European supervisory authorities publish report on cross-border supervision of retail financial services

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Quick take – more than just a review of retail

The Joint Committee (JC) of the European Supervisory Authorities (ESAs) published a report on the cross-border supervision of retail financial services on July 9, 2019 (the Report). The Report offers insights into the ESAs’ views on the supervision of branches and cross-border financial services (including online services) and contains proposals for future regulatory developments. The Report deals with all types of retail financial services and products, including, for example, securities, funds, banking services, insurance and payment services. Despite the title of the Report, many of the statements made by the JC therein are not limited to retail financial services, but are also relevant for the wholesale business. Firms providing financial services to clients in other member states of the European Union or the European Economic Area (Member States), either on a cross-border basis or via a branch, should therefore carefully consider the statements made in the Report. This Client Alert highlights some of the most important points raised in the Report.

Background

The cross-border provision of financial services and the freedom to establish branches in other Member States is one of the cornerstones of the European common financial market. The provision of financial services in Member States other than a firm’s home Member State raises questions as regards the applicable supervisory regime and the allocation of responsibilities between the national competent authority (NCA) of the host Member State and the NCA of the home Member State. The JC reviewed major EU financial markets directives and regulations such as MiFID2,1 PRIIPS,2 UCITS4,3 AIFMD,4 PSD2,5 CRD46 and the IDD7 and other legislative acts (together, the EU Financial Markets Regulations). It concludes that the rules on branches and the cross-border provision of financial services in the EU Financial Markets Regulations differ from each other and that some important questions have not been dealt with at all.

The Report’s “findings” appear to point to fragmentation and barriers that the EU’s aims to develop the EU’s Single Market for financial services further, whether as a part of the Capital Markets Union project or otherwise, still needs to overcome. It is likely that the JC, and/or other EU-level financial regulatory policymakers, will take action or direct NCAs to take action to reduce fragmentation and improve supervisory convergence. The timing of the Report’s publication, ahead of the EU’s 2019-2024 legislative cycle and new incoming College of Commissioners, points to a number of priority areas that are likely to be on the legislative policymakers’ work programmes. The Report’s findings may also be areas that the ESAs will push ahead as part of their supervisory convergence remit in their respective parts of the EU Financial Markets Regulations. Firms may want to establish strategic scenario plans and take preparatory measures to limit any adverse impacts on their operating models and distribution channels.

Jurisdiction shopping spotted as an issue

The JC emphasizes that the freedom of establishment and the freedom to provide cross-border services should not be misused for what it refers to as “jurisdiction shopping”. This term refers to regulatory arbitrage, i.e. an entity is established and authorised in a Member State for the sole reason because such Member State has less stringent supervisory rules than other Member States, even though the firm intends to conduct business mainly in such other Member States. To prevent such regulatory arbitrage, the JC suggests that firms should only be granted a license in a Member State where they intend to conduct at least part of their business. The JC does not further specify how significant such part would have to be. We would however caveat that the ESAs as well as NCAs and the European Central Bank (acting in its role as head of the Eurozone’s Banking Union and its Single Supervisory Mechanism) have indicated their own views, albeit in the context of their Supervisory Principles on Relocations (SPoRs), on what they consider to be an appropriate location of services in relevant jurisdictions.8

Locking down the location of online services

The JC concludes that there are no rules in EU Financial Regulations which address the question of whether a firm established and authorised in Member State A that offers online financial services (such as an online brokerage or the online sale of insurance contracts) to customers in Member State B is deemed to be conducting cross-border business in Member State B. The consequence would be that the conduct of business rules of Member State B would apply and that the NCA of Member State B would be in charge of supervising the conduct of the firm.

The JC proposes to apply standards similar to those proposed by the EU Commission in its recent proposal on the taxation of a so-called “significant digital presence”.9 This would mean that a firm offering online financial services to customers in another Member State would be deemed to conduct business in such other Member State if the importance of such services warrants their service being regarded as part of the host Member State’s economy. Firms that are affected by this will want to assess what this might mean to digital distribution and delivery models, including what mitigants and fallbacks might be put in place both in documentation and non-documentation workstreams.

Provision of services by a branch and the head office

Typically the branch and the home state entity of a firm may cooperate in providing financial services to clients. Thus, some elements of a service are provided by the branch, while other elements are provided by the home state entity. This leads to confusion as to the rules applicable to such a service, for example whether the conduct of business rules of the home Member State or the conduct of the host Member State apply. The JC therefore recommends that the EU co-legislators introduce new rules providing either (i) that a service to a retail client in the host Member State shall generally be deemed to be provided by the branch, unless proven otherwise, or (ii) that a firm shall clearly disclose to the customer whether the service shall be deemed to be provided by the branch or by the home state entity.

Improving standards applicable to introducing brokers and other third parties involved in the distribution of financial products

The JC notes that some Member States allow the use of third parties other than tied agents and regulated entities (such as introduction brokers) in the cross-border distribution of financial products. Such third parties are not authorised or registered and therefore it is difficult for NCAs to monitor their conduct. The JC expresses the concern that this may give raise to regulatory arbitrage. It proposes that EU co-legislators address this issue and introduce a requirement for the NCA of the home Member State to review the use of third parties before granting a passport for the cross-border provision of services.

Strengthening cooperation in investigations and on-site inspections

The JC also proposes to strengthen the cooperation between the NCA of the home Member State and the NCA of the host Member State in connection with investigations and on-site inspections. For example, when the NCA of the host Member State investigates a firm, the NCA of the home Member State may consider allowing the NCA of the host Member State to conduct such an investigation or on-site inspection itself or let officials of the NCA home Member State participate in such an investigation.

While the JC’s commentary in this area does not (yet) go the way of the ECB-SSM’s work on on-site inspections10 it is certainly quite plausible that the ESA will take a number of actions and/or coordinate with NCAs to improve cooperation as already evidenced by ESMA’s use of its Common Supervisory Action on securities selling across the EU-27.11 We anticipate that this may just be the start of such coordinated investigations across the EU-27 and quite possibly in some of the areas that the Report looks into.

  1. Directive 2014/65/EU of the European Parliament and of the Council of 15 May 2014 on markets in financial instruments, OJ L 173, 12.6.2014, p. 349-496.
  2. Regulation (EU) No 1286/2014 of the European Parliament and of the Council of 26 November 2014 on key information documents for packaged retail and insurance-based investment products (PRIIPs), OJ L 352, 9.12.2014, p. 1-23.
  3. Directive 2009/65/EC of the European Parliament and of the Council of 13 July 2009 on the coordination of laws, regulations and administrative provisions relating to undertakings for collective investment in transferable securities (UCITS), OJ L 302, 17.11.2009, p. 32-96.
  4. Directive 2011/61/EU of the European Parliament and of the Council of 8 June 2011 on Alternative Investment Fund Managers, OJ L 174, 1.7.2011, p. 1-73.
  5. Directive (EU) 2015/2366 of the European Parliament and of the Council on payment services in the internal market, of 25 November 2015, OJ L 337, p. 35-127.
  6. Directive 2013/36/EU of the European Parliament and of the Council of 26 June 2013 on access to the activity of credit institutions and the prudential supervision of credit institutions and investment firms, OJ L 176, 27.6.2013, p. 338-436
  7. Directive (EU) 2016/97 of the European Parliament and of the Council, of 20 January 2016 on insurance distribution (recast), OJ L 26, 2.2.2016, p. 19-59.
  8. Please see our dedicated coverage on ESMA’s recent supervisory expectations on back-branching available here as well as our series on the EU’s SPoRs available here.
  9. Proposal for a Council Directive laying down rules relating to the corporate taxation of a significant digital presence, COM (2018) 147 final.
  10. See coverage from our Eurozone Hub on the ECB-SSM’s finalized rules on on-site inspections and internal model investigations here.
  11. See coverage from our Eurozone Hub here.

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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