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Given the risks of corruption and shadow banking

EU urges to G-20 growth and financial reforms


Before leaving for the G20 Summit, President Herman Van Rompuy said: "The European Union enters this summit in a much better economic shape than a year ago in Los Cabos. Our strategy for combating the crisis is bearing fruits but we will relentlessly continue our efforts as risks and challenges remain. The economic crisis has further stressed the need for all to pay their fair share of taxes. In St Petersburg, the European Union will seek to advance in the fight against tax evasion and ensure the widest possible backing for automatic sharing of tax information." 

On 23 July, European Council President published a joint letter informing the 28 EU heads of state or government about the key issues. They called on fellow G20 leaders to unite around a common purpose to improve global confidence, remain vigilant and proactive to support the global recovery, and find the way to strong, balanced, sustainable and inclusive growth. 

On the main priorities of the summit, they stressed that growth and employment need to be at the top of the G20 agenda, financial reform needs to be completed, more work needs to be done to combatand evasion, tax avoidance and evasion, the reform of the international financial architecture needs to be completed and progress made in relation to development, energy, and the fight against corruption. They emphasised the action already taken by the EU in these areas and set out their views on what the G20 should do to make further progress in all of them. 

The Presidents of the European Council and of the European Commission represent the EU in the G20 leaders´ process established in 2008 after a joint EU-US initiative. The European Union is a full member of the G20.

Risks inherent in shadow banking

In addition to advising on the preparation of documents for large business tax evasion, shadow banking, financial inclusion and education (see the advance of, the Commission adopted yesterday a communication on shadow banking and proposed new rules for money market funds (MMFs). The measure was the last year demand from European institutions and fora, such as the European Economic and Social Council (EESC). There, in addition to a separate opinion, was claimed in opinions like banking union, rapporteur by the Spanish Carlos Trias.

The communication is a follow-up to last year´s Green Paper on Shadow Banking (IP/12/253). It summarises the work undertaken so far by the Commission and sets out possible further actions in this important area.

The first of these further actions – the proposed new rules for money market funds – is unveiled today and aims to ensure that MMFs can better withstand redemption pressure in stressed market conditions by enhancing their liquidity profile and stability.

Internal Market and Services Commissioner Michel Barnier said: “We have regulated banks and markets comprehensively. We now need to address the risks posed by the shadow banking system. It plays an important role in financing the real economy and we need to ensure that it is transparent and that the benefits achieved by strengthening certain financial entities and markets are not diminished by the risks moving to less highly regulated sectors."

Half the size of bank assets

Shadow banking is the system of credit intermediation that involves entities and activities that are outside the regular banking system. Shadow banks are not regulated like banks yet engage in bank-like activities. The Financial Stability Board (FSB) has roughly estimated the size of the global shadow banking system at around €51 trillion in 2011. This represents 25-30% of the total financial system and half the size of bank assets. Shadow banking is therefore of systemic importance for Europe´s financial system.

Since the beginning of the financial crisis back in 2007, the European Commission has undertaken a comprehensive reform of the financial services sector in Europe. The aim is to establish a solid and stable financial sector – essential for the real economy – by addressing the shortcomings and weaknesses highlighted by the crisis. But risks must not be allowed to accumulate in the shadow banking sector, in part because new banking rules could be pushing certain banking activities towards this less highly regulated shadow banking sector.

Money market funds (MMFs) are an important source of short-term financing for financial institutions, corporates and governments. In Europe, around 22% of short-term debt securities issued by governments or by the corporate sector are held by MMFs. They hold 38% of short-term debt issued by the banking sector. Because of this systemic interconnectedness of MMFs with the banking sector and with corporate and government finance, their operation has been at the core of international work on shadow banking.

Main elements of communication

The Communication sets out the issues at stake in relation to the shadow banking system and the measures already taken to deal with the risks related to shadow banking such as the rules governing hedge fund activity (MEMO/10/572) and reinforcing the relationship between banks and unregulated actors (the provisions related to securitisation exposures in the revised Capital Requirements legislation (MEMO/13/272).

It outlines the priorities identified on which the Commission intends to take initiatives in areas such as:

  1. Framework for money market funds the new rules proposed today (MEMO/13/764) cover money market funds (MMFs) that are domiciled or sold in Europe and aim to improve their liquidity profile and stability:

  • Liquidity management: MMFs would be required to have at least 10% of their portfolio in assets that mature within a day and another 20% that mature within a week. This requirement is there to allow the MMFs to repay investors who want to withdraw funds at short notice. In order to avoid that a single issuer bears undue weight in the net asset value (NAV) of an MMF, exposure to a single issuer would be capped at 5% of the MMF´s portfolio (in value terms). For standard MMFs, a single issuer could account for 10% of the portfolio.

  • Stability: to take account of the constant NAV, MMF´s propensity to require sponsor support to stabilise redemptions at par, the new rules would require this type of MMF to establish a predefined capital buffer. This buffer will be activated to support stable redemptions in times of decreasing value of the MMFs investment assets.

  1. Transparency of the shadow banking sector: to be able to monitor risks in an effective manner and intervene when necessary, it is essential to collect detailed, reliable and comprehensive data on this sector.

  2. Securities law and the risks associated with securities financing transactions (principally securities lending and repurchase transactions). These transactions can contribute to an increase in leverage and strengthen the pro-cyclical nature of the financial system, which then becomes vulnerable to bank runs and sudden deleveraging. Furthermore, the lack of transparency of these markets makes it difficult to identify property rights (who owns what?), monitor risk concentration and identify counterparties (who is exposed to who?)

  3. Framework for interactions with banks. The high level of interconnectedness between the shadow banking system and the rest of the financial sector, particularly the banking system, constitutes a major source of contagion risk. These risks could notably be addressed by tightening the prudential rules applied to banks in their operations with unregulated financial entities.

Furthermore, particular attention will be paid to the supervision arrangements of shadow banking entities/activities in order to ensure that specific risks are adequately addressed. Certain areas such as the set-up of resolution tools for non-bank financial institutions and a structural reform of the banking system require further analysis and will be clarified later.

Ultimately, the aim is to ensure that the potential systemic risks to the financial sector are covered and that the opportunities for regulatory arbitrage are limited in order to strengthen market integrity and increase the confidence of savers and consumers.

The Commission’s communication is in line with the Financial Stability Board’s recommendations, which will be endorsed by the G20 Leaders in Saint Petersburg on 5-6 September 2013.

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