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The Law of Financial Services Groups by H R Morris, Charles (3rd October 2019)


From: The Law of Financial Services Groups

Charles H R Morris

From: Oxford Legal Research Library (http://olrl.ouplaw.com). (c) Oxford University Press, 2015. All Rights Reserved.date: 01 April 2020

Regulation of banks — Regulators

(p. 1) Introduction

A.  The Law of Financial Services Groups: Theme and Scope

0.001  This is a book about financial services groups: more specifically, it is about the laws and regulations that shape and determine how such groups are formed, structured, and regulated, and how entities within such groups interact with each other. Its focus is on how such influences and requirements work in practice: how they can be understood, addressed, and managed by a transactional or advisory lawyer or regulatory adviser.

0.002  What is a financial services group? Obviously enough, it is a group comprising at least one business entity that provides financial services (as for what a group is: this is something that we shall address in detail in Chapter 1). Many such groups are well-known finance behemoths, but others may be better known within other sectors. In this latter category, we find not only high street giants that own banking or insurance firms, but also a vast range of retailers and consumer service providers of all sizes that also provide finance intermediation services.

0.003  In order to cover such a wide-ranging theme in a single volume, whilst maintaining an appropriate balance between comprehensiveness, depth, and expertise, we must impose a number of limitations on this book’s scope and focus.

0.004  The focus of this book is on groups comprising financial services firms (from banks to investment firms/broker dealers, financial intermediaries, and insurers). It predominantly considers the corporate structures and financing of such groups, and the financial regulations, company law, and corporate insolvency law underpinning such aspects. This corresponds to the practice areas of the non-contentious corporate, finance/capital markets, and financial regulation teams into which large law firms tend to be organized.

0.005  This book does not therefore cover financial market infrastructure entities and providers, such as central securities depositories, central counterparties, and market operators. It does (p. 2) not address (except in passing) tax and only briefly considers human aspects (at Chapter 18). These are all very important subjects, but each would merit at least a book to itself.

0.006  It is impossible adequately to write a comprehensive treatment of this subject without taking an international view. On the other hand, laws and financial regulations are, for the most part, jurisdiction-specific: any attempt to address all jurisdictions would either be so superficial as to be of little practical use, or would require the involvement of a multi-author team. I am an English law-qualified, London-based lawyer, but have worked predominantly on internationally focused projects throughout my career so far. The technical content of this book is therefore rooted in English law and UK and EU regulation (with occasional forays into US regulation), but always with a view to and sensitivity towards their function within a wider global context. Moreover, most of the general principles addressed in this book are relevant across the globe, especially given the dominant role of the international standards set by the Basel Committee on Banking Supervision (BCBS) and the Financial Stability Board (FSB) in the fields of prudential regulation and resolution respectively.

B.  Structure and Approach

1.  Part I: Corporate Law Foundations

0.007  This book is divided into six parts. Part I is an exposition of the basic corporate law concepts that underpin all subsequent parts. We start, at Chapter 1, by considering the nature of corporate groups: why and how they have come into existence. This provides a conceptual framework to explain the legal and economic tensions that are addressed throughout this book. We then consider some of the ways in which legislators and regulators have defined groups and similar relationships. These concepts form the essential vocabulary for the laws and regulations discussed in this book. Chapter 1 then considers some of the typical features of corporate groups, before concluding with a few high-level observations on the taxation of groups.

0.008  Chapter 2 is an overview of the fundamentals of company law and corporate insolvency law, and consolidated group accounts. The reader will not wish to turn to Chapter 2 for a comprehensive and deep discussion of company law for its own sake, but rather for a clarification of the core legal and accounting foundations upon which the laws and regulations discussed in subsequent chapters are built, free from extraneous details and distractions.

2.  Part II: Prudential Regulation

0.009  Chapter 3 is our first foray into financial regulation proper, in which we are introduced to the basic principles of prudential regulation (with particular focus on capital adequacy requirements). These principles are based upon, and develop the company law and corporate insolvency laws discussed in Chapter 2. The remainder of Part II is an in-depth exploration of how the principles of capital adequacy and other aspects of prudential regulation apply to groups of companies.

0.010  Chapter 4 considers how, on a general basis, these requirements operate at a group level, and explores some of the fundamental issues raised in the prudential supervision of groups. (p. 3) Chapters 5, 6, and 7 consider how these concepts are applied to the core types of financial services groups under UK and EU regulation: under the CRD regime, the Solvency II regime, and the financial conglomerates regime. Chapter 8 continues this approach by considering some of the more obscure types of prudential groups, and how prudential requirements apply to predominantly non-financial services groups and fund structures.

0.011  Chapter 9 concludes Part II by exploring how such principles are applied on a cross-border basis for international groups with multiple regulators, including after Brexit.

3.  Part III: Resolution

0.012  Chapter 10 introduces the basic principles of modern bank resolution. Chapter 11 explores how such concepts are applied to, and indeed shape and are shaped by, groups. This book is not primarily concerned with the mechanisms and legal safeguards associated with resolution per se; rather, it focuses upon how such concerns drive the shape and features of corporate groups in the course of their development and active lives.1

0.013  Chapter 12 looks at minimum requirements for own funds and eligible liabilities (MREL) and total loss absorbing capacity (TLAC): requirements for the pre-positioning of liabilities throughout a group, and which aim to facilitate resolution (by absorbing losses, and enabling the effects of an external resolution action to be pushed down throughout a group). Chapter 13 concludes Part III by exploring how different resolution regimes and resolution authorities interact in the resolution of a group, and the tensions and challenges that may thereby arise.

4.  Part IV: Structural Regulation

0.014  Chapter 14 surveys the close interaction between group structure and prudential regulation/resolution. Specifically, it considers how certain structures may impede supervision, resolution, or bring groups (or parts of groups) outside the scope of supervision altogether. It also considers how the regulators may respond to such structural features, and considers the powers at their disposal to address their concerns. Chapter 14 concludes by introducing the concept of structural separation, as further explored in the remainder of Part IV.

0.015  Chapter 15 is a detailed review of the new UK bank ring-fencing regime: how it evolved, its features, and its practical implications for bank mergers and acquisitions (M&A) transactions. Chapter 16 focuses on parent/holding companies: both those at the top of a group, and at intermediate points within it. It considers the regulatory requirements placed upon otherwise unlicensed holding companies. It also addresses the US bank holding company regime (which bears vestiges of the earlier Glass-Steagall regime), and the Volcker rule. Finally, it takes a look at intermediate parent requirements: a form of geographical structural separation imposed, or soon to be imposed, on the US and EU establishments of large third country groups.

(p. 4) 5.  Part V: Intragroup Arrangements and Management

0.016  Chapter 17 provides an overview of the general company/insolvency law implications of intragroup transactions, and the regulatory pressures placed upon them (including intragroup outsourcing, especially in the light of Brexit). It also considers the impact of affiliations upon financial services firms’ interactions with third parties.

0.017  Chapter 18 briefly looks at the human element of financial services groups. Specifically, it considers how directors’ duties, rules relating to senior managers, and rules relating to the remuneration of financial services professionals operate in a group context, and looks at some of the issues that arise when employees act on behalf of different entities within a group.

6.  Part VI: Practical Applications

0.018  Part VI approaches the themes discussed in this book through the lens of a number of transactions or scenarios that may be encountered in practice, tying these back to the technical discussions throughout the book. Thus, it serves as a conclusion or round-up, but it could also be a reader’s point of entry: a deal lawyer, trying to think through the issues posed by a particular transaction at hand, might wish to start with the most relevant section of Part VI, and follow the cross-references to the technical discussions of the relevant issues in earlier chapters.

7.  Appendix

0.019  The Appendix presents an overview of the different kinds of financial services firms found in the UK and the EU (and their analogues across the world). Understanding how different entities are classified is a prerequisite for comprehending how prudential and resolution-based requirements are applied to the groups to which they belong.

C.  Brexit

1.  The Story so Far

0.020  This book was written under the shadow of Brexit. The idea for this book was originally conceived in mid-2017 (little more than a year after the Brexit referendum), and it was substantially completed in April 2019, mere days after the UK had been scheduled to leave the EU.

0.021  The story so far is only too familiar, but too important to omit. A referendum on the UK’s membership of the EU was held on 23 June 2016. Voters were given a binary choice: ‘Remain a member of the European Union’ or ‘Leave the European Union’. From this choice, 51.9 per cent of voters took the second option. The formal legal process was triggered on 29 March 2017, when Theresa May, the UK Prime Minister, submitted a formal notice to Donald Tusk, the European Council’s President, pursuant to Article 50 of the Treaty on the European Union. Thus, the UK was set on a course whereby it would have left the European Union on (p. 5) 29 March 2019. Mere days before that date, the EU Member States agreed to an extension. As at the date of writing, the deadline has been extended again to Hallowe’en 2019.

2.  The Impact of Brexit on the Substantive Laws Covered by This Book

0.022  The critical political question is, of course, what Brexit will look like: whether hard, or soft (and if so, what kind of soft), deal or no deal (and what deal). However, from this book’s perspective—any kind of Brexit, on whatever terms, looks much the same: certainly, nothing in the EU and Theresa May’s controversial draft withdrawal agreement would have any direct impact on the laws and regulations discussed in this book. This state of affairs is unfortunate (to say the least) for the financial services and ancillary industries, but it does mean that we can predict, and model, the impact of Brexit on the issues discussed in this book with a very high degree of certainty. The only major unknowns are if2 and when (although, one might also add the possibility that the UK leaves the EU, but rejoins or remains in the EEA3).

0.023  Vast swathes of the civil service, regulators, the financial services industry, and their respective advisers (including, it is probably little exaggeration to say, every lawyer working in the City of London and many elsewhere) have spent the best part of two years (in some cases, more) preparing for, and thinking very hard about the technical impacts of a no deal/hard Brexit (which, as mentioned above, would look much the same as any other kind of Brexit, from this book’s perspective). The steps and processes required to operate within, and comply with, such state of affairs may not yet be perfectly implemented, but the substantive legal and regulatory outcome is reasonably clear.

0.024  At one level, the outcome is simple. The law and regulation of the EU and its remaining Member States will remain the same—as, broadly, will the substantive provisions of UK regulation and law.4 The critical differences will be in how the EU, its Member States, and businesses established therein will interact with the UK (and businesses established therein). Again, at one level, this is reasonably simple: we know how third countries, and businesses established therein, are treated under EU law and regulation. From the perspective of the EU and its Member States, the UK will become a third country. From the perspective of the UK—every state in the world will become or remain a ‘third country’. And so one just applies the same old principles on this basis (whilst watching out for the many glitches and exceptions that complicate this basic premise).

3.  Impact on Domestic UK Law and Regulation

0.025  When the UK exits the EU, it will cease to be a Member State of the EU, in accordance with the process outlined in Article 50 of the Treaty on the European Union. That is simple enough, from the perspective of the EU and its Member States: but what effect would this have as a matter of UK domestic law? To answer this question, one needs to consider the present status of EU legislation within the UK, and the domestic statutory mechanisms (p. 6) through which the UK will extricate itself therefrom, pursuant to the European Union (Withdrawal) Act 2018 (hereafter the Withdrawal Act).

0.026  The EU legislation discussed in this book comprises two broad types: directives and regulations. Directives do not have direct effect, but require Member States (to whom their operative provisions are expressed to apply) to implement their requirements through national laws and regulations. In the UK, such directives have mostly been implemented through secondary legislation and by rules and regulations of the regulators. Ultimately, the authority for such legislation and regulation derived from section 2(1) of the European Communities Act 1972 (hereafter the ECA). Conversely, EU regulations are directly applicable across Member States, without requiring national implementation. In the UK, this has been achieved through section 2(2) of the ECA, which provides that all rights and obligations arising under EU regulations are directly applicable in the UK.

0.027  Section 1 of the Withdrawal Act will repeal the ECA with effect from exit day.5 If section 1 were the only relevant provision, then this would terminate the direct effectiveness of EU regulations within the UK and would compromise or invalidate existing UK secondary legislation and regulation implementing EU directives: leaving significant lacunae in the UK’s statute book. However, sections 2 to 7 of the Withdrawal Act will preserve such ‘retained EU law’, primarily by providing statutory authority for the continuing effect of implementing measures and by incorporating directly effective EU regulations (so far as operative immediately before exit day) into UK law and regulation.

0.028  The bare preservation of retained EU law in this manner would result in a number of deficiencies (sometimes referred to as ‘inoperables’). For example, many of the retained EU laws relate to relationships and decisions to be made between Member States or their authorities, or require certain processes and procedures to be effected through the EU constitutional machinery. Such deficiencies would be superfluous at best, and at worst could hamstring the effective operation of the UK legal and regulatory system.

0.029  Therefore, section 8 of the Withdrawal Act authorized the creation of secondary legislation to prevent, remedy, or mitigate such deficiencies. A large number of statutory instruments have therefore been (and continue to be) made to remedy such deficiencies. These are supplemented by similar amendments by the UK regulatory authorities to their rulebooks.

0.030  Thus, until the UK and EU respectively introduce new (or amend existing) legislation, the EU legislation cited throughout this book will remain applicable to both the EU Member States and the UK after Brexit. References to any regulation in this book should therefore be construed (in a post-Brexit situation) to refer to such regulation, as onshored and amended by the legislative framework discussed above.

0.031  The UK’s civil servants and regulators have done a fantastic job preparing for onshoring the corpus of EU legislation or—to quote the Bank of England—‘nationalising the acquis’. But it is inevitable that glitches will remain, only to be uncovered in due course. One of the (p. 7) biggest challenges for a practising lawyer is working out where the rules are. Finding one’s way around the vast body of financial regulation was difficult enough as it was, but tracing the forthcoming amendments through the various statutory instruments and draft rules has made it exponentially harder. Not too infrequently one finds an amendment in an entirely unexpected place, or one finds that a necessary amendment has been omitted, or that an important provision has been deleted by accident. This is only to be expected, and we can be thankful that the regulators have broad powers to make emergency amendments and to construe the new system of law in a pragmatic way.

D.  The EU and EEA

0.032  Many of the EU laws and regulatory measures discussed in this book are relevant to the entire European Economic Area (EEA), rather than the EU alone. The Member States of the EEA comprise all of the EU Member States plus Norway, Liechtenstein, and Iceland. It is common, in practice, to conflate the EEA and the EU when discussing or considering the impact of financial regulation on financial services and businesses across the area. Whilst, for much of the time such approach is serviceable, it overlooks a number of important legal disconnects.

0.033  With no or few exceptions, the EU legislation referred to in this book is expressed to have ‘EEA relevance’. Yet such EU legislation does not actually take effect in the non-EU EEA Member States until it has been incorporated into the EEA Agreement6 by a decision of the EEA Joint Committee, and then (where necessary7) implemented by domestic law—although some Member States, in effect, implement directives prior to their incorporation into the EEA Agreement.8 This is by no means an automatic and swift process. Many of the most important directives and regulations, in force throughout the EU for much of the 2010s, were only incorporated into the EEA Agreement in late March 20199 (meanwhile many such directives and regulations were already on the verge of being significantly amended across the EU, by the banking reform package10). Moreover, from the early 2010s, the European Supervisory Authorities (ESAs) took an increasingly important role in the development of EU financial services regulation, in particular with the development of the single rulebook,11 yet their status and authority were unrecognized across the wider EEA. A series of memoranda of understanding and other soft legal statements and decisions12 gave some substance to the ESAs’ influence over the non-EU EEA Member States, but their authority remains limited, and non-binding.

(p. 8) 0.034  The problem is that the precise impact of the disconnect is unknown, as it is so little seen in practice. True, cross-border and branch passporting of entities between the EU and other EEA Member States is well established and common, but there are simply not enough major financial services groups that are headquartered in Norway, Liechtenstein, or Iceland that have networks of subsidiaries within the EU, and from which a generalized view on how the technical group-related laws covered by this book work, and are interpreted, in practice.

0.035  Norway has traditionally adopted financial regulations that are broadly, but not perfectly, aligned with EU standards, ahead of their formal incorporation into the EEA Agreement.13 However, such implementation is a matter of domestic law, and therefore one must be careful not to draw generally applicable conclusions for the EEA from it.

0.036  In the global financial crisis, the treatment of the failure of Icelandic banks by EU Member States tested many of the key EU-derived financial services laws. However, the regulatory system has changed significantly in the intervening years, and the legal issues that arose were generally limited to a few (albeit very important) concerns and to the interaction between the host and home states of branches. Moreover, the responses from the EU Member States and regulators were largely ad hoc and departed from the norm (witness, for example, the UK government’s decision to compensate depositors of the Icelandic banks). Fundamental issues such as the impact of consolidation, responsibility for consolidated supervision, and resolution are therefore mostly untested.

0.037  This book (like most) takes the easy, but only practical, option of referring generally to EU law and regulation (with occasional explicit reference to the broader EEA). If, following resolution of the Brexit chaos, the UK were to rejoin (or remain in) the EEA, UK lawyers (including this one) will need to up their game and get to grips with the finer intricacies of interactions between firms established in the EU and the wider EEA.

E.  The Banking Reform Package and Investment Firm Review

0.038  Apart from Brexit, the most significant current area of relevant EU regulatory reform is the so-called banking reform (or risk reduction) package, comprising two directives and two regulations: CRDV,14 BRRD2,15 CRR2,16 and SRMR2.17 Each such directive or regulation amends, rather than replaces, its predecessor. As at the date of writing, each directive and regulation has been published in the Official Journal, and some of the provisions—most (p. 9) significantly, those relating to total loss absorbing capacity (see Chapter 12)—have already come into effect.

0.039  The banking reform package is broadly contemporaneous, and sometimes conflated with, the EU legislative review of the prudential regulation of investment firms, comprising a directive (the IFD18) and a regulation (the IFR19). Unlike the banking reform package, the legislation has not yet been published in the Official Journal, but we have near final texts.

0.040  Regardless of the outcome of Brexit, it is highly likely that the UK will follow suit and implement most aspects of the banking reform package and the investment firm regime. Indeed, both packages of draft legislation were specified in the Financial Services (Implementation of Legislation) Bill, as sure a signal as any that the legislators and regulators intended to implement them.

0.041  This book reflects the law as at 11 July 2019, but also addresses the impact, or expected impact, of the banking reform package and the investment firm review.. As the investment firm review legislation has not, at the date of writing, yet been published in the Official Journal, numbered references thereto may diverge slightly from the numbering in the published legislation.(p. 10)


1  For a more detailed overview of recovery and resolution, see Simon Gleeson and Randall Guynn, Bank Resolution and Crisis Management (OUP 2016) and Michael Schillig, Resolution and Insolvency of Banks and Financial Institutions (OUP 2016).

2  If (or for so long as) the UK remains in the EU, then the status quo will remain as is, subject to the ever-changing course of law and regulation: the key upcoming regulatory developments are summarized at 0.038–41.

3  For which, see 0.032–7.

4  The mechanisms by which this will occur are explained at 0.025–30.

5  The Withdrawal Act originally specified this date as 29 March 2019. For each delay to Brexit, domestic amendments to this date were required. See, e.g., the European Union (Withdrawal) Act 2018 (Exit Day) (Amendment) Regulations 2019, SI 2019/718.

6  Agreement on the European Economic Area [1994] OJ L1.3.1.

7  EU regulations must be implemented into Icelandic and Norwegian domestic law (even though, in the EU, they are directly effective). This is unnecessary in Liechtenstein, because its legal system automatically joins provisions of international law into its internal legal order, thus EU regulations become effective upon incorporation into the EEA Agreement. All three jurisdictions must nonetheless implement directives.

8  For Norway, see 0.035.

9  Decision of the EEA Joint Committee No 79/2019 of 29 March 2019 amending Annex IX (Financial Services) to the EEA Agreement.

10  See 0.038.

11  See 5.054.

12  See Council conclusions as approved by the EU and EEA-EFTA Ministers of Finance and Economy on 14 October 2014, and the Multilateral Memorandum of Understanding on cooperation, information exchange and consultation between the EFTA Surveillance Authority, ESMA, EBA, EIOPA (26 March 2018).

13  For a useful summary, see DNB Group Annual Report 2018 104–7.

14  Directive (EU) 2019/878 of the European Parliament and of the Council of 20 May 2019 amending Directive 2013/36/EU as regards exempted entities, financial holding companies, mixed financial holding companies, remuneration, supervisory measures and powers and capital conservation measures [2019] OJ L150/253..

15  Directive (EU) 2019/879 of the European Parliament and of the Council of 20 May 2019 amending Directive 2014/59/EU as regards the loss-absorbing and recapitalisation capacity of credit institutions and investment firms and Directive 98/26/EC [2019] OJ L150/296.

16  Regulation (EU) 2019/876 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 575/2013 as regards the leverage ratio, the net stable funding ratio, requirements for own funds and eligible liabilities, counterparty credit risk, market risk, exposures to central counterparties, exposures to collective investment undertakings, large exposures, reporting and disclosure requirements, and Regulation (EU) No 648/2012 [2019] OJ L150/1.

17  Regulation (EU) 2019/877 of the European Parliament and of the Council of 20 May 2019 amending Regulation (EU) No 806/2014 as regards the loss-absorbing and recapitalisation capacity of credit institutions and investment firms [2019] OJ L150/226.

18  Originally proposed by the European Commission, ‘Proposal for a Directive of the European Parliament and of the Council on the prudential supervision of investment firms and amending Directives 2013/36/EU and 2014/65/EU’ COM(2017) 791 final.

19  Originally proposed by the European Commission, ‘Proposal for a Regulation of the European Parliament and of the Council on the prudential requirements of investment firms and amending Regulations (EU) No 575/2013, (EU) No 600/2014 and (EU) No 1093/2010’ COM(2017) 790 final.