26.01  The cross-border supervision of banks is a topic which has ranked high on the list of ‘hot’ banking regulatory topics over the last few years. In the modern financial markets banks tend to be international whilst regulators tend to remain national, and any suggestion of pooling of powers or competences between national regulators might soon lead to undesirable national political consequences. However, it is also generally accepted that this particular issue cannot safely be filed under ‘too difficult’ for the foreseeable future. Some of the most complex bank failures of recent years have been of cross-border institutions, and the failure of an international bank poses particular difficulties for any national government affected by that failure—not least because of the extreme political difficulty inherent in concerted intergovernmental action to rescue an international bank. The broad consensus at international level that something should be done about the issue has not, however, led to anything significant being done about it.

26.02  The current vogue is for ‘colleges’ of supervisors. The basic idea is that in order to regulate an international bank you convene a meeting of all of the regulators who regulate different parts of that bank (in jurisdictions which have different regulators for different financial activities there may be several regulators present from one jurisdiction), and discuss in a concerted fashion the progress and performance of the bank as a whole.

26.03  The difficulties with the college of supervisors approach are well known. The Babel of conflicting views which the college of a large supervisor can engender is an alarming experience, and the primary conclusion to be drawn from any (p. 492) such convention is generally the unsurprising one that different regulators have different priorities, driven generally by national considerations. Attempts to slim down colleges of supervisors are also surprisingly difficult—how do you deal with the regulator in a small country where the bank’s activities, although a few per cent of its total balance sheet, constitute a substantial part of that country’s banking system. More importantly, there is the issue that the powers of financial regulators generally end where a bank gets into severe difficulties, and the powers of the courts and of court-appointed insolvency practitioners take over. It is sad but true that the primary role of a college of supervisors is to watch from the wings whilst things are going well, and to dissolve itself when they are not.

26.04  The exception to this general principle is the EU. As part of the EU regulatory architecture the EU has adopted a lead supervisor approach in which a single supervisor is appointed as responsible for overseeing the affairs of any group which straddles more than one member state. Since the EU architecture does not, by and large, give national supervisors any actual powers outside their home jurisdictions, the role of EU lead supervisor is broadly confined to consolidated supervision, although a lead supervisor does chair the meetings of the relevant college of supervisors, and the status of lead supervisor is believed in some quarters to give its holder some persuasive authority in dealing with other member state regulators. However, the complexities within the EU regime indicate that even the structuring of a set of rules to automatically determine which supervisor shall be the lead supervisor is a challenging and demanding task.

26.05  The basis of the EU approach is that where a bank is at the head of a group, its regulator is responsible for supervising the activities of that group on a consolidated basis. It is notable that although such credit institutions are required to provide disclosure on both a solo and a consolidated basis, significant subsidiaries of such groups are also required to provide pillar 3 disclosures as to their own activities, whether or not they are themselves regulated.

26.06  Where a bank is controlled by a parent which is both a financial holding company¹ and is established in the same member state as itself, it must perform its prudential reporting from the perspective of its own holding company. This idea of ‘upward consolidation’ requires some explanation, since it is alien to the thinking of accountants and most financial professionals. The key point here is (p. 493) that the regulator’s power to regulate is based on its power to authorize, and a regulator cannot therefore directly regulate an unauthorized company. In an arrangement where a regulator regulates a bank, but the shares of the bank are held through a holding company, the regulator cannot regulate the holding company if the holding company itself remains unauthorized. What it can do, however, is to say to the regulated bank, ‘We will withdraw your authorization unless the group of which you are a part complies with certain requirements.’ This is why the obligation to report on a consolidated basis rests on the group member and not on the group parent.

26.07  For these purposes the term ‘group’ has the old-fashioned meaning of a parent and its full subsidiaries. As regards participations (ie holdings of between 20 per cent and 50 per cent in the capital of another entity), the requirement is for proportional consolidation—ie if an entity has 30 per cent of the capital of another, it must consolidate 30 per cent of the assets of that other, and 30 per cent of its liabilities.

26.08  For these purposes, an entity is also treated as a member of a group if it is ‘closely connected’ with it. The notion of ‘close connection’ in this context dates back to the Seventh Company Law Directive,² which addressed (amongst other things) the fact identified in the aftermath of the BCCI collapse that institutions could in practice be inextricably connected without having any formal relationship of parent and subsidiary. Institutions are closely connected with each other for this purpose if:

1. (1)  they are managed on a unified basis, pursuant to formal contract or provisions in their memorandum or articles of association; or

2. (2)  the administrative, management, or supervisory bodies of the undertakings consist of broadly the same persons.

This arrangement is known in the EU regime as an ‘Article 12(1) relationship’, since this definition is to be found in Article 12(1) of that directive.

26.09  Regulators have a broad discretion to require consolidation of entities which they perceive to have ‘capital ties’ with a regulated group. Provision is also made for regulators to be able to require consolidation in circumstances where one credit institution exercises ‘significant influence’ over another, whether by the existence of a common management or otherwise.

26.10  In principle, consolidated supervision is applied within a group at the level of every bank within that group. Thus, where a group contains a parent bank which owns a subsidiary bank which in turn owns a subsidiary bank, there will be five regulatory submissions—three solo and two consolidated—and a sixth if (p. 494) the subsidiary bank itself owns subsidiaries. This is shown diagrammatically in Figure 26.1—each shaded box indicates a solo return, and each dotted box a consolidated return.

• View full-sized figure

Figure 26.1  Illustrative multiple bank group

26.11  Within the EU, however, an exception is made where the entities are all established within a single jurisdiction. Thus, in the example given, if all of the banks were in the UK, it would be permissible for the UK regulator to require only the parent to be consolidated. This permission is subject to conditions—in particular, there must be no foreseeable material obstacle to the transfer of assets within the group, the parent must control the subsidiary, and so on. Where there is an ultimate parent holding company in the same jurisdiction, the regulator is also permitted to dispense with consolidated supervision at the subsidiary bank level.

26.12  EU regulators also retain, under the capital requirements directive (CRD),³ the right not to apply solo supervision to the parent bank of a group, provided that the parent reports on a consolidated basis. This is a controversial power, and few EU regulators avail themselves of it.

26.13  The EU position is also complicated by a series of ‘tie-break’ provisions designed to determine which amongst a number of competing national regulators should be the EU consolidated regulator for a multi-national group with presences in a number of EU markets. The EU consolidated supervisor functions as a sort of referee amongst the EU supervisors who have jurisdiction over a particular bank group, and is responsible for the co-ordination of the gathering and (p. 495) dissemination of information relating to the group, and also for the planning and co-ordination of supervisory activities relating to it, and for dealing with emergencies in respect of the group as a whole. There has been some discussion as to whether, in the event of a failure affecting a cross-border group within the EU, the consolidated supervisor could perform this role effectively, since the directive gives the co-ordinating supervisor responsibility but little power. It is likely that the supervisor could usefully assist national regulators in reaching agreement, but unlikely that it could achieve anything in the event of disagreement between those regulators.

26.14  These provisions are not straightforward even where the group holding company is established in the EU, and rapidly become incomprehensible where the group is ultimately headquartered outside the EU.

The basic EU principle is relatively straightforward.

26.15 

1. (1)  Where a bank established in a member state is itself the parent of a group, or is the parent institution within that member state (ie it is the ultimate holding company in that member state), the regulator in that member state is its consolidated supervisor.

2. (2)  Where a bank has as its parent a holding company within the EU, the regulator which authorized that bank is the consolidated supervisor of that group, regardless of the jurisdiction in which the holding company is established.

3. (3)  Where a group contains more than one bank, and those banks are established in different EU member states, the supervisor of the bank in the jurisdiction in which the holding company is established is the consolidated supervisor.

4. (4)  Where a group contains multiple banks established in different member states, but there is more than one parent within the EU (ie where the ultimate parent is outside the EU and the EU bank members of the group are held through different holding companies) and each parent is established in a different member state, the consolidated supervisor is the regulator in the jurisdiction containing the bank with the largest balance sheet.

5. (5)  Where a group contains multiple banks established in different member states, and the parent company is established in a different jurisdiction from any of the banks, the bank with the largest balance sheet shall be deemed to be the parent bank in the EU and that bank’s regulator will be the consolidated supervisor.

6. (6)  The relevant EU supervisors may agree amongst themselves that the consolidated supervisor should be any of them, and are not bound by the principles previously set out.

26.16  Where—as is common—an EU bank has a financial holding company, the consolidated supervisor is not required to play any part in the supervision of that holding company.

(p. 496) 26.17  Next, there is the issue of cross-border subgroups. Where a UK group (for example) has a subsidiary in another non-EEA country, the credit institution which holds that subsidiary must report on a consolidated basis in respect of the group formed by the credit institution and the non-EEA subsidiary or subsidiaries. This rule is of no very great effect where the non-EEA subsidiary is held directly by the parent credit institution of the group, since in such a case the consolidated report will be similar. However, what it does mean is that if a non-EEA subsidiary is held at a lower level within a group, this may result in the inadvertent creation of a requirement to deliver a consolidated return at the level of the group entity which holds the position.

26.18  The next level of complexity arises where an EU bank is part of a group headquartered outside the EU. In this case the EU supervisor is required to ascertain whether the group as a whole is subjected by the regulator in the jurisdiction in which it is established to consolidated regulation which is ‘equivalent’ to that established under the directive.

26.19  The difficulty, of course, arises where the supervision of the overseas entity is not held to be equivalent to the EU regime. In this case supervisors face a situation in which they are permitted to do a wide variety of different things. The most extreme is to apply their own rules to the relevant group at the group level. This can result in the apparently absurd outcome that a group based in Brunei or Sudan is required to prepare a consolidated set of accounts for its worldwide activities and submit it to the relevant EU regulator. In practice, regulators resist this approach, since they would otherwise be deluged with irrelevant information, and the traditional UK approach has been that this approach should only be used ‘in response to very unusual group structures’. In these circumstances the regulator and the group have a common interest in confining the scrutiny of the European regulator to the European activities of the group concerned, and supervision at the ultimate group level is done using what is known as ‘supplementary supervision’—the conglomerates approach described in the previous chapter.

26.20  A firm that is a member of a UK consolidation group is required to comply with the obligations relating to capital adequacy on the basis of the position of the group as a whole—in other words, if a subsidiary enters into a transaction which would be permissible for it on a stand-alone basis but which causes the group of which it is a member to contravene the regulatory capital restrictions to which it is subject, then that firm has committed a breach of the rules applicable to it.

26.21  It should be noted that although consolidated supervision is generally applied across the financial services industry, there is a potentially important exception for investment firms which either do not deal on account, or which deal on own account but are not permitted to hold client money or to maintain external customers in respect of the dealing services which they provide. Such firms may be exempted by national regulators on a case-by-case basis from the consolidated supervision requirements otherwise imposed on investment firms.