Emerging trend: local regulators and supervisors seek enhanced resources for international financial services firms operating in their jurisdiction

In the US, the Federal Reserve’s Dodd-Frank Act introduced an intermediate holding company (IHC) requirement on international banks operating in the US with US$50bn or more in US non-branch or agency assets by July 2016. This IHC is subject to US Basel III, capital planning, Dodd-Frank stress testing, liquidity, risk management requirements and other US banking regulations on a consolidated basis.

In the European Union (EU), financial services regulators and supervisors appear to be replicating this US approach that requires additional resources for large international financial groups operating within their jurisdiction.  Specifically, we note that in:

1.      Banking       

The main EU banking legislation, the Capital Requirements Directive (CRDV) introduced the establishment of an EU holding company requirement (Intermediate Parent Undertaking) for large third country banking groups where the total assets in the EU was greater than €40bn, including third country branches. This requirement becomes effective in December 2023.

The European Commission’s latest proposals for amending CRD legislation (CRDVI) now seek more requirements on third country bank branches, such as having a physical presence (branch or subsidiary) if they provide banking services in the EU. Moreover, they view that only EU nationals (legal person, entity or branch) can provide services in the EU, and that third country branches cannot provide cross-border banking services, except for a reverse solicitation exemption. In their initial proposal for CRDVI, they proposed compulsory subsidiarization. This proposal is currently subject to political scrutiny and appears to be softening with voluntary subsidiarization to enable the local supervisor to assess the risks to financial stability. For example, an individual EU country views that the third country branch is systemic, or meets other requirements, such as additional capital, liquidity, reporting or disclosure requirements.  The proposal also suggests that the European Banking Authority (EBA) should review the third country branch landscape. 

This regulatory trend is replicated in the view of the main EU banking supervisor, European Central Bank’s Single Supervisory Mechanism (ECB SSM), who in their 2018 supervisory expectations on booking models clarified the “need for banks to retain demonstrable control and oversight of balance sheet risk assumed in the euro area. Banks not only need to ensure adequate levels of local capital and liquidity, but they also need adequate local risk management staff in terms of quantity and quality as well as appropriate local internal governance, IT and reporting infrastructures.” The ECB SSM followed up early this year in their review of EU banks and investment firms‘ “desk book-mapping exercise,” where they noted that banks had not made sufficient progress in ensuring adequate local trading presence and risk management capabilities in their newly established entities in the euro area.  

2.      Insurance

A similar supervisory view in Europe is emerging among Insurance supervisors, which may result in the prohibition of third country branches for insurers and brokers. In August 2022, the European Insurance and Occupational Pensions Authority (EIOPA) consulted on the use of governance arrangements in third countries, which built on EIOPA’s view that an insurance undertaking should not be an empty shell company. Instead, it should demonstrate an appropriate level of corporate substance, including the presence of key decision-makers, function holders and staff to an extent proportionate to the nature, scale and complexity of the entity’s business in the EU. This EIOPA consultation has recently closed and EIOPA is considering its next steps.

3.      Investment firms

CRDV now requires significant investment firms (mainly international) to become credit institutions if their assets exceed €30bn. As such, they are subject to more regulatory requirements and supervision by the ECB SSM.

The European Commission’s proposed revisions to the Alternative Investment Fund Managers Directive (AIFMD) reflect the EU authorities’ concern of “letter box entities” operated by third country investment fund managers offering services in the EU. The proposals include the requirement to employ “at least two persons full-time or engage two persons who are not employed by the AIFMD, but nevertheless are committed to conduct that AIFMD’s business on a full-time basis and who would be resident in the EU.” These proposals are still going through political scrutiny, and we envisage them to apply from late 2024 to early 2025.

These are just some of the emerging trends for international financial services firms seeking enhanced resources (i.e., more local staff and capital) to operate in the EU.

EY will continue to monitor these developments and provide thoughts on the developing regulatory frameworks applying to firms operating cross borders.

The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organization or its member firms.