May 2 (Bloomberg) -- The European Union is considering legislation to boost oversight of repurchase agreements should moves by the European Central Bank to set up a transactions database fail to allow regulators to discover risks building up in the financial system.
The European Commission is “closely following” the ECB initiative, which involves setting up a central repository to collect real time data on repo trades, according to a commission document obtained by Bloomberg News.‘
The commission “will assess whether transparency at EU level has improved, while reserving the right to take legislative measures to remedy the situation,” according to the undated document.
Repo trades, contracts in which one investor agrees to sell a security and then buy it back at a future date at a fixed price, are being scrutinized by the EU as part of a wider push to rein in possible threats to financial stability from so-called shadow banking. Securitizations and the business model of money-market mutual funds are among other potential risks in the EU spotlight.
The Financial Stability Board has estimated that the global shadow banking system was worth $67 trillion in 2011, with EU-based activities accounting for about $31 trillion.
“Greater transparency of these markets would be beneficial for financial stability,” Chantal Hughes, a spokeswoman for Michel Barnier, the EU’s financial services chief, said in an e-mail.
“We are in particular concerned about excessive levels of leverage, pro-cyclicality and concentration risks,” she said. “We are looking into various practical ways to bring about more transparency. However, no decision has been taken by the commission yet.”
Aside from weighing transparency rules, the Brussels-based commission is planning to legislate on how traders can use collateral provided as part of a repo or securities lending trade, according to the document.
Strategies in which a security is handed over as collateral from one trader to another, only for the new holder to lend it on again as part of a separate transaction, can leave the financial system less resilient against crises, according to the EU document.
“Interconnections between financial institutions and the collateral transformation strategies implemented by certain financial actors” mean that “the default of a large financial institution may destabilize the securities markets,” the commission says in the paper.
“Furthermore, the complex and opaque nature of these markets makes it difficult to identify property rights” and to “monitor risk concentration,” according to the document. The turmoil unleashed by the failure of Lehman Brothers Holdings Inc. in 2008 is evidence of this, it says.
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