* G20 to endorse shadow banking package Sept 5-6
* Focus on activities rather than entities
* No individual shadow banks to be named
* Minimum "haircut" proposal on securities lending expected
* EU to propose money market funds law on Sept 4
By Huw Jones
LONDON, Aug 25 World leaders are expected to
take a softly-softly approach to regulating the so-called shadow
banking sector when they meet in Russia next month to avoid
damaging the flow of finance to the global economy.
While governments have cracked down on risk-taking by
traditional banks in the wake of the financial crisis, the
shadow banking sector, an assortment of financial intermediaries
that handle $60 trillion of transactions a year - roughly the
same size as the world economy - remains a source of systemic
risk for taxpayers.
Such intermediaries, which include hedge funds, money market
funds and structured investment vehicles, provide credit to the
financial sector, but, unlike banks, have no access to central
bank support or safeguards such as deposit insurance and debt
They often rely on short-term funding sources, such as the
repurchase or repo market, in which borrowers sell the lender a
security as collateral and agree to buy it back later at a set
time and price.
At their meeting on Sept. 5-6 the Group of 20 economies
(G20) will endorse reforms but stop short of rushing through
far-reaching changes because of the role shadow banking
activities play in providing liquidity to the still fragile
banking sector, according to people familiar with the G20's
Banks' use of off-balance-sheet vehicles to repackage and
sell on U.S. subprime mortgages kickstarted the financial crisis
in 2007, but such shadow banking activity, known as
securitisation, is viewed as key to helping wean banks off
central bank money and fund themselves.
"There is a fuss about this because the crisis of 2008 was
essentially a shadow banking crisis, as most of the lending in
the United States and UK was financed through short-term repo,"
said Alistair Milne, professor of financial economics at
"The shadow banking reform is more about not getting into
trouble in the future, so they can take a bit more time," added
Milne, a former Bank of England and UK Treasury official.
Regulators pushed through a new regulatory regime for
traditional banks - the Basel III framework, which forces them
to hold more capital - in record time.
There is growing appreciation at the G20 that unlike action
on banks, which targeted the institutions themselves, reform of
the more complex shadow banking world should be focused on
"Just increasing capital won't work in most cases because
it's not about entities, but mostly about markets, interlinked
transactions and networks," said Andres Portilla, director of
regulatory affairs at the Institute of International Finance, a
banking and insurance lobby in Washington.
Lobbying has already been intense on the sidelines.
Hedge funds and large money market funds and securities
lenders like BlackRock insist they did not play a central role
in the crisis. They even object to the term shadow banking,
which they consider pejorative, with BlackRock suggesting
"market finance" as an alternative.
NO "HIT LIST"
The G20 has drawn up a list of top global "systemic" banks
and insurers who must hold more capital because their size and
complexity could lead to market mayhem if they were to fail.
Regulators in Britain have already collected data on hedge
funds and found so far that none is systemic.
People familiar with the G20 work said the summit won't
pursue a "hit list" approach in shadow banking but likely
endorse a broad supervisory framework with optional tools to
stop the sector undermining financial stability.
Hedge funds and broker-dealers who become excessively
leveraged using the repo markets will be a key target.
While top firms will be relieved they won't be singled out,
the G20 is likely to brush aside their opposition to a
requirement for them to apply a minimum discount - or "haircut"
- on the value of collateral they take to cover securities
lending and repos.
The aim of this first global rule is to ensure that the
collateral taken provides a big enough safety cushion if market
The International Securities Lending Association (ISLA) is
opposed, saying it could disrupt trading, while BlackRock says
mandatory haircuts would likely exacerbate market moves.
The G20 may tread carefully by leaving the door open to
refinements through a public consultation and promises to gather
more data on possible impact before finalising the new rule.
IIF's Portilla said the proposal would reignite debate about
possible shortages of collateral such as top quality bonds and
cash due to the combined effect of all the G20's new rules.
Separately, the European Union will publish a draft law on
Sept. 4 to reform money market funds in the 28-country bloc
based on work done by G20 regulators, following on from similar
steps announced by the United States.
The EU is set to propose capital requirements on some types
of money market funds, going further than the United States.
Both sides of the Atlantic have already approved tougher
rules on securitisation activity, which remains moribund since
the crisis, prompting the G20 to shift its focus to how such a
key method for funding banks can be revived safely.
(Editing by Carmel Crimmins and Will Waterman)