as the liquidity coverage requirement that applies to credit institutions in accordance with Commission Delegated Regulation (EU) 2015/61;
    3. Meet internal governance and risk control requirements and implement booking arrangements in order to track the assets and liabilities linked to the business conducted by the TCB in the Member State.

  • Reporting requirements

    TCBs are required to report regularly to their competent authorities i) information on their compliance with the requirements laid out in the CRD and in national law and ii) financial information in relation to the assets and liabilities on their books;

  • Supervision

    Competent authorities are required to conduct regular reviews of TCBs’ compliance with their regulatory requirements, including for AML purposes, and take supervisory measures to ensure or restore compliance with those requirements. Competent authorities of class 1 TCBs are required to include them in the colleges of supervisors of the relevant group, where one already exists, or otherwise set up an ad hoc college for class 1 TCBs of the same group operating in more than one Member State.

For reasons of proportionality, and in particular to avoid any unnecessary additional administrative burden for small(er) TCBs, the scope and level of prudential requirements is proposed to be modulated to differentiate between class 1 and class 2 TCBs. The former class comprises the larger TCBs (i.e., those holding assets equal to or in excess of €5 billion), as well as TCBs authorised to take deposits from retail customers and TCBs considered “non-qualifying”, the latter two regardless of their size. Class 2 comprises all TCBs not classified as class 1.

A TCB is considered ‘qualifying’ where its head office is established in a country i) that has in place a supervisory and regulatory framework for banks and confidentiality requirements that have been assessed as equivalent to those in the EU and ii) that is not listed as a high-risk third country that has strategic deficiencies in its regime on anti-money laundering and counter terrorist financing.

TCBs will have a transitional period of 12 months following the 18 months transposition period of the Directive to obtain the authorization.

  • Impact on existing TCBs

    • Based on 31 December 2020 data, up to 40 out of 106 TCBs authorised to operate in various Member States would have qualified as class 2 and, hence, those 40 would be subject to comparatively less stringent prudential and reporting requirements under the new framework;
    • Based on the same data and as of that date, only 3 TCBs had assets on their books in excess of EUR 30 billion and, thus, would be subject to the assessment of systemic importance.

Summary

The CRD VI will introduce significant changes for TCBs operating in the EU, with a focus on enhancing resilience, transparency, and risk management practices. These changes, particularly the third-country branch requirement and stricter regulatory oversight, will require a strategic overhaul of TCBs’ operations. Therefore, we recommend to proactively address these challenges already at an early stage by conducting an impact assessment so that TCBs can adapt their business model, understand the classification system, strengthen their risk management processes, and enhance their compliance infrastructure. By navigating these challenges, TCBs can emerge as well-positioned players in the dynamic EU market.

The third-country firms without an existing branch in the EU will need to review their cross-border operations to avoid breaching the EU third-country branch requirement. Any existing reverse solicitation framework or local guidance, interpretation, etc. already in place for the provision of investment services may need to be analysed in detail – on top of the Directive or Regulation level – regarding a potential extension and/or enhancement for the core banking services under CRD VI.

Acknowledgement

Many thanks to Micol Paloschi for her valuable contribution to this article.

About this article

Authors
Silvia Devulder

Partner, Head Legal Romandie in Financial Services | EY Switzerland

Focusing on Legal Derivatives & Capital Markets topics, including the IBOR transition. Speaking five languages, playing tennis and enjoying family time with my boys.

Darko Stefanoski

Partner, Law Leader in Financial Services | EY Switzerland

His heart belongs to two places: one is Macedonia, where he has his roots, and the other is Switzerland, where he was born and lives.

Related topics Banking and capital markets Financial Services Law
Upvote