27 April 2012

Commissioner Barnier: Towards better regulation of the shadow banking system

Barnier spoke about the goals of the ongoing consultation, the aims as far as the regulation of "shadow banking" is concerned, and where the discussion is to go from here.

I – First point: What is the goal of the Green Paper published a month ago?

The first aim of this consultation document – a clear definition of shadow banking – is not the easiest to reach. If we wish to clearly identify all of the players and contribute to the work going on at international level – particularly within the framework of the FSB – we will have to reach an agreement on what this concept actually means.

This task is made all the more difficult by the fact that "shadow banking" is a "complex ecosystem" with close ties to the traditional banking system. One of the challenges we face is the pro-cyclic nature of the system: while it often provides liquidity during prosperous times, it can, conversely, consume liquidity during moments of crisis.

Of course, it is far too early to reach any specific conclusions. However, based on the work carried out by the FSB, we have so far identified two main activities worthy of our attention: firstly, securitisation, and secondly, securities lending or borrowing with repurchasing ("repo").

Furthermore, there are five types of bodies that appear to be concerned by the shadow banking system:

• financial bodies that are active in intermediation or other credit granting but do not accept deposits and are not regulated in the same way as banks;
• funds, including exchange traded funds (ETFs), that invest in credit products;
• monetary funds or certain equivalent products;
• insurers providing credit guarantees;
• and lastly, specific investment or financing vehicles.

As well as clarifying the field of "shadow banking", our Green Paper has three other objectives:

1. Our first aim is to review the numerous measures we have already adopted in relation to certain activities and players in the shadow banking system. I am thinking in particular of our texts on Alternative Investment Fund Managers, UCITS and the strengthening of capital requirements for banks and insurance companies, which all include measures on shadow banking. We are not starting at zero, but we have to fill the gaps.
2. The consultation should then enable us to consult all the stakeholders so that everyone – particularly all the financial intermediaries who feel concerned by this matter – can have the opportunity to put across their point of view.
3. Lastly, and more practically, we aim to assess the risks presented by "shadow banking" and list the issues we need to address.

II – Second point: What do we hope to achieve by regulating the system?

It is, of course, far too early to go into detail and make specific proposals for the various activities and players involved in "shadow banking": that is, in fact, the aim of the consultation exercise and of today’s session. However, I would like to establish four general principles from the outset:

1. First of all, we aim to ensure that regulators and supervisory authorities can have a complete overview. In other words, they need to have the means and powers to familiarise themselves with and master the leverage exerted by all the financial intermediaries in the shadow banking system. Here I am thinking in particular of practices such as securities lending, rehypothecation and repurchasing, which can lead to excessive risk-taking, sheep-like behaviour ("runs") and excessive volatility in liquidity provision. These practices, left unchecked, played a decisive role in the difficulties faced by AIG, Bear Stearns and Lehman Brothers. We must be in a position to identify who owns what along the financing chains linked to these practices. And we must improve the transparency, supervision and security of these practices for all players on the market, wherever they may be situated along the securities lending chain. Lastly, we must ensure that the supervisory authorities are properly equipped to control the total leverage exerted by these practices. These issues could be included in our discussion of the standardisation of securities law in Europe.
2. Second general principle: We do not wish to repeat the mistakes made with the special securitisation vehicles, which were left to develop by the supervisory authorities and which served no purpose other than regulatory arbitrage. Our aim this time around is to prevent rather than cure.
3. Thirdly, we will be very careful not to call into question the alternative financing chains, which complement bank lending and are of direct benefit to the real economy. I do not think that financial intermediation should be left entirely and solely in the hands of the banks. And I am aware of the role that alternative sources of financing have to play in these difficult times for the European economy, where the banks have to adhere to more stringent prudential ratios. Alternative financing is therefore necessary, but it is important that it is carried out in a solid and transparent framework. Monetary funds can play a useful role here, since they can provide substantial financing in the short term. However, the financial crisis showed that such funds, particularly those offering a stable Net Asset Value to investors, could be vulnerable to mass buy-backs. We are therefore coordinating with the work currently underway within the FSB and IOSCO to look into ways of improving the regulatory framework in order to minimise the structural weaknesses of these funds. This is one of the main priorities of our Green Paper.
4. Lastly, we must, of course, ensure consistent regulation across the various financial sectors. In particular, I believe that the minimum capital to be tied up for a single operation must be comparable across all sectors to avoid encouraging any form of supervisory arbitrage.

III – Third point: Where do our discussions go from here?

As you can see, we have a complex task before us, and we must not make any mistakes. We are already very active at international level, and the Green Paper and the responses already received will be very useful as we prepare for the next stages, specifically the G20 meeting in Los Cabos in June.

The FSB and the international standard-setting organisations will then publish their conclusions and recommendations during the second half of 2012.

The expert group chaired by the governor of Finland’s central bank, Erkki Liikanen, which I have asked to make proposals on the structure of the banking sector, will issue its report in October. Our discussions of shadow banking will naturally have to take into account any structural measures which that report may propose.

We will use all these elements as a starting point for targeted sectoral consultation exercises, which will most probably be followed by proposals for regulations. We should aim to have these measures take effect as early as possible, chiefly to avoid too great a time-lag in relation to the Basel III rules and the European Market Infrastructure Regulation (EMIR).

As you can see, we are determined to see the task of regulating the shadow banking system through to a successful conclusion. However, we must still proceed with caution. I am aware of the complexity of the issue, and especially of the need to ensure consistent regulation for all players while not calling into question the alternative sources of financing that can be so beneficial to the real economy. It is for this reason that we are working in such close cooperation with our international partners, specifically within the G20 and the FSB. It is also for this reason that I attach such great importance to consulting all the interested parties.

Full speech

Sharon Bowles speech

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