Commission Communication on the Second Banking Directive

After nearly two years of consultation, the Commission has finalised its Communication on freedom to provide services and the general good in the Second Banking Directive (89/646/EEC). Its intention is to explain what it thinks amounts to providing cross-border services and to provide guidance about what restrictions host States may impose on banks as being in the "general good".

The Second Banking Directive

The Second Banking Directive came into force on 1 January 1993. It provides for a single EU-wide banking authorisation (or "passport"). This allows for a streamlined notification procedure where credit institutions (and in some cases their banking subsidiaries) wish to conduct banking activities across borders (right to provide services) or to establish a branch in another Member State (right of establishment).

All of a credit institution's banking activities throughout the EU are subject to the supervision of the authorities in the Member State where its Head Office is located (this is known as "home State control"). "Host States" - those Member States where a bank exercises its right of establishment or its right to provide services - have very limited supervisory functions. They can only insist that a "foreign" credit institution operating there complies with certain rules - rules which they have to justify as being "in the general good".

The Commission published a draft version of this Communication in November 1995 which formed the basis of wide consultation. The Commission says that its conclusion from the meetings with and responses from the banking industry, consumer organisations and supervisors was that there is considerable uncertainty as to the basic concepts of providing services and the general good. Its aim in the Communication is to apply the principles of the European Court of Justice (ECJ) to some of the key concepts in the Second Banking Directive and provide guidance.

Freedom to provide services

The Communication begins with a reminder that all credit institutions must comply with the notification procedure laid down in the Directive before they start to provide cross-border services. It then comments that, since the obligation is to notify only when cross-border services are carried on for the first time, some credit institutions may not need to go through this procedure. These are credit institutions which had carried on cross-border services before the Directive came into force, even if the banking services were only provided on one occasion. The only condition is that the provision of such cross-border services must have been lawful at the time.

The Communication then examines exactly what amounts to providing cross-border banking services. The starting-point is that the activity must be carried on within the territory of another Member State. In other words, the "characteristic performance" of the service, which is the essential supply for which payment is due, needs to be identified.

A key consequence of this characteristic performance test is that commercial canvassing will no longer amount to conducting cross-border services. This is good news. Not only would an intention to conduct business in the form of canvassing have been treated identically from a regulatory perspective to actually carrying on cross-border business, but also a confusing distinction has disappeared. The draft Communication distinguished between advertising in the form of "simple promotion" and commercial canvassing: the former would not have triggered the notification obligation, commercial canvassing would. Yet the way the draft distinguished between the two was at best unworkable, while what credit institutions would have seen as no more than a routine advertising campaign may have amounted to canvassing and necessitated a notification.

How?

The Communication then discusses what amounts to characteristic performance, and therefore conducting cross-border business. It suggests, without clearly saying so, that there is a distinction between characteristic performance and where a customer lives. This means that a bank may have customers resident or domiciled in a particular Member State without conducting (cross-border) business there. When a customer travels to the Member State where the institution is established to receive the service, the Commission considers that the bank does not need to notify. This is also the case where the bank sends a representative temporarily to another Member State either to carry on an activity preceding or following the essential activity in question, such as surveying property before granting a loan.

Less obviously, but perhaps more significantly, the Commission considers that providing banking services over the Internet does not mean that prior notification is necessary because the supplier should not be deemed to be carrying on its activities in the customer's territory.

Establishment or services?

The Commission also tries to shed some light on the murky distinction between a branch and providing services. Different notifications are necessary, depending on whether the credit institution wishes to set up a branch in the host State, or whether it wishes to conduct cross-border services there. But distinguishing the two is not always easy. Referring to the ECJ's case-law, the Communication highlights the main conceptual difference. Providing services is more temporary in nature, whereas establishing a physical presence in the form of a branch has an element of permanence. It then confuses matters rather by saying that there is no reason why cross-border services should not be provided permanently.

The Communication then focuses on a number of problem areas. One is whether and, if so, when independent intermediaries are to be treated as a branch of a credit institution. The Commission considers that the key issues are whether the intermediaries have the authority to bind the credit institution and how much freedom they have. The amount of freedom depends to a large degree on the extent to which they are subject to the control of the credit institution (the more, the more likely they are a branch). In order to be a branch, there must also be an element of permanence.

The Communication reviews the case-law and concludes that, in order to be considered a branch, an intermediary must:

• have a permanent mandate;
• be able to commit the credit institution in relation to third parties; and
• be subject to the management and control of the credit institution he represents. It is therefore necessary to examine whether the intermediary can organise his own work and decide on the proportion of time to work for the credit institution. Another factor is exclusivity: can the intermediary represent more than one competing bank?

This analysis is, however, open to question. Case-law does not support the need to be subject to the management and control of the bank an intermediary represents; in fact, it seems rather to contradict it.

Finally, the Communication discusses the consequences of a failure by the credit institutions to notify, and the consequences of the wrong type of notification. It considers that notification is an administrative procedure and cannot have an impact on the validity of any banking contracts. Tantalisingly, it suggests that one day it will press for the notification procedure to be removed.

The general good

As for the general good, the Commission starts by referring to the key provision in the Second Banking Directive. This states that credit institutions operating either a branch or by way of cross-border services must obey the rules of the host State adopted in the interest of the general good.

The first main difficulty is that the Second Banking Directive does not oblige Member States to provide details of exactly what these rules are. Clearly, this does not make complying with them any easier. Accordingly, the Commission considers that a Member State's regulators should inform incoming credit institutions of the relevant general good rules "in the spirit of the Second Directive".

Since the concept of measures in the general good is not defined in the Directive, the Communication reviews the case-law and confirms that any such measure must:

• protect the general good;
• be non-discriminatory and not confer an advantage on the host State's "own" credit institutions when compared to "foreign" institutions;
• be objectively necessary and not duplicate rules in the credit institution's home State; and
• be proportionate to the objective pursued.

The Communication points out that provisions in the general good cannot be applied to areas which have already been harmonised, such as in relation to the solvency ratio or large exposures. This would amount to duplication. It then analyses each of the general good tests, providing some useful (but nevertheless very general) guidance about how they are to be interpreted.

The Communication comments that EC law does not in general prevent reverse discrimination, which is when a Member State discriminates against banks it authorises in favour of "foreign" banks. It also provides examples of rules which the ECJ has ruled may protect the general good, such as consumer protection, the prevention of fraud, the cohesion of the taxation system and protection of the reputation of the national financial services industry.

The Communication also highlights what is often overlooked. In assessing the proportionality (a sort of reasonableness test) of a host State's restrictions, a different measure applies, depending on whether the restriction is applied to a branch or to the provision of services. In general, less onerous measures should be applied to services business.

Nevertheless, regrettably, the Commission does not comment on the large number of actual restrictions currently imposed on banks by some Member States.

Choice of law

Following the consultation process, the Commission has added a section to the final version of the Communication. This clarifies the relationship between EC law (guaranteeing the freedom of establishment and the freedom to provide services) and mandatory or public policy rules.

Where a bank in one Member State concludes a contract with a consumer in another, even if the parties agree to subject the contract to the law of the bank's Member State, in some circumstances that contract must respect the mandatory rules of the Member State where the consumer is resident. What had always been assumed but was never clarified is confirmed by the Commission, namely that such mandatory rules must comply with the case-law on the general good.

Conclusion

The Commission's decision to consult on its Communication is to be welcomed. It has led to a better text. Certainty is desired by those credit institutions wishing to exercise their passport rights.

Whilst it does not and cannot clarify all areas of doubt and is only a statement of the Commission's understanding of current case-law (which may change) and so is not legally binding, it is nevertheless an important document. At the very least, when a bank is challenged by a Member State to comply with rules that the bank thinks are overly restrictive, the Communication will be a valuable weapon.