Shadow banking rules: AMF MD reveals regulatory agenda

Author: Gemma Varriale | Published: 23 Jul 2012
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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 markets.

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.