EU Targets Money Funds in Bid to Strengthen Shadow Bank Rules

Money-market funds may face tougher rules as part of a European Union bid to prevent so-called shadow banks from causing another financial crisis, according to draft EU documents obtained by Bloomberg News.

The EU may seek to regulate some types of shadow banks to make sure their solvency receives the same scrutiny as that of regular banks, according to documents prepared by EU staff who work on financial-services issues. Other measures could include limits on large exposures and tighter rules on transactions between a holding company and its subsidiaries, according to the papers.

This could mean forcing money-market funds with a fixed share value to switch to a floating-value system. EU financial officials “in particular discussed that regulatory approach,” according to the EU documents, written in preparation for a Sept. 14-15 meeting of finance ministers and central bankers in in Nicosia, Cyprus.

Michel Barnier, the EU’s financial-services chief, told the ministers that he’s working on regulations targeted at “key actors” in the shadow-banking system. The Financial Stability Board has estimated that global shadow-banking activities were worth about $60 trillion in 2010, as much as 30 percent of the total financial system.

The European Commission, the 27-nation EU’s executive arm, plans to publish draft rules for shadow banks in November. A policy document reflecting preparations for that initiative showed that policy makers seek to strengthen supervision while preserving “a useful channel of financial intermediation” that can help the economy while the financial crisis limits the amount of funding that banks can provide.

Financial Shocks

Money-market mutual funds merit particular attention because of risks to their liquidity, Barnier said in Cyprus, adding that he was “disappointed” the U.S. Securities and Exchange Commission hasn’t agreed on rules for the $2.6 trillion industry. U.S. regulators had to step in to prevent further contagion after the 2008 collapse of the $62.5 billion Reserve Primary Fund, one of the biggest financial shocks that came in the aftermath of Lehman Brothers’ Holdings Inc.’s failure.

The EU is considering many of the same options as the SEC, according to the planning documents. These include “redemption gates” to prevent investor withdrawals from hurting financial stability, as well as reviews of pricing techniques.

Credit Risk

The European Central Bank has recommended that any move from constant-value shares to variable share value should be accompanied by other measures, according to the documents. These could include limits on credit risk and on the balance between long-term lending and short-term borrowing, as well as bank-like capital and liquidity requirements, the documents say.

The EU also is considering how to strengthen supervision of exchange-traded funds and securities lending markets, including repurchase agreements. These transactions, known as repos, are contracts in which one investor agrees to sell a security and then buy it back at a future date at a fixed price.

EU financial officials are waiting for global guidelines before endorsing specific actions for repos, according to the documents.

The EU is studying options for non-banks such as stricter rules on cash collateral reinvestments, limiting reuse of client assets, and toughening requirements on segregating client assets from those of the firm, according to the documents.

To contact the reporter on this story: Jim Brunsden in Brussels at jbrunsden@bloomberg.net; Rebecca Christie in Brussels at rchristie4@bloomberg.net

To contact the editor responsible for this story: Anthony Aarons at aaarons@bloomberg.net; James Hertling at jhertling@bloomberg.net

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