LONDON (Reuters) - The European Union may apply its mandatory capital rules for banks to a wider set of institutions to cover risks in “dark corners” of the financial system, an EU draft document said.
It outlines possible reforms to regulate “shadow banking”, or lightly supervised intermediaries outside mainstream banks such as some hedge funds and broker-dealers, which generate trillions of euros to finance the economy through securities lending, repurchase markets and securitizations.
Extending the scope of capital rules to shadow banks would respond to concerns among EU lawmakers that similar activities should be regulated in the same way, the document obtained by Reuters said. The paper has been written by the bloc’s European Commission and is due to be published on September 4.
“It is not possible to discuss shadow banking without considering the scope of application of the EU banking prudential rules,” the document said.
“These considerations respond to the overarching aim, as reaffirmed on several occasions by the G20, of eliminating all dark corners in the financial sector.”
Mandatory capital requirements would go beyond a set of international standards for shadow banking published on Thursday.
The European Banking Authority, an EU watchdog, will be asked to assess the size of financial entities that fall outside the scope of current bank capital rules in order to assess which pose systemic risks, the document added.
The EU executive will decide in 2015 if mandatory limits are needed on banks’ exposures to shadow banks, the document said.
Globally the shadow banking sector is estimated at around $60 trillion, with $31 trillion in the EU.
The document, which may be revised before publication, says the commission will also look at risks from “certain investment techniques and strategies” used by mutual, exchange-traded and other funds.
“In particular, the review will examine how investment funds use securities financing transactions. Funds will have to ensure that use of this type of transaction does not impair their liquidity,” the document said.
The review will see if rules on what type of assets can be used as collateral to back the transactions need tightening up. “Particular attention will be given to funds connected by this type of transaction to the banking system,” the document said.
The commission may propose a securities law to regulate how securities are re-lent throughout the financial system, making it difficult to know who actually owns them.
The collapse of Lehman Brothers bank in 2008 highlighted this problem, showing how a default of a large institution may destabilize securities markets, the document said.
The European Commission will also publish its first draft law on Wednesday, September 4, to toughen up supervision of another part of the shadow banking sector - money market funds (MMFs).
A copy of the draft law on MMFs obtained by Reuters shows the EU executive sticking with its proposal to force one type of fund to hold cash equivalent to 3 percent of the fund, a step the industry has said will make such funds uneconomic.
The aim is to reassure investors in rocky markets and avoid “runs” seen in the United States during the 2007-09 financial crisis. It would apply to constant net asset value funds (CNAV) whose share price shows little change over time, making it harder for investors to see how the fund is performing.
If the buffer falls 10 basis points under 3 percent for a month it “shall automatically cease to be a CNAV MMF”.
There would be an “appropriate transitional period” for CNAV funds to decide whether to build a buffer or become a net asset value fund (NAV) whose share price reflects its performance.
The buffer rule would be reviewed three years after it comes into force but to become law it will need approval from the European Parliament and member states, with changes likely to be made to the draft.
The United States, the biggest center for MMFs, has also proposed new rules but they don’t include a planned buffer.
Editing by Laurence Fletcher and Pravin Char