Why Asia should hold fire on replicating EU holdco rules

China and Japan should wait for outcome of US regulatory review and Brexit before retaliating

Good things come to those who wait. This is what China and Japan may find in their stand-off with the European Union over the bloc’s proposed rules on holding companies.

The law on so-called “intermediate parent undertakings” (IPUs) was proposed by the European Commission in November 2016. If adopted without amendment, it will require a foreign bank with operations in more than one EU country to place all its businesses in the region under a single IPU, if it is a global systemically important bank or has at least €30 billion ($36.7 billion) in EU assets, which will include branches.

Since then, the Presidency of the European Council has suggested removing the automatic inclusion of G-Sibs, raising the asset threshold to €40 billion and allowing foreign firms to set up two IPUs if their home country requires a separation a wholesale and retail business.

Chinese and Japanese regulators have focused on the original proposal, criticising it for the harm it could do to their banks, given the idiosyncrasies of their operations in the EU, and for the law’s potential to disrupt their banks’ existing resolution plans. For good measure, both countries have thrown in veiled threats to introduce the same rules for foreign banks in their jurisdictions.

But before going through with the threats, China and Japan should wait and see how the following two developments pan out.

First, the US may soften its rules on foreign banks. A US Treasury report last June proposed changes to the current framework, citing the need “to encourage foreign banks to increase investment in US financial markets and provide credit to the US economy”.

The report recommended raising the threshold for compliance with the country’s onerous stress-testing regime, which would bring fewer foreign firms within scope. It also suggested reviewing other regulatory standards that apply to intermediate holding companies, saying that, if the firms’ home-country regulations are sufficiently comparable to US rules, foreign banks should be allowed to meet certain US requirements through compliance with home-country regimes.

If the US goes ahead with such reforms, the EU will look increasingly isolated in its overbearing requirements on foreign firms, and it will be easier for banks to argue that the EU’s stringency is closing off foreign investment. A relaxation of the IPU law will then be more likely.

Second, the IPU rule could look very different post-Brexit. Given the principle of the UK-EU talks that “nothing is agreed until everything is agreed”, the IPU law could be seen as another chess piece being moved in a very messy and complex period of European diplomacy. In the event of a no-deal Brexit, the EU will likely tighten its rules on third-country banks. On the other hand, if a comprehensive exit deal is reached, there is a good chance the final IPU law will be softened further.

Even if the eventual law mirrors the original proposal, it will no longer apply to some Asian banks after Brexit. Once their London-based assets are discounted, they will fall below the €30 billion threshold – provided, of course, they don’t move a large part of their operations to continental Europe by then, to maintain a foothold in the EU.  

Either way, if Asian regulators want to replicate the IPU rule, they should do so after Brexit, not before.

This is not to say they shouldn’t keep their finger on the trigger. The threat of retaliation is an effective way to force the EU to reconsider its rules. But pulling the trigger too soon may only normalise such requirements and undermine any chances of the US and the EU revisiting their approach to foreign banks.

Editing by Olesya Dmitracova