The new legislation on credit finance entities in Spain

NOVEMBER 2015 THE NEW LEGISLATION ON CREDIT FINANCE ENTITIES IN SPAIN ÍNDEX INTRODUCTION 2 LEGAL STATUS: RELATIONSHIP BETWEEN EFCs AND ECs 4 REGULATORY CYCLE 7 CROSS-BORDER ACTIVITY 15 TRANSITIONAL ISSUES 16 APPENDIX: COMPARATIVE CHART 17 LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 2/24 On October 16, the Spanish Ministry of Economy and Competitiveness opened the public consultation process for the draft royal decree (the “Draft Royal Decree”) regulating credit finance entities (establecimientos financieros de crédito, “EFC”) that implements the basic provisions of articles 6 to 14 of the Law on Promoting Business Financing (Law 5/2015, of April 27). The Draft Royal Decree will eventually replace Royal Decree 692/1996, of April 26, on the regulation of credit finance entities, which has given legal support to this type of loan firms by regulating and implementing the brief first additional provision of Law 3/1994, of April 14, aligning Spanish legislation governing credit institutions with the Second Banking Coordination Directive (expressly repealed by the sole repeal provision, paragraph d) of the Law on Promoting Business Financing, Law 5/2015). Despite substantial continuity between the earlier regulation and that provided in Law 5/2015, certain significant changes have been made, in particular on the possibilities available to EFCs, which are not usually fully exploited. INTRODUCTION EFCs represent the last stage in the development process stemming from the fact that the business of granting credit in Spain, unlike in other culturally and geographically close nations (e.g., France and Portugal), is not restricted by law. Though lending is often considered the banking business par excellence, the key feature of banks (and other credit institutions, “ECs”) is, in fact, their ability to take deposits, which is indeed restricted by law both in Spain and in every other country in the world. Banks have not historically provided the full gamut of financial services as they were not authorized to offer certain specialist forms of credit transactions. It was the effect of these operational limitations that left a niche open within the regulated system for certain specialist credit institutions to operate their business within a restricted scope, allowing them to capture savings by using formulas other than current accounts or transactional deposits. Banking barriers have been gradually removed, and limited-scope credit institutions (known in other financial systems as “finance companies”) have steadily converged into a single type of regulated entity subject to official supervision that is allowed to grant credit of any kind but barred from taking savings from the public, except via the appropriate securities market mechanisms: the EFCs. EFCs became, then, a regulated way to conduct a business that is, in general, unrestricted. However, there are sound reasons to prefer using a channel that involves submission to regulatory controls that are almost as strict as those imposed on the banking industry and to the oversight of the Bank of Spain. The first is that accepting the regulatory framework provides certain legal and practical benefits, including the possibility of obtaining funding from the banks under better terms and conditions than those available to the market in WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 3/24 general, and the advantage of access as reporting entities to the Central Risk Information Office, which provides key information to operate in the credit market. The second is the reputational benefit derived from regulatory oversight, which is no small matter given that non-bank credit in Spain has traditionally been a marginal business, though this does not mean that it has not prospered. As the business of lending entails the problem of funding, and given that EFCs are barred from raising funds via deposits or similar products, it is hardly surprising that these firms, with a few exceptions, have thrived as part of larger business groups, whether financial (the major banking groups use ETCs to channel specialist credit products) or non-financial (leading groups in different sectors such as consumer goods and the automotive industry have used EFCs to manage the ancillary business of financing their own sales). Indeed, there are few truly independent EFCs. The legal status of EFCs has always been problematic, although this does not seem to have had serious practical implications. Because they cannot take deposits, they are not, strictly speaking, ECs with the meaning of the term in the relevant EU Directives (which explains the peculiar use of the word “establecimiento” in their legal denomination in Spanish rather than “entidad,” the term used for “institution” in the Spanish translations of the Directives).1 ECs are not, then, subject to harmonized legislation. However, Spanish law considers them credit institutions for all purposes, whether adverse or favorable, because this is what makes them attractive in business terms: prior acceptance of the restrictions inherent to the regulated channel allows access to their benefits. This has resulted in a manifest contradiction between the definition of EC contained in article 1.1 (a) of Royal Legislative Decree 1286/1986, of June 28 (which transposed the definition of “credit institution” from the Directives as “any company that, in the course of its typical and habitual business, obtains funds from the public in the form of deposits, loans, repurchase agreements and similar transactions involving the obligation to return a financial asset, applying the funds to granting loans or making transactions of a similar nature,”) and the list of institutions in section 2 that expressly mentioned EFCs. This terminological confusion raised certain legal concerns that, as mentioned above, do not appear to have had significant effects in practice, given that the use made of this type of firm has generally been fairly limited, given its possibilities. While there is no reason to believe that any major change is likely in the use of these vehicles, it may be worth exploring their new regulation. 1 It would have been clearer to use the term “deposit institution.” In fact, the organizations defined as “credit institutions” in EU legislation are deposit-taking institutions. See the prevailing definition in article 4.1 (1) of Regulation (EU) No. 575/2013, of the European Parliament and of the Council, of June 26, 2013. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 4/24 LEGAL STATUS: RELATIONSHIP BETWEEN EFCS AND ECS EFCs are public limited companies of a special kind, licensed by the Ministry of Economy and Competitiveness to grant loans and guarantees of all kinds and conduct ancillary business, pursuant to reports from the Executive Service of the Commission for the Prevention of Money Laundering and Monetary Offenses (SEPBLAC) and the Bank of Spain and registration in its special register. Since the business of granting credit is unrestricted, the law does not provide for any special reservation of activity in favor of EFCs. However, restriction does exist with regard to their names. Credit finance entities must, and only they can, use the words “establecimiento financiero de crédito” or the abbreviation “EFC” in their names. Treatment as ECs The first additional provision of Law 3/1994, of April 14, expressly stated that EFCs were not ECs. Paragraph 1 read that “credit finance entities will comprise those entities that are not credit institutions (…).” However, section 2 of article 1.1 of Royal Legislative Decree 1286/1996, of June 28, as seen above, provided that “The following will be deemed credit institutions: … e) credit finance entities” (our underlining).” Thus, they were “not” credit institutions but they were “deemed” to be such. However, this conceptualization was not limiting in any way, so it could reasonably be understood that an EFC was a kind of EC. The reason for this apparent contradiction seems to be historical: the legislator was keen to maintain EFCs within the scope of EC regulations by defining them as credit institutions with limited operational scope, a sort of “incomplete bank” or ECs’ “little brother,” but without exposing them entirely to the connections arising from the nomen iuris, given its use in Community legislation. In short, the aim was simply to maintain some ECs as non-deposit taking entities while sidestepping the difficulties arising from the lack a “deposit institution” concept in the Directives.2 In this light, EFCs were to be governed by all EC regulations, except in those matters that were incompatible with their nature.3 Subsequent banking reforms (first, Royal Decree Law 14/2013, of November 29, and then, by omission, article 1 of Law 10/2014, of June 26, on the regulation, supervision and solvency of credit institutions and article 6.1 of Law 5/2015 make it plain that EFCs are not credit institutions. And no prevailing legislation “deems” them to be such or uses any similar turn of phrase. However, article 7.1 of the Law muddies this apparent clarity where it states that EFCs will be governed by the provisions of Law 5/2005 and its implementing 2 This creates both terminological problems and inconsistencies, not only in Spanish legislation but also in other closely related legal systems like that of Portugal. 3 To add to the confusion, numerous regulatory provisions continued to differentiate between credit institutions and credit finance entities as if the former concept did not embrace the latter. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 5/24 regulations, and “in all matters not expressly provided for in such legislation, the applicable legal regime will be that established” for ECs. Sections 2 and 3 continue as follows: “2. In particular, the regulation of significant shareholdings, suitability and incompatibility of senior officers, corporate governance and solvency contained in Law 10/2014, of June 26, on the regulation, supervision and solvency of credit institutions and its implementing regulations, will apply to credit finance entities, as well as legislation governing transparency, the mortgage market, insolvency, and money laundering and terrorism financing prevention in credit institutions. 3. The third additional provision on the regime applicable to transactions involving the total or partial transfer of assets and liabilities between credit institutions of Law 3/2009, of April 3, on structural changes in commercial companies, will apply to credit finance entities.” Meanwhile, article 3 of the Draft Royal Decree provides that the “general” EC regulation will apply on a supplementary basis to EFCs in all matters not specifically regulated. Is saying that the legal regime applicable “will be” that regulating ECs the same as saying that EFCs are “deemed” as ECs? In other words, does the Draft Royal Decree change the legal status of EFCs, or is it merely a change in applicable legislation? Reading the legislation in light of Community law, we would opt for the first conclusion. EFCs are what article 4.1 (26) of Regulation (EU) No. 575/20134 calls a “financial institution,”5 which is something completely different from an EC. Hence, we may understand that by issuing article 7, the legislator has sought, with more or less technical success, to economize in the regulation of EFCs in certain areas which are substantially identical to ECs and, therefore, require the same legislative treatment. However, the legislator has not meant to equate both legislations, nor establish EFCs as a type of EC. This reading is the most consistent with the concept of supplementary provisions. Whereas credit finance entities could formerly be understood as included wherever the law referred to ECs in general, this automatic assimilation is no longer possible. In other words, it will still be necessary to turn to the legislation governing ECs to seek the regulation of matters affecting EFCs that are not sufficiently regulated in their specific legislation, but it will no longer be acceptable to include EFCs wherever the legislation refers to ECs. 4 Regulation (EU) No. 575/2013 of the European Parliament and of the Council, of June 26, 2013, on prudential requirements for credit institutions and investment firms, and amending Regulation (EU) No. 648/2012. 5 This means an institution which is not an EC but conducts one or more business activities typical of an EC. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 6/24 Authorized activities The initial consequence of the above is clearly to reveal the non-harmonized nature of EFCs, pursuant to the EU Directives regulating ECs that are not applicable per se. Therefore, EFCs may not carry out certain activities permitted to ECs under their specific applicable statute. For example, they may not (i) provide payment services, (ii) issue electronic money or (iii) provide investment services.6 The first two can be, however, conducted by hybrid payment and electronic money entities, although the provision of investment services is outside the scope of business accessible to EFCs. To sum up: a) EFCs can grant loans and guarantees of any kind and conduct ancillary or related business. b) EFCs can provide payment services and issue electronic money, provided they obtain the pertinent licenses to operate as hybrid payment and electronic money entities, giving rise to EFC-EPs and EFC-EDEs. All other activities, whether or not financial, fall outside the scope of their authorized activities and constitute administrative infringements. With regard to funding, EFCs are barred from taking deposits (i.e., reimbursable funds from the public), as is the case for any other person or entity, but they may finance their business through (i) interbank loans, (ii) intragroup or shareholder loans, (iii) debt issued subject to the securities market, provided (under the Draft Royal Decree) that such instruments mature in over one month, (iv) borrowings in the mortgage market (by issuing warrants, bonds or equity units), or (v) asset securitization. Regulatory sources The regulatory framework applicable to EFCs is established in Law 5/2015 on promoting business financing and the Draft Royal Decree. While both are more complete than their forerunners, neither is exhaustive, and it is still necessary to supplement their terms with legislation applicable to ECs. Thus, we must turn to other legislation to complete the regulation of EFCs, basically Law 10/2014, Royal Decree 84/2015, of February 13, implementing this Law and Regulation (EU) 575/2013, in particular as regards: 6 ECs are allowed to conduct all of these activities under art. 4.1 a) of the Spanish Payment Service Act (Law 16/2009, of November 13), art. 2.1 a) of the Electronic Money Act (Law 21/2011, of July 26), and art. 65 of the Securities Market Act (Law 24/1988, of July 24), recently consolidated by Royal Legislative Decree 4/2015 of October 23, in vacatio legis at the time of writing). WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 7/24 a) The rules of corporate governance and the regime applicable to directors and senior managers. b) Infringements and penalties c) Solvency rules (and limits on major risk exposure) The Draft Royal Decree also requires future regulatory development by the Bank of Spain and other authorities on accounting matters (although it is unlikely that there will be any significant departure from the rules applicable to ECs) and, mainly, liquidity requirements. For technical reasons, the banking provisions established by Regulation (EU) No. 575/2013 cannot be applied to EFCs, as they are designed for deposit-taking institutions. However, it is necessary to establish certain minimum liquid assets. Hybrid EFCs (EFC-EP and EFC-EDE) will also be subject, cumulatively, to the regulations applicable to payment entities under the Payment Services Act (Law 16/2009, of November 13, “LSP”) and its implementing regulations and to electronic money entities under the Electronic Money Act (Law 21/2011, of July 26, “LDE”) and its implementing regulations, which must be reconciled with general banking legislation at all times. Therefore, EFCs are subject to legislation that refers separately to CEs, whether or not it specifically targets them, including, in particular, regulations on the prevention of money laundering and terrorism financing. In the new legislative framework, we do not believe that any regulation applicable to ECs should automatically apply to EFCs. Rather, there must be specific grounds requiring the supplementary application of EC legislation, or the regulations to be applied to EFCs must expressly include EFCs. This is the case, for instance, with tax regulations, which expressly establish a similar regime for EFCs as that applicable to ECs. Moreover, article 29.2 of the Draft Royal Decree provides that guidelines issued or adopted by the Bank of Spain will not be automatically applicable to EFCs, but rather the regulator is required to expressly indicate which rules are applicable and which are not. REGULATORY CYCLE Licensing and registration The Ministry of Economy and Competiveness authorizes EFCs, pursuant to reports from the Executive Service of the Commission for the Prevention of Money Laundering and Monetary Offenses (SEPBLAC) and the Bank of Spain in their respective areas of competence. The Bank of Spain continues to keep the special official register of EFCs and their senior officers, and registration is mandatory before they can start operating. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 8/24 A single license will be issued for a hybrid EFC, either an EP or EDE, but, in addition to the general requirements, they must comply with those of the Payment Services Act or the Electronic Money Act, as appropriate. The requirements established by the Draft Royal Decree to obtain a license are, in general and with little variation, in line with those applicable to any regulated financial intermediary, depending on the reality of each business: a) The applicant must be duly incorporated as a public limited company (sociedad anónima) with indefinite duration following the simultaneous incorporation procedure. The company must be a newly created entity; as an exception, an organization already incorporated as a bank7 may seek a license as an EFC. b) The company’s corporate purpose must be limited to the activities proper to an EFC and, where appropriate, those of an EP or EDE. c) The company must have its registered office and maintain effective management and administration in Spain. d) The company must have a minimum share capital of €5 million, issued as registered shares fully paid up in cash. e) Shareholders must be qualified by their significant shareholdings, defined under the same terms applicable to banks and, in general, other financial sectors, i.e., directly or indirectly representing 10% or more of capital or voting rights, or a percentage sufficient to allow the exercise of significant influence. f) The board of directors must have at least three duly qualified and experienced members. These requirements extend to the directors of the parent company where it is a financial holding company or a mixed financial holding company,8 and they also apply to chief executives and any other persons who, under EC regulations, hold key offices in the entity (or in the parent company when it meets the above conditions). The minimum number of directors (which is a regulatory matter) remains unchanged in the Draft Royal Decree compared to the 1996 regulation, although in practice, it will be necessary to reconcile it with corporate governance requirements and the need to make room for independent directors and set up committees. 7 Also, by extension, a credit cooperative. 8 That is, a parent company required to consolidate due to its activity under Regulation (EU) 575/2013. See sections (26) and (27) of article 4.1. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 9/24 g) The company’s administration and accounting structures must be properly organized, and it must have appropriate controls in place to ensure sound and prudent management and adequate procedures to prevent money laundering or terrorism financing. The incorporation procedure is very similar to the existing one and to the procedure followed for licensing of any other financial intermediary, depending on the specifics of each case. The documentation supporting the above requirements, the initial list of shareholders (and in case of corporations, beneficial owners holding a share capital of 5% or more), the business plan and the document supporting the deposit of a minimum 20% of share capital with the General Public Depository must all be filed in duplicate with the Office of the Secretary General of the Treasury and Finance Policy. The Ministry of Economy is required to obtain the pertinent reports and issue a decision within three months after all documentation has been submitted (other items may be added to the minimum legal documentation requirements), and, in any event, within 12 months of receiving the license application. Administrative silence will be interpreted as rejection. For EFC-EPs and EFC-EDEs, a single license will be issued and in a single procedure. As mentioned above, the specific requirements of EPs and EDEs, as the case may be, will be added to the general requirements. Transactions subject to subsequent approval In consonance with ECs and other financial intermediaries, any operations having a significant impact on the initial circumstances accredited to obtain authorization are subject to approval by the Ministry of Economy or the Bank of Spain. Thus: a) Amendments to an entity’s bylaws must be subject to the Ministry's approval, except where such changes are minor or required by law, in which case they must be reported to the Bank of Spain. The Ministry will have two months to approve changes after all documentation is submitted. In this case, however, administrative silence will be positive. b) Acquisition of significant shareholdings is subject to the absence of any prior objection on the part of the Bank of Spain under the conditions applicable to ECs. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 10/24 c) Any of the structural changes defined in Law 3/2009, of April 3,9 will be subject to prior approval by the Ministry of Economy (including partial transfers of assests and liabilities as provided for in the third additional provision,10 which is expressly applicable to them). Article 10 of Law 5/2015 is silent with regard to “similar operations” (literally, agreements “with similar financial or legal effects to the foregoing”), stating only that “mergers, spinoffs, or total or partial transfers of assets and liabilities involving a credit finance entity will require approval by the Ministry of Economy and Competitiveness, in accordance with the regulatory procedure established.” However, article 15.1 of the Draft Royal Decree, transposing the 12th additional provision of Law 10/2014 (which could be technically improved), provides, probably overzealously and perhaps to be corrected, that official authorization will be required not only for mergers, spinoffs, and transfers but also for “any agreement having similar financial or legal effects.” The Draft Royal Decree seeks, then, to apply to EFCs the above banking provision, which we consider less than beneficial even in the original law. At least the procedure is less exacting, as the limit for approval is six months, provided the operation only affects the EFC, as the terms of the 12th additional provision of Law 10/2014 would apply in full if an EC were involved Ongoing obligations The daily operation of an EFC is (and will continue to be) subject to very similar regulatory framework to that of banks, as expected in view of the similarity of their businesses. In addition to the oversight of the Bank of Spain and the SEPBLAC, EFCs are also subject to the following ongoing obligations, among others: a) Until such time as any specific rules may be issued (secondary regulation is provided for in article 13.2 of Law 5/2015), credit finance entities are required to continue applying accounting standards applicable to banks, and there seems, in fact, to be no technical reason why they should differ, especially as regards loan provisions. b) They must maintain their equity and observe the limits on major risk exposures established for credit institutions by Regulation (EU) 575/2013, although these rules are to some extent relaxed where an EFC is considered to be an SME,11 in which case it is not required to set aside any anti-cyclical or other equity “cushion.” 9 The law mentions “merger, spinoff, and en bloc or partial transfer,” but it excludes transformation. An EFC can only be transformed into a credit cooperative, as transformation into a bank would entail a regulatory change in the bylaws but not a commercial change. We understand that it would likewise be impossible to relocate the company’s registered office abroad and maintain the Spanish license, for obvious reasons. 10 This additional provision would apply whether both the transferor and the transferee are ECs, whether both are EFCs, or whether one is an EC and the other an EFC. 11 In accordance with Commission Recommendation 2003/361/EE, of May 6, 2003. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 11/24 If an entity is also an EP or EDE, the solvency requirements established by the LSP or the LDE are applicable. These requirements will be cumulative. However, we must underscore that since EFCs are not ECs, they are not directly subject to Regulation (EU) 575/2013, as they fall outside of its scope, and are only subject to Spanish legislation. At least in theory, then, the solvency requirements applicable to EFCs could be regulated by Spanish law, departing from the EU standard. This is unlikely to happen, however, not only for technical reasons but also because it would jeopardize the declaration of equivalence included in the fifth additional provision of the Draft Royal Decree. This peculiar declaration (“This Royal Decree subjects [EFCs] to a licensing, supervisory and prudential regime comparable in terms of stringency [to that applicable to ECs]”) is technically significant as it allows ECs to deal with EFCs as if they were ECs for multiple purposes. Accordingly, ECs may (i) apply the capital requirements of ECs to their exposures to EFCs; (ii) grant EFCs credit subject to the same limits as if they were ECs; and (iii) treat them as bank affiliates for the purposes of prudential consolidation. c) They are required to report the same solvency statements as ECs to the Bank of Spain, under the Commission’s Implementing Regulation (EU) 680/2014, of April 16, 2014, although less frequent reporting may be required. d) They are not subject to bank liquidity requirements. Instead, they will be subject to specific requirements whose technical contents are yet to be established. e) Under regulation one, section 1 a) of Bank of Spain Circular 1/2013, they are required to report to the Central Risk Information Office and, therefore, may use its database. f) They will be subject to identical corporate governance and remuneration control standards as banks, and the same incompatibility regime will apply as to senior bank officers. In particular, their boards will be required to set up a risk committee and an appointment committee. Furthermore, as “public interest entities” (subject to supervision by the Bank of Spain) under article 3.5 a) of the Spanish Auditing Act (Law 22/2015, of July 20),12 EFCs will be required by the 3rd additional provision of this Act to set up an audit committee, unless an exception is applicable.13 Under article 38.3 of Law 10/2014 for small entities, if the Bank of Spain authorizes it, this committee may also act as the risk committee. 12 In vacation legis at the time of writing. 13 For example, where the credit finance entity is considered an SME. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 12/24 As the membership of these committees must include independent directors, it follows that EFCs will have to appoint independent directors to their boards. All of these obligations are subject to administrative oversight, and the sanctions regime established by Law 10/2014 for ECs will apply. Accordingly, EFCs, their directors, executives and significant shareholders may face pecuniary and non-pecuniary sanctions, which may include loss of license to operate. Once again, EFC-EPs and EFC-EDE will have to add to their regulatory picture, including that established for infringements and penalties, the provisions contained in the LSP and the LDE, which will be fully applicable to the hybrid EPs and EDEs, respectively. Specific mention of consolidated groups Given that the Draft Royal Decree refers to the entire Regulation (EU) 575/2013, we must conclude that solvency requirements will apply on a consolidated basis, notwithstanding any individual requirements where appropriate. From the standpoint of Regulation (EU) 575/2013 (article 4.1 (26)), EFCs are “financial institutions” and, therefore, their business can be consolidated with that of CEs and, we might add, with other organizations subject to solvency requirements in other sectors. To date, the most common types in the Spanish systemhave been: a) EFCs affiliated to banks and, therefore, part of their groups. These EFCs benefitted in the past, and in fact continue to benefit, from less demanding treatment, and they could even be completely exempt from compliance with prudential requirements on an individual basis. b) EFCs affiliated to industrial groups, which were formerly treated as standalone entities for prudential purposes, despite consolidation for accounting purposes. However, there are, or there may be, “consolidated EFC groups” (in fact, the Draft Royal Decree mentions them): a) Groups whose parent company is an EFC; b) Groups having a financial or mixed financial holding company as their parent company; or c) Groups having a presence in various sectors in which an EFC is the parent company or, if not, the most relevant entity. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 13/24 It would also be possible to imagine financial conglomerates centered on an EFC, although this is purely hypothetical. In all of these cases, we understand that the regulatory treatment applicable to the “consolidated EFC group” would be exactly the same as for a “consolidated EC group.” Corporate crisis and market exit One of the key issues distinguishing the regulation of EFCs from that of CEs is that of corporate crisis. A whole new body of law on ECs has swiftly developed in Spain in recent years, beginning with Law 9/2012, of November 14, and leading to Law 11/2015, of June 18, on credit institutions and investment firms’ recovery and resolution14 (“Law 11/2015”). This legislation could be described as a body of “para-insolvency” law, as a result of which CE’s corporate crises, in all or some of their phases, will usually be managed outside the channels of ordinary commercial law in procedures subject to administrative oversight. This para-insolvency channel combines with other specific insolvency provisions (special conditions applicable to insolvency procedures) including exclusion from the general regime established by the Insolvency Regulation15 to apply a specific Directive16 transposed into Spanish law via Law 6/2005, of April 22, on restructuring and winding-up of credit institutions (“Law 6/2005”). While the rather unfortunate wording of article 7 of Law 5/2015 leaves room for doubt, especially where it mentions the “insolvency regime” in paragraph 2, we understand that: a) The special bank restructuring and resolution regime should not be considered applicable to EFCs, unless they are EC affiliates under article 1.2 of Law 11/2015, basically for the following reasons: o Reference to EC legislation as supplementary must be construed under the specific terms of that relationship, i.e., the law governing ECs may be invoked to cover any gaps in EFC legislation, but it is no longer acceptable (if it ever was) simply to read EFC where the law says EC. o The ratio legis allowing special legislation for ECs does not apply to EFCs. Given their nature, EFCs do not conduct the activities of ECs that would make it advisable to manage corporate crises in extra-insolvency proceedings. It is true that an EFC could become “systemic” in the broad sense of “important” for the economy, but only in the same terms as 14 Transposition into Spanish law of Directive 2014/59/EU, of May 15, 2014. 15 Regulation (EU) 1346/2000, of the Council, of May 29, 2000, on insolvency proceedings. 16 Directive 2001/24/EC of the European Parliament and of the Council of April 4, 2001, on the reorganization and winding-up of credit institutions. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 14/24 entities in other sectors, whose failure must follow ordinary insolvency proceedings. o Law 5/2015 itself excludes EFCs from application of article 30 of Law 10/2014, i.e., these entities are not required to have a “viability plan” and are not subject to the “measures provided in article 24 of Law 9/2012,” (preliminary measures), references that we believe must be construed, respectively, to the recovery plan and early action under the Law 11/2015. It does not seem reasonable to understand that the legislator would have wanted to apply the restructuring regime for CEs to EFCs, after clearly excluding them from the least costly restructuring procedures. o Finally, the prevailing regime is transposition of Directive 2014/59/EU, of May 15, 2014, article 1 (whose wording is identical to article 1 of Law 11/2015) that clearly states that it applies to CEs, CE affiliate financial institutions or holding companies, but not to financial institutions such as EFCs. Aside from the relevant question as to whether EFCs should be considered subject to Law 11/2015, which, we insist, they should not, this matter has undeniable practical consequences: EC liabilities are potentially subject to “internal recapitalization” (bail-in), while EFCs are not (unless they are EC affiliates). b) The same conclusion cannot be drawn on the “insolvency regime” because article 7 of Law 5/2015 expressly states, among other matters, that EFCs will be “specifically” subject to the “insolvency regime” applicable to ECs. However, this reference to the insolvency regime must necessarily exclude Law 6/2005, of April 22, as this is a private international law applicable strictly to CEs (article 1 already excluded EFCs) and the concept of CE must therefore be construed strictly in line with the directives. Hence, we understand that the reference to the “insolvency regime” relates to the “special insolvency procedures,” meaning those specific procedures established by the Insolvency Act or other legislation potentially applicable to ECs in the event of insolvency. The issue of court-appointed administration and replacement of directors as provided in Law 10/2014 is another matter, as these are not in themsevles financial restructuring measures but rather precautionary measures applicable within the framework of banking oversight, even though they may often be applied in connection with restructuring measures. There is no reason here to assume that the Bank of Spain should be deprived of such tools in relation to regulated entities for which a ratio legis indeed exists, at least as regards justification for their regulation. Court-appointed administration and the replacement of directors are not WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 15/24 sanctions per se, so lack of any legal cover via an express mention in Law 5/2015 is not, therefore, an unsolvable obstacle. CROSS-BORDER ACTIVITY If EFCs did not meet the definition of ECs established by EU Directives, it made sense that they should not enjoy the right to establish branches or freely to provide services. This did not mean that EFCs could not operate outside Spain (or that other financial institutions could not do so in this country), but rather that their operations were subject to the regulation established for entities in third countries. Accordingly, they were subject to dual licensing, at home and abroad. Spanish banking regulations (i.e., Royal Decree 1245/1995) were consistent with this approach and, indeed, only envisaged the equivalence of EFCs with ECs, as in Royal Decree 84/2015 currently in force, in the case of EFCs “through which” an EC operated (i.e., EFCs wholly, or almost wholly, owned by ECs and operating not under their own “passport” but under the delegated “passport” of the parent EC). This way, Spanish regulations were aligned with the EU rule for financial institutions now established in article 34 of Directive 2013/36/EU, of June 26, 2013, and formerly in article 24 of Directive 2006/48/EC and other preceding legal texts. Matters were rather more complex in practice. Because of the terminological confusion in Spain (and in other countries), EFCs could present themselves as ECs and invoke rights under their own passports with some legal basis, as they could build an argument in this regard because they were “deemed” ECs. This issue has become clearer now that EFCs are no longer to be considered ECs: a) EFCs meeting the conditions established in article 34 of Directive 2013/36/EU, of June 26, 2013, (or their foreign counterparts in Spain) will be authorized to operate under a “delegated passport” as “indirect activities” of the parent EC. Aside from the requirement that one or more ECs hold a minimum 90% stake, EFCs must also be consolidated and effectively subject to consolidated supervision. b) Other EFCs may operate abroad through the channels established in articles 20 and 21 of the Draft Royal Decree, provided they are authorized to do so under the laws of the host country. Opening branches (or freely providing services) is not considered a right, but rather the Draft requires filing an application with the Bank of Spain “notwithstanding any possible application” that may be required in the host country. The creation or acquisition by a Spanish EFC of any ownership interest in an EC or EFC outside the EU is subject to approval by the Bank of Spain. Likewise, the acquisition of an ownership interest or the creation of an EFC in the WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 16/24 European Union will be governed by the terms of “significant shareholdings” in banking regulations, which may not be easy to understand but seems to indicate that the acquisition must not be opposed by the Bank of Spain or the regulator in the host country. Hybrid EFCs (i.e., EFC-Eps and EFC-EDEs) will have their own passports as EPs and EDEs respectively. TRANSITIONAL ISSUES EFCs operating on the entry into force of Law 5/2015 but not providing payment services (or issuing electronic money) are not required to take any action beyond adapting their regime internally as necessary, which they were, in any case, required to do since the entry into force of Law 10/2014. EFCs providing payment services (or issuing electronic money) had six months to adapt to the regime established for hybrid entities under the third transitional provision of Law 5/2015 and to provide proof of adaptation to the Bank of Spain, without having to reapply for a license. If an EFC failed to provide proof of having adapted within this six-month period (which expired on October 28, 2015), it would lose its right to continue providing payment services (or issuing electronic money). EFCs have the possibility at any time of transforming themselves into banks, and credit cooperatives despite the absence of any precedent, by applying the procedure established in the fourth additional provision of Royal Decree 84/2015, of February 13. In essence, this entails a new license, although, logically, certain requirements are adapted the reality of the existing company, and we can assume that experience would be taken into account to speed up the process. The Draft Royal Decree also provides for the same process to be carried out in reverse and transform banks into EFCs. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 17/24 APPENDIX: COMPARATIVE CHART WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 18/24 TOPIC LAW 3/1994 and ROYAL DECREE 692/1996 LAW 5/2015 and DRAFT ROYAL DECREE SCOPE OF ACTIVITY Despite the complete lack of consistency in the treatment as ECs, 17 Law 3/1994 and Royal Decree 692/1996 listed as authorized EFC activities: a) Granting loans and credit, including consumer loans, mortgage loans and credit to finance commercial transactions. b) Factoring with or without recourse, and ancillary activities. c) Financial leasing and ancillary activities. d) Issuing and managing credit cards. e) Granting sureties and guarantees. f) Payment services.18 The possibility that EFCs might engage in asset securitization was considered, and they were prohibited from taking reimbursable funds from the public, except from securities issued under the Securities Market Act. Law 5/2015 expands the scope of EFCs’ activities to include inverse mortgages and specifically regulated EFCs providing payment services or issuing electronic money (“Hybrid Entities”), establishing a single licensing procedure under the authority of the Ministry of Economy and Competitiveness, and a specific nomenclature (“EFC-EP” and “EFC-EDE”) that may be optionally included in the entity’s corporate name. The Draft Royal Decree establishes the process for licensing of such Hybrid Entities, placing the companies so licensed under dual regulation as EFCs and as payment entities (“EP”) or electronic money entities (“EDE”), as appropriate. It also provides for situations in which a company’s status as an EFC, EP or EDE may be terminated, revoked or expired. 17 Article 55 of the former Credit Institutions Oversight and Control Act, introduced by Law 3/1994 and the First Additional Provision of this Law, defined EFCs as “entities which are not credit institutions”. However, article 1 of Royal Decree 692/1996 establishes that “credit finance entities will be deemed credit institutions.” 18 The provision of payment services was not included in the wording of Royal Decree 692/1996. However, the possibility that EFCs might conduct this business was established by article 52 by reference to article 55 of the Credit Institutions Oversight and Control Act, both introduced by Law 3/1994, and in the amendment of the 1st Additional Provision of this law introduced by Law 16/2009, of November 13, on payment services. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 19/24 LICENSE, REVOCATION, WAIVER AND EXPIRATION Procedures for granting licenses, and their revocation, waiver and expiration are unsystematically regulated by Royal Decree 692/1996:  Competence for the authorization process is the Bank of Spain’s, subject to a prior report from the Executive Service of the Commission for the Prevention of Money Laundering and Monetary Offenses (SEPBLAC).  Revocation is regulated by reference to noncompliance with the requirements for the conduct of business established in article 5.1, and the procedure refers to the former ECs Oversight and Control Act.  The only mention of waiver of the condition of EFC is the return of the deposit paid to the Bank of Spain required in the license application.  Expiration (erroneously referred to as “revocation” in article 3.3 in fine) occurs where a period of one year elapses from the date of authorization before an EFC starts up its business for reasons attributable to its promoters. In the case of authorization for EFCs controlled by a foreign owner, article 4 of Royal Decree 692/1996 distinguishes between the party exercising control (bank, investment firm, insurance or reinsurance Law 5/2015 returns the licensing authority to the Ministry of Economy and Competitiveness, as originally envisaged in the First Additional Provision of Law 3/1994 and article 3.1 of Royal Decree 692/1996. Before licensing an EFC, the Ministry of Economy and Competitiveness will obtain prior reports from the Bank of Spain and the SEPBLAC on matters of their competence. The Draft Royal Decree regulates and structures the procedures for licensing, revocation, waiver and expiration, maintaining, in essence, the regulation established in Royal Decree 692/1996 and with reference to Law 10/2014 on matters not expressly provided for. To authorize EFCs controlled by a foreign owner, the distinction is maintained depending on whether the controlling party is licensed or registered in the EU, and the scope of application is extended to include electronic money entities. Finally, the Draft Royal Decree exempts EFCs from the time limits on the business of new banks established by article 8 of Royal Decree 84/2015, of February 13. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 20/24 institution, individuals or corporations, whether or not licensed or registered in a member State of the EU):  Where licensed to operate in the EU, the Bank of Spain will consult with the supervisory authorities responsible for the credit institution, investment firm, or insurance or reinsurance entity which will control the Spanish credit finance entity.  Where not licensed to operate or registered in the EU, the Bank of Spain may require guarantees covering all activities for which licensing is sought in Spain. SUPERVISION AND SOLVENCY Under Law 3/1994, control and inspection of EFCs was assigned to the Bank of Spain, which it continued to discharge after the repeal of the Fist Additional Provision of this Law, despite the absence of any similar mention in Royal Decree 692/1996. With regard to the solvency requirements applicable to EFCs, the conditions established for ECs in the Oversight and Control Act applied on a supplementary basis in the absence of implementation through Royal Decree 692/1996. Law 5/2015 ratifies the Bank of Spain’s supervisory function with respect to EFCs and establishes that it will be discharged under the provisions of Part III of Law 10/2014. However, this is not a blanket reference to this law but rather provides that a series of regulatory adaptations to the regime must be developed and, in any event, it excludes EFCs from application of: a) Article 30 of Law 10/2014 and part six of Regulation (EU) 575/2013 on the obligation to draw up a general viability plan; and b) Articles 44 and 45 of Law 10/2014 on the obligation to maintain an equity cushion and an anti-cyclical cushion in the case of SME EFCs. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 21/24 Nevertheless, EFCs are required to hold a minimum volume of liquid assets sufficient to enable them (i) to cover any potential outflows of funds arising from liabilities and commitments; and (ii) to maintain adequate funding sources and of maturity of assets, liabilities and commitments. Articles 26 and 27 of the Draft Royal Decree regulate these legal mandates as follows:  Solvency obligations: The provisions applicable to ECs established in Part II of Law 10/2014 and Part II of Royal Decree 84/2015 will apply to EFCs, subject to exceptions in the case of EFCs that are part of a consolidated group, and those that are SMEs. In the case of EFC-Eps and EFC-EDEs, the Draft Royal Decree differentiates between equity pertaining to the different business areas.  Minimum volume of liquid assets: EFCs are required at all times to maintain a sufficient cushion of liquid assets of high credit quality to cover net cash outflows during any period of severe financial instability. This cushion must be equal to expected net cash outflows for a period determined by the Bank of Spain, and it may not be less than a given proportion of gross cash outflows anticipated for such period. The Draft Royal Decree also enumerates the assets that can be included in this cushion, i.e., cash and available in credit facilities subject to certain requirements. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 22/24 STRUCTURAL CHANGES Royal Decree 692/1996 merely includes a brief mention of mergers involving two or more EFCs in article 10. With regard to the procedure, the competence is removed from the authority with general responsibility (the Bank of Spain) and placed with the Ministry of Economy and Finance (currently Ministry of Economy and Competitiveness),19 and it refers to the licensing process but extends the decision period to three months (compared to two months for the licensing process). Law 5/2015 refers more broadly to operations involving structural changes, defined as mergers, spinoffs and total or partial transfers of assets and liabilities, as regulated by the Third Additional Provision of Law 3/2009 on the regime applicable to mergers, spinoffs and the total or partial transfer of assets and liabilities between ECs. While Royal Decree 692/1996 limited mergers to “two or more EFCs,” Law 5/2015 and the Draft Royal Decree allow the intervention of other kinds of entities in such operations when referring to “mergers, spinoffs and the total or partial transfer of assets and liabilities involving an EFC.” Both Law 5/2015 and the Draft Royal Decree assign competence to the Ministry of Economy and Competitiveness, providing continuity with the process for licensing, revocation and waiver, referring to the first of these procedures with regard to the process and extending the decision period to three months. Applications for authorization to undertake structural changes will be addressed to the Office of the Secretary General of the Treasury and Finance Policy, and once approval has been granted and the change has been recorded in the Companies Register, it will be recorded in the Bank of Spain’s Register of EFCs. 19 This shift in competence is evident in article 7 on the rejection of license applications, which suggests that the lack of internal consistency in Royal Decree 692/1996 as regar ds the matter of competence could be due to a lapsus calami on the part of the legislator when the competence to license credit finance entities originally assigned to the Ministry of Economy was amended by Law 54/2005, of January 21, and passed on to the Bank of Spain. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 23/24 CROSS-BORDER ACTIVITIES Articles 50 and 55 of the ECs Oversight and Control Act, introduced by Law 3/1994, extended to EFCs the regime applicable to the opening of branches and free provision of services by Spanish EFCs in member States of the EU “subject to regulatory adaptations as may be established,” as well as the regime for the opening of branches and free provision of services in Spain by ECs registered in other EU member States. However, Royal Decree 692/1996 did not carry out the legal mandate to implement specific regulations governing these regimes as extended to EFCs. Article 20 of the Draft Royal Decree regulates cross-border activities by Spanish EFCs in other member States of the EU, requiring authorization from the Bank of Spain to open a branch and prior notice for starting the free provision of services. Article 21, meanwhile, regulates the creation and acquisition of significant shareholdings in credit and similar institutions registered in other EU member States and in non-EU states by Spanish EFCs, for which the regulations established for significant shareholdings in Part I, Chapter II of Royal Decree 84/2015 apply in the first case. The creation of a credit or similar institution in a non-EU state requires an application for approval by the Bank of Spain. WWW.CUATRECASAS.COM LEGAL UPDATE I BANKING, INSURANCE AND FINANCIAL INSTITUTIONS 24/24 © 2015 CUATRECASAS, GONÇALVES PEREIRA. All rights reserved. This newsletter contains a selection of news and information prepared by Cuatrecasas, Gonçalves Pereira. This information does not constitute legal advice in any of our professional practice areas. The intellectual property rights to this newsletter belong to Cuatrecasas, Gonçalves Pereira. 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