The great and the good of the European political and
financial communities came together in Brussels last month to discuss the
European Commission’s Green Paper on Shadow Banking previously released in
March.
Conference moderator Gillian
Tett (US Editor of the Financial Times) billed the event as the regulatory
equivalent of a Lady Gaga concert as it was the hottest ticket in town.
Over 200 people gathered to listen to senior policymakers
from the region’s central banks & national regulators, as well as prominent
politicians, trade unionists, financial market representatives and academics.
Opening the conference was Michel Barnier, Member of the European Commission for the Internal
Market and Services who outlined the theme of the conference ‘‘Towards better
regulation of the shadow banking system’’.
Barnier commented that he wanted to make shadow banking one
of his main priorities for 2012; it was not about penalising players in the
shadow banking system who play an important role in financing the real economy.
He described the aim of the consultation paper was to obtain a clear definition
of shadow banking – this was a key topic throughout the day as each and every
speaker or commentator offered many differing viewpoints on the term ‘‘shadow
banking’’.
Barnier referred to the recent work carried out by the
Financial Stability Board (FSB) Task Force on Shadow Banking that had
identified two key areas that required regulators’ attention: securitisation
and securities lending or borrowing with repurchase (repo).
In addition to clarifying the definition of shadow banking,
he outlined that the other objectives of the Green Paper were to:
- Review the numerous measures already adopted in relation to certain activities and players in the shadow banking system.
- Enable the Commission to consult all concerned stakeholders.
- Aim to assess the risks presented by "shadow banking" and list the issues that need to be addressed.
Barnier then focused on what he hopes to achieve by regulating
the shadow banking system and established four general principles:
- Ensure that regulators and supervisory authorities can have a complete overview.
- Not to repeat the mistakes made of previous regulatory regimes - the aim this time around is to prevent rather than cure.
- Be very careful not to call into question the alternative financing chains, which complement bank lending and are of direct benefit to the real economy.
- Ensure consistent regulation across the various financial sectors to avoid any form of supervisory arbitrage.
Barnier closed by saying ’’All these elements are to be used
as a starting point for targeted sectoral consultation exercises, which will
most probably be followed by proposals for regulations. The aim is to have
these measures take effect as early as possible, chiefly to avoid too great a
time-lag in relation to the Basel III rules and the European Market
Infrastructure Regulation (EMIR).’’
The second keynote of the morning was given by the Bank of
England’s Paul Tucker, Deputy Governor,
Financial Stability, Member of the Monetary Policy Committee and Member of the
Financial Policy Committee. Tucker gave an insight into some of the proposals
that might be considered for a concrete policy agenda on shadow banking
regulation.
He started off by framing the term shadow banking employed
by the FSB and the EU Commission as ‘‘Credit intermediation, involving leverage
and maturity transformation, that occurs outside or partly outside the banking
system.’’
And then stated ‘‘non-bank intermediation of credit is not a
bad thing in itself. Indeed, it can be a very good thing, helping to make
financial services more efficient and effective and the system as a whole more
resilient. We must remember that as we make policy.’’
He then highlighted the main areas of consideration that policymakers
should focus on and hinted at the possible measures to be discussed (I have
only listed the reference to securities lending and repo):
Securities lending, repo and collateralised-financing markets
- There should be greater market transparency, perhaps ideally via a Trade Repository with open access to aggregate data, so that the world can see what is happening in these very important but opaque financing markets.
- Financial firms and funds should not be able to lend against securities that they are not permitted or proficient enough to hold outright.
- Non-bank financial firms should be regulated in how they employ cash collateral.·
- The authorities should be able to step in and set minimum haircut or margin levels for the collateralised financing markets (or segments of them). (That would need to be pursued at international level. It might be linked to central bank haircuts.)
The conference then focused on the publication of the FSB
Interim Report on Securities Lending and Repos, which was explained by David Rule, Head of department,
Financial Services Authority, and Chair of FSB Shadow Banking work stream on
Securities Lending and Repo.
The report describes the segments, operations and practices
of these securities financing markets, which may constitute an important
element of the shadow banking system. The segment classifications are categorised
into four main, inter-linked segments:
(i) A securities lending segment which comprises
lending of securities by institutional investors to banks and broker-dealers
against the collateral of cash or securities.
(ii) A leveraged investment fund financing and
securities borrowing segment which comprises financing of leveraged investment
funds’ long positions by banks and broker-dealers using both reverse repo and
margin lending secured against assets held with the prime broker, as well as
securities lending to hedge funds by prime brokers to cover short positions.
(iii) An inter-dealer repo segment which comprises
primarily government bond repo transactions amongst banks and broker-dealers
that are typically cleared by central counterparties (CCPs).
(iv) A repo financing segment which comprises repo
transactions primarily by banks and broker-dealers to borrow cash from
“cash-rich” entities, including central banks, retail banks, money market
funds, securities lenders and increasingly non-financial corporations.
The Workstream views the following aspects of securities
financing markets as constituting potentially important elements of the shadow
banking system, as defined by the FSB:
- Repo financing by non-bank entities to create short-term, money-like liabilities, typically collateralised by longer-term securities
- Leveraged investment fund financing that may lead to further leverage and maturity transformation
- Securities lending cash collateral reinvestment by which the cash proceeds from short sales are used to collateralise securities borrowing and then reinvested by securities lenders into longer-term assets, thus constituting a long credit intermediation chain with maturity transformation
- Collateral swaps (also known as collateral downgrade/upgrade transactions) that can further lengthen transaction chains or allow banks to meet liquidity requirements
The Workstream has preliminarily identified seven issues
arising from the securities financing markets that might pose risks to
financial stability and/or need further investigation by the Workstream:
(i) Lack of transparency
(ii) Procyclicality of system leverage and
interconnectedness
(iii) Other potential financial stability issues
associated with collateral re-use
(iv) Potential risks arising from fire-sale of
collateral assets
(v) Potential risks arising from agent lender
practices
(vi) Securities lending cash collateral reinvestment
(vii) Insufficient rigour in collateral valuation and
management
Following this panel was a keynote address given by Vitor Constâncio, Vice-President,
European Central Bank and aired the view of the ECB on policy issues concerning
securities financing.
He outlined the relevance of shadow banking for European
financial stability and suggested some preliminary considerations on three
policy issues that are currently at the centre of the international debate on
repo markets:
(i) The pro-cyclical nature of margin requirements
used in securities financing
(ii) Encourage the use of CCP in repo markets
(iii) Repo and securities lending market practices
raise concerns from a financial stability point of view
He then focused on how to enhance the monitoring of repo and
securities financing markets and proposed the creation of an EU Central
Database on Euro Repos. ‘‘A central database fed by infrastructures and
custodian banks to the extent that they internalise repo settlement in their
own books, would be the place for the much needed central view on repo market
and its participants, both banks and non-banks. ‘‘
Next it was the turn of Sharon
Bowles (UK MEP), the influential Chair of the European Parliament's
Economic and Monetary Affairs Committee who gave a very well informed speech.
She mentioned the initiatives previously discussed on securities lending and
repos as well as MMF.
Prior to the close of the conference, there were two
additional panels on Money Market Funds and ETFs. Amongst the discussion were
topics such as how to reduce the risk of runs on money market funds, other
systemic risks that MMF may pose, how to address them at global level,
improving disclosure and transparency to better protect investors and the
changes needed to the EU regulatory regime. For ETFs, it included dealing with
collateral and securities lending in asset management, the framework needed for
derivatives in investment funds and avoiding excessive or hidden leverage.
The closing keynote speech was delivered by Lord Adair Turner, Chairman of the UK
Financial Services Authority. He reiterated the main themes previously
highlighted by Tucker and Rule but stated that a move to CCPs for securities
lending and repo transactions in line with OTC derivatives should also be ‘‘up
for consideration’’.
Not present at the conference but important to note were the
comments this past week from two other significant players on the regulatory
front. Firstly, Andreas Dombret a member
of the Bundesbank’s executive board said shadow banking is the greatest concern
to regulators, who still do not fully understand its impact on the financial
system. He reinforced the perception that the so-called shadow banking system
is at the forefront of European regulators’ concerns. He stated that what he
prefers to call “non-bank banking” is the greatest challenge facing regulators
today. “There is also an obvious interlinking of the banking system and
non-bank banking, including hedge funds,” he says. “We want to understand where
those risks are, how concentrated they are and how correlated they are.”
Dombret also expressed his hopes that a new focus on
macro-prudential regulation will enable supervisory authorities to lean against
speculative bubbles and systemic risk. “The supervision of individual
institutions is important and needs to be done in a rigorous w ay,” says
Dombret. “But one of the important lessons from the crisis is that the sum of
all of the individual risks is less than the systemic risk, the threat to the
integrity of the system overall.”
Secondly, US Fed Governor Daniel Tarullo specified that more must be done on shadow banking;
“Although some elements of pre-crisis shadow banking are probably gone forever,
others persist," Tarullo said in remarks delivered at the Council on
Foreign Relations in New York. "Moreover, as time passes, memories fade,
and the financial system normalizes, it seems likely that new forms of shadow
banking will emerge." Tarullo singled out money market and tri-party repo
markets as areas where action should be taken in the "short-run."
The comments aired during and after the conference underline
that the political momentum is in full swing and that any moves by market
participants against any proposals currently mentioned in all consultation papers
and subsequent reports will be very difficult to prove given the general
feeling that action needs to be taken. Of course it is now up to the market
participants and regulators to prove that these are the correct actions to take.
Links to consultation
papers and speeches:
European Commission:
Financial Stability Board:
Bank of England:
European Central Bank:
Federal Reserve:
http://www.federalreserve.gov/newsevents/speech/tarullo20120502a.htm
