European Union launches clampdown on shadow banking

thenews 2013.09.04 08:55

Special funds used by big companies to park billions of euros of cash face stricter rules to make them safer, the European Commission said on Wednesday, taking a first step to reform unregulated finance known as shadow banking.

The draft law will regulate money market funds, demanding some set aside cash buffers to avoid a panic should many investors withdraw their money at once.

This would lower what EU financial services chief Michel Barnier said was a risk to the financial system from the trillion euro sector but users of the funds warn that demanding they hoard more for a rainy day would make them too expensive.

The changes are part of efforts to shine a light on shadow banking, a 24-trillion-euro industry in Europe that comprises money market funds, some hedge funds, and firms involved in securities lending and repurchase markets.

Such groups borrow and lend, just like banks do, but because they are not banks they often fall outside the remit of regulation, which is why they are considered to operate in the 'shadow' of traditional finance.

In the European Union, money market funds are mainly based in France, Ireland and Luxembourg and are heavily used by companies and banks which borrow from them.

For companies, they are an alternative home for short-term cash. Unlike banks, they have no access to support from central banks such as the European Central Bank if things go wrong.

But the vast unchartered territory unnerves regulators in part because the sector is closely intertwined with banks, who often sponsor the funds as well as relying on them for finance themselves.

"We have regulated banks and markets comprehensively," said Barnier, the EU Commissioner who has led a four-year revamp of financial rules. "We now need to address the risks posed by the shadow banking system."

The European plans draw on ideas in a global blueprint that will be submitted for approval to the world's 20 leading economies when their leaders meet in Russia on Thursday and Friday. In some cases, the EU reform is more ambitious.