The question of how to deal with shadow banking has been
preoccupying regulators for months. The tsunami of new laws that followed the
2008 financial crisis has to date completely failed to address the unregulated
shadow banking sector. It is the last major item on the regulatory agenda and
supervisors are under huge pressure to get it right.
Shadow banking activities account for up to 30% of the total financial system
and half the size of bank assets. It is a system that’s complex and highly
interconnected with the regular banking network. It’s hard to see how the
sector has managed to remain beneath the regulatory radar until now.
But this will not be the case for long. The full glare of the regulatory
spotlight is now focused firmly on shadow banking and the long
intermediation chains that characterise the sector and obscure information.
Against this background, IFLR spoke
with Edouard Vieillefond, the managing director in charge of the regulatory policy
and international affairs division of the French regulator. At a time when
there is widespread confusion and disagreement on how to regulate such a
systemically important sector, Vieillefond’s frank and detailed responses are
refreshing. These laws will determine the success or otherwise of the financial
markets of the future. Here are his thoughts.
What initiatives do
you think should be brought forward to regulate shadow banking?
Firstly, there is an issue with the very name - shadow banking. The term
‘shadow banking’ has negative connotations. In fact, the term should be
synonymous with market-based financing or non-bank financing.
We shouldn’t kill this activity. Don’t forget that a lot of
market-based activity will be necessary in the future to adapt to the new
prudential regulations. In continental Europe and especially in France, 70% of
the activity is financed through banks and 30% by the financial markets. This
will evolve and we need to accompany this shift from bank to market financing.
In the US, 75% of the activity is already financed through the financial
But we certainly need to regulate the sector. We need to
avoid any situation where because of Basel III or Solvency II this financing
activity occurs without any regulation or with insufficient regulation. That is
the purpose of the shadow banking work stream in the FSB.
How then should we
regulate shadow banking?
I think the FSB’s all-encompassing approach is the right one. It effectively
deals with the links between the banking system and the shadow banking system.
The first area to address on shadow banking is consolidation,
or accounting rules. New
international financial reporting standards (IFRS) must be sufficiently strict.
Otherwise, it will be pointless discussing any shadow banking regulation.
Another key point for us is the implicit support that some
banks give to entities such as MMFs. If there is such support, this should be
considered as a guarantee and therefore as a liability on the balance sheet of
banks. There therefore should be capital and liquidity requirements.
Funds are a particular priority for us in shadow banking.
For me, constant net asset value (NAV) MMFs should either disappear and go
towards floating or variable NAVs, because they are creating money.
Alternatively, we should at least devise other tools to regulate them very
strongly because it’s really a bank-like activity. The FSB and IOSCO both seem
to be going in this direction.
Rules should be as tough as if they were banks, with similar liquidity
requirements and specific rules on redemption to avoid systemic risks.
We don’t think ETFs are shadow banking per se, but some of the replication techniques around the ETF might
be. An equity ETF is like any equity fund, it’s not systemic by nature. But if
it’s a synthetic ETF built with a performance swap with a counterparty like a
bank, or if there is securities lending, then the techniques that are used may
become shadow banking. The FSB’s
fifth work stream is looking into this, specifically securities lending to see
whether it is sufficiently regulated.
Do we have sufficient proofs for the collateral given when
parties borrow a security? Should the collateral have the same quality, the
same quantity and the same diversification rules as the initial security? These
issues need also to be assessed. There is currently a work-stream on that
within Esma [the European securities and markets authority].
The last important issue for us is securitisation. We want
to restart good securitisation while avoiding the excesses of the past. We are
working hard on this subject within Iosco to assure that it is sufficiently
regulated and that no important divergence emerges in all jurisdictions dealing
with retention rules, transparency and standardisation. If we want something to be more
investor friendly, we should move towards more templated information, maybe
more stress tests, and refine information to find out how the product would
behave in certain scenarios. The producer would be responsible for this refined
information. This would help to revive the securitisation segment again and
help cross border activity which today is very low.
So these are our priorities for shadow banking: we should
regulate sufficiently, but also intelligently, to promote the activities that
are useful for the economy.