Background

The Capital Requirements Directive VI (CRD VI) represents the sixth iteration of the European Union’s prudential regulation framework, which is aligned with CRR III to incorporate the final Basel III standards. The primary objectives of this directive include enhancing financial stability, transparency, and governance, as well as explicitly integrating environmental, social, and governance (ESG) factors into supervisory processes.

Abstract

The Capital Requirements Directive VI (CRD VI) introduces stringent requirements, including output floors for internal models, enhanced fit-and-proper criteria, mandates related to environmental, social, and governance (ESG) risks, and rigorous oversight of branches located in third countries. These modifications impact all institutions based in the European Union and, through extraterritorial applicability, non-European Union banks conducting operations within the EU, such as Canadian financial institutions, including the Royal Bank of Canada (RBC), Scotiabank, and Toronto-Dominion Bank (TD), as well as entities based in Dublin. This article evaluates the provisions of CRD VI and examines the implications for these banks.

Introduction

Originating from the reforms established in the aftermath of the 2008 financial crisis, the Capital Requirements Directive VI (CRD VI) and the Capital Requirements Regulation III (CRR III) enact the final Basel III reforms within European Union legislation, as referenced by dentons.com. This directive enhances the resilience of financial institutions, stipulates governance standards, and incorporates Environmental, Social, and Governance (ESG) considerations into the risk frameworks of banks.

Overview of CRD VI

• Output Floor: Implements a minimum capital requirement through standardised methodologies to restrict internal model variability, applicable at both group and subsidiary levels, with complete execution anticipated by 2032.
• Fit & Proper Requirements: Boards must exhibit independence, possess competence in Environmental, Social, and Governance (ESG) matters, and maintain adequate resources and training.
• ESG Risk Integration: Banks are required to integrate Environmental, Social, and Governance (ESG) considerations into the Internal Capital Adequacy Assessment Process (ICAAP), Supervisory Review and Evaluation Process (SREP), transition planning, and stress testing. Moreover, supervisory authorities are empowered to mandate the mitigation of ESG-related risks, with climate change being explicitly acknowledged as a systemic issue.
• Third-Country Branch Regime: Non-EU banks engaged in core banking activities within the European Union are required to establish a local branch by the year 2026–2027, in compliance with EU-wide authorisation and prudential regulations.
• Transparency: Enhanced disclosures regarding capital, risk exposure, governance, environmental, social, and governance (ESG) risks, and operations in third countries.

Impact on Canadian Banks

• Regulatory Compliance: Canadian banking institutions engaging in operations within the European Union are required to restructure their EU-based activities (such as branches situated in Ireland or Germany) by integrating the Capital Requirements Directive VI into domestic legislation by 10 January 2026, with full enforcement anticipated by 11 January 2027.
• Branch vs. Subsidiary Decisions: In order to sustain market access, non-European Union banks are required to establish authorised branches or subsidiaries, noting that branches encounter more stringent prudential requirements, particularly in the context of systemic risks.
• Capital Planning: Canadian banks will be required to recalibrate their capital buffers to ensure compliance with output floors and new prudential ratios, which may lead to modifications in lending strategies and business models.
• ESG Adoption: Enhanced Environmental, Social, and Governance (ESG) processes and oversight necessitate that banks allocate resources towards ESG governance, data management, and analytical capabilities in order to fulfil Internal Capital Adequacy Assessment Process (ICAAP) and Supervisory Review and Evaluation Process (SREP) criteria, as well as comply with supervisory interventions.

Impact on Dublin-Based Banks

• Regulatory Burden: Institutions located in Dublin are required to implement more rigorous governance practices, enhance capital planning, and improve ESG disclosures, while also adapting fit-and-proper frameworks. Smaller banks may encounter disproportionately high compliance costs.
• Increased Competition: Stricter capital regulations may hinder the ability of smaller firms to compete with larger non-EU banks, particularly in the realm of cross-border services.
• Third-Country Collaboration: Companies providing services to Canadian or UK clients may encounter operational complexities arising from the harmonised supervision of branches within the European Union.

Strategic Responses

• Regulatory Harmonisation: Aligning compliance across jurisdictions, such as Canada and Ireland, to streamline reporting and capital planning.
• ESG Capability Investment: Developing ESG risk frameworks, data infrastructure, and transition planning tools to meet ICAAP/SREP and supervisory expectations.
• Governance Upgrades: Enhancing board training, fit-and-proper protocols, and system-level governance to align with CRD VI requirements.
• Structural Optimisation: Considering whether to establish subsidiaries rather than branches to obtain passporting rights and regulatory clarity.

Conclusion

CRD VI substantially enhances regulatory obligations for financial institutions within the European Union, impacting Canadian banks and entities located in Dublin. Adherence to these regulations by January 2026 is imperative. Financial institutions must adjust their strategic, capital, environmental, social, and governance frameworks to succeed under the heightened expectations established by this directive.

This Article was written by Virginia Dhururu.

References

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