News round-up: Turmoil in shadow banking

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Search for the topics that interest you: Accounting, Collateral, DataWatch, Finding a fix, International repo, Money market funds, Securities lending, Securitization, Shadow banking, and Tri-party repo.

Items are arranged chronologically, within topics that are listed alphabetically.

Accounting

“FASB Plans to Revise Repo Agreement Standards” by Michael Cohn, Accounting Today, March 21:

The Financial Accounting Standards Board has added a new item to its agenda to revise the accounting standards for repurchase agreements in response to the problems that led to the collapse of MF Global.

Last year, FASB revised its standards for repurchase agreements in response to the use of so-called “Repo 105” transactions that were identified by the bankruptcy examiner for Lehman Brothers. …

Because repurchase agreements involve shared rights to the transferred financial assets, they were, and continue to be, difficult to characterize because they possess attributes of both sales and secured borrowings, FASB noted.

JP Morgan Chase & Co. 2011 Form 10-K annual report, February 29: (RepoWatch editor’s note: RepoWatch presents the following so readers can see how one financial institution reports repos and securities lending.)

Note 13 – Securities financing activities

JPMorgan Chase enters into resale agreements, repurchase agreements, securities borrowed transactions and securities loaned transactions (collectively, “securities financing agreements”) primarily to finance the Firm’s inventory positions, acquire securities to cover short positions, accommodate customers’ financing needs, and settle other securities obligations. …

The following table details the Firm’s securities financing agreements, all of which are accounted for as collateralized financings during the periods presented. December 31:

Securities purchased under resale agreements: $235 billion in 2011, $222 billion in 2010.

Securities borrowed: $142 billion in 2011, $124 billion in 2010.

Securities sold under repurchase agreements: $198 billion in 2011, $263 billion in 2010.

Securities loaned: $14 billion in 2011, $11 billion in 2010.

The amounts reported in the table above (as resale and repurchase) were reduced by $115.7 billion and $112.7 billion at December 31, 2011 and 2010, respectively, as a result of agreements in effect that meet the specified conditions for net presentation under applicable accounting guidance. …

Note 30 – Commitments, pledged assets and collateral: 

Pledged assets

At December 31, 2011, assets were pledged to collateralize repurchase agreements, other securities financing agreements, derivative transactions and for other purposes, including to secure borrowings and public deposits. Certain of these pledged assets may be sold or repledged by the secured parties and are identified as financial instruments owned (pledged to various parties) on the Consolidated Balance Sheets….

Total assets pledged: $456 billion in 2011, $450 billion in 2010.

Collateral

At December 31, 2011 and 2010, the Firm had accepted assets as collateral that it could sell or repledge, deliver or otherwise use with a fair value of approximately $742.1 billion and $655.0 billion, respectively. This collateral was generally obtained under resale agreements, securities borrowing agreements, customer margin loans and derivative agreements. Of the collateral received, approximately $515.8 billion and $521.3 billion, respectively, were sold or repledged, generally as collateral under repurchase agreements, securities lending agreements or to cover short sales and to collateralize deposits and derivative agreements.

DataWatch

“Financial risk and the potential problems of legal entity identifiers” by Christopher Elias, Business Law Currents, March 22:

Since the onset of the financial crisis, financial firms and regulators have become obsessed with assessing counterparty risk. Recognizing the interconnected and global nature of the financial system has led all parties to rethink how they go about adequately tracing and ameliorating the risk of financial transactions.

One key proposal to flow out of the Dodd-Frank legislation is for a system that allows for the standard identification of financial counterparties. … The establishment of legal entity identifiers is considered to be a key to reforming the current system. …

But despite good intentions, LEIs pose a number of practical and legal challenges to regulators and the regulated alike.

“No optionality on LEIs. Make them mandatory” by Keith Mullin, Editor-at-large, International Financing Review, March 17:

The use of LEIs is close to being written into law in the US under the Dodd-Frank Act. I think they’re a great idea….

The Office of Financial Research, a newly formed body operating under the umbrella of the US Treasury, has been tasked with bringing about data standardisation. Its EU cognate is the European Markets Infrastructure Regulation….

The use of LEIs should be mandatory; the initial thinking is that they’ll be optional. Regulators should offer data and technology vendors a transition timetable to adapt existing identification systems to the common standard. If it’s such a good idea, which everyone seems to agree it is, why waste time?

“Towards a common financial language,” speech by Andrew G Haldane, Executive Director, Financial Stability, Bank of England, March 14:

Most financial firms have competing in-house languages, with information systems silo-ed by business line. Across firms, it is even less likely that information systems have a common mother tongue. Today, the number of global financial languages very likely exceeds the number of global spoken languages. The economic costs of this linguistic diversity were brutally exposed by the financial crisis. …

Yet there are grounds for optimism. Spurred by technology, other industries have made enormous strides over recent years towards improving their information systems. …

Compared with these industries, finance has been a laggard. But the tide is turning. … So stand back for a good news story – a story of how finance could transform both itself and its contribution to wider society.

(RepoWatch editors’ note:  See FTAlphaville’s March 21 review of the Haldane speech, “Babel, banks and broken business models.”.)

“Wall Street Says New Oversight Agency Is Too Costly” by William Alden, New York Times DealBook, March 7:

In a letter sent to the Treasury Department, the financial industry is urging that the new agency, the Office of Financial Research, be financed by the Federal Reserve instead of the banks that it oversees until it is beyond its fledgling stage.

“Identification Specifics Take Shape” by Michael Shashoua, waterstechnology, March 7:

This month’s Inside Reference Data coverage of the legal entity identifier (LEI) and OTC derivatives identification efforts finds that specifics about the standards, as well as the choices firms must make, are coming into focus.

Finding a fix

“MMFs, deposit insurance, and regulation in the age of shadow bank runs” by Cardiff Garcia, FTAlphaville, April 2:

RepoWatch summary: On October 14, 2008, the FDIC began insuring in full all non-interest-bearing deposit accounts at FDIC-insured banks, instead of insuring them just to $250,000 as it had since October 3. As a result, cash once invested in money market funds has poured into banks. One way to look at this, writes Garcia, is that money from the shadow banking sector is now insured by the FDIC, without shadow bankers having to pay FDIC fees, as banks do.

The increased guarantee is scheduled to stop at the end of this year.  Garcia asks, should shadow banking have some further protection?

From Garcia:

So rather than park their money with MMFs, some investors are now guaranteed to get their money back 100 cents on the dollar with the safest backing on earth as collateral. And they didn’t even have to pay for it.

Which brings us to the question of whether deposit insurance should be extended or not. And if so, for how long?

Sorry, but there’s no easy answer to this question.

In an ideal universe, our preferred solution would probably be for the insurance to remain in place until the economy has recovered sufficiently to lift the values of non-public sector collateral that’s appropriate and available to the shadow banking system.

But after that, things get trickier. This deposit insurance functioned as a kind of bailout, with the government assuming the risk for MMF investors to at least have a place to park their money where its value will be guaranteed.

Unless the government will happily stand ready to do the same in the future event of another run on MMFs — an unpopular idea, surely, and which also brings with it the obvious moral hazard dilemma — then some other regulations will be necessary.

One idea is for fee-based insurance, where the banks pay the government for the insurance and then pass along the cost to investors. This seems like a reasonable idea to us, with the caveats that the pricing will be tricky to get right and that many banks simply won’t want to participate. The latter is an especially important worry during a time when the largest banks are still implicitly Too-Big-To-Fail.

In other words, such a policy might have to be forced on the banks.

“Global finance: Conflicting signals” by Brooke Masters, Financial Times, April 1:

Post-crisis pledges by world leaders to work towards harmony in regulating banks and markets are in danger of coming to naught. …

While everyone agrees markets should be easier to monitor and no bank can be “too big to fail”, many countries are putting forward contradictory and competing proposals on both. Even on bank capital, the one big success story, unity is breaking down as European Union, UK and US authorities accuse one another of watering down or delaying the tougher standards.

“Financial Regulatory Reform 2012 Report Card” by U.S. Chamber of Commerce, March 27:

This report card evaluates the progress being made by regulators and policymakers to achieve modern, well-regulated, fair, transparent, and vibrant capital markets. It looks both at the implementation of The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 as well as key regulatory reform issues not addressed by the new law.

By all accounts, regulatory reform is incomplete. So, for those unfinished reforms outlined in this report, CCMC assigns a grade, in addition to an incomplete, based on where progress stands now before regulators finalize rules. This report also provides suggestions on how regulators and Congress can bring up the grade ….

“Basel Group Said to Set June Deadline for Liquidity-Rule Deal” by Jim Brunsden, Bloomberg News, March 21:

Global banking regulators set themselves a June deadline to reach an agreement on changes to draft liquidity rules amid concerns that delays may undermine investor confidence, according to two people familiar with the discussions.

“Fitch: Basel III Measures May Heighten Repo Volume, Risks” by Liz Capo McCormick, Bloomberg News, March 19:

RepoWatch summary: Tougher rules for banks under Basel III may raise costs and drive more borrowers and lenders toward repos and increased risk, writes McCormick.

From McCormick:

Risks may rise in the U.S. market for borrowing and lending securities if tougher global bank regulation increases some types of trading of repurchase agreements, according to Fitch Ratings. …

“There is a focus on the possibility of increased banking regulation incentivizing the shadow banking market, particularly high-risk activity that attracts higher capital charges under Basel III,” said (Robert) Grossman, managing director of macro credit research at Fitch in New York and one of the report’s authors, in a telephone interview today. “Repos are a significant part of the shadow banking market and that is why we are trying to highlight the potential liquidity risks.” …

“Given their inherent leverage, short tenor, and relatively opacity, repo markets remain a potential channel for liquidity risks during market distress,” the Fitch report said.

“Failure Is No Longer a (Free) Option for Agency Debt and Mortgage-Backed Securities” by Michael Fleming, Federal Reserve Bank of New York, March 19:

A recommended charge on settlement fails for agency debt and agency mortgage-backed securities took effect on February 1, 2012. This follows the successful introduction of a charge on settlement fails for U.S. Treasury securities in 2009. With a fails charge, a seller of securities that doesn’t deliver on time must pay a charge to the buyer. … In this post, I discuss how and why the fails charge was implemented.

…persistent settlement fails at a high level can cause participants to withdraw from the market, adversely affecting market liquidity and stability….

As with the Treasury fails charge, the agency debt and agency MBS fails charges only kick in when short-term interest rates are low … The charge for agency debt securities, like that for Treasury securities, applies to fails outstanding a day or more, whereas the agency MBS charge only applies to fails outstanding three days or more.

(RepoWatch Editor’s Note: Track fails at Primary Dealers’ weekly reports.)

“DTCC Prepares to Launch New Central Counterparty for Mortgage-Backed Securities Trading,” Press Release, Depository Trust & Clearing Corporation, March 12:

The Depository Trust & Clearing Corporation (DTCC) announced today that the Securities and Exchange Commission has approved its application to operate a new central counterparty (CCP) designed to reduce risk and costs in the $100-trillion-a-year market for U.S. mortgage-backed securities (MBS).

Starting in April, the Mortgage-Backed Securities Division of DTCC’s Fixed Income Clearing Corporation (FICC) subsidiary will begin functioning as the CCP for MBS trades. It will guarantee settlement of all matched MBS trades, a crucial step for the securities industry where the settlement of an MBS trade often does not take place until months after the trade itself was made. The FICC guaranty will ensure completion of these long-settling trades even if one of the trading parties defaults on its initial trade commitment or pool delivery obligation.

“This is the first CCP to be created in U.S. cash markets in more than a quarter of a century. We expect it will greatly reduce risk by offering pool netting services and streamlining the settlement of mortgage-backed securities trades,” said DTCC’s President and Chief Executive Officer Donald F. Donahue.

“Capital Regulation, Liquidity Requirements and Taxation in a Dynamic Model of Banking” by Gianni De Nicolò, Andrea Gamba and Marcella Lucchetta, International Monetary Fund, March 2012:

Current Basel III regulation introduces a mandatory liquidity coverage ratio: banks would be prescribed to hold a stock of high quality liquid assets such that the ratio of this stock over what is defined as a net cash outflows over a 30-day time period is not lower than a certain percentage threshold. …

The introduction of liquidity requirements reduces bank lending, effciency and social value significantly, since these requirements hamper bank maturity transformation. In addition, the reduction in lending, efficiency, and social values increases monotonically with their stringency. …

We should stress that these results do not have to be necessarily interpreted as an indictment of liquidity requirements. If liquidity requirements were found to be optimal regulations to correct some negative externalities arising from excessive bank’s reliance on short term debt, which we do not model, then our results indicate how large the costs associated with these negative externalities should be to rationalize the need of liquidity requirements….

Given our finding of the adverse effects of liquidity requirements, the argument by Admati, DeMarzo, Hellwig, and Pfleiderer (2011) that capital requirements can be designed to substitute for liquidity requirements is reinforced.

International repo

“Ireland gets slim pickings from ECB deal” by Hugo Dixon, Reuters, April 2:

Ireland has received slim pickings from its deal with the European Central Bank. Dublin is trumpeting the fact that it has been allowed to make a 3.06 billion euro injection to its banks with a long-term bond rather than cash. … But once one unpacks the deal’s mind-numbing complexity, the benefit isn’t great.

The new money-go-round works as follows. Dublin gives Irish Bank Reconstruction Corporation, which is wholly owned by the state, a new bond. Irish Bank Reconstruction Corporation then takes the bond and repos it with Bank of Ireland, a largely privately-owned bank. Bank of Ireland then takes the bond and repos it with the European Central Bank. Meanwhile, Irish Bank Reconstruction Corporation uses the cash to repay emergency liquidity assistance it has received from the central Bank of Ireland.

“JP Morgan to launch financing collateral management platform in Hong Kong” by BBR Asset Management News staff, March 14:

JP Morgan Worldwide Securities Services in partnership with the Hong Kong Monetary Authority is planning to launch a repo financing collateral management platform in Hong Kong.

The new repo financing programme will facilitate repo financing transactions between members of Hong Kong’s Central Moneymarkets Unit and international financial institutions. …

HKMA executive director of financial infrastructure department Esmond Lee said that with the launch of this repo financing program, the authority has taken a step forward in the development of Asia’s capital markets.

“More signs that corporate cash piles are heading into repo” by Izabella Kaminska, Financial Times, March 13:

An interesting announcement from Eurex Repo on Tuesday:

“Eurex Repo, Eurex Clearing and Clearstream, all part of Deutsche Boerse Group, will introduce an extension of the integrated and innovative GC Pooling market for secured funding which will be made available for active GC Pooling participants (banks) to further strengthen their service scope towards corporate customers. Launch is scheduled for Q4 2012.”

… The measures have been designed to help banks tap growing corporate cash piles by providing non-financial clients with the option of accessing the secured GC Pooling funding market, as well as central counterparty clearing. …

Corporates in Europe are now the banks’ banks.

Money market funds

“ICI’s Feb. Trends Show Assets Flat, Confirms Repo, Treasury Buildup” by Investment Company Institute, April 2:

Late last week, the Investment Company Institute released its latest monthly “Trends in Mutual Fund Investing: February 2012,” which showed money market mutual fund assets inched lower by $2.8 billion to $2.65 trillion last month. …

ICI’s Portfolio Holdings series shows Repurchase Agreements jumped again in February, rising by $37.3 billion in to $566.9 billion. Repos remain the largest portfolio holding among taxable money funds with 24.0% of assets …

“The battle over money funds” by Thomas Cooley and Kim Schoenholtz, Reuters, March 8:

From the point of view of taxpayers, policy action to address the systemic threat is long overdue. Aside from the government-sponsored enterprises, the most glaring omission in the Dodd-Frank financial reform was the failure to address critical short-term markets such as those for money funds and repurchase agreements.

Securities lending

“Will Basel III be the saviour of sec lending?” by Elizabeth Pfeuti, aiCIO, March 21:

Banking regulation Basel III could breathe new life into the securities lending sector, market participants claimed yesterday at a forum in London.

Heads of securities lending teams from some of the world’s largest custodian banks cited items under the Basel III framework that could mean more supply and demand for the practice.

“Insurers warned over ‘shadow banking’ risk” by Brooke Masters, Financial Times, March 13:

Securities lending by insurers needs tighter global oversight to stop it from becoming a form of “shadow banking” and a dangerous source of financial instability, a top Bank of England official has told a London insurance gathering.

Paul Tucker, the Bank of England deputy governor, is leading global efforts to obtain more control over shadow banks – nonbanks that extend credit and act like banks. He said securities lending, while critical to market making and short-selling, can be problematic when the borrower uses the securities in question to secure overnight loans and fails to tell the second lender that the collateral is lent.

Mr Tucker said that creating a trade repository would make the market easier to monitor and regulate. It would also prevent the same securities from being lent to several places simultaneously.

“Collateral swaps can involve maturity transformation and leverage. And the market is invisible,” Mr Tucker said, noting that stock lending by the insurer AIG helped contribute to the run that led to its 2008 rescue by the US government. (RepoWatch editor’s note: AIG losses from securities lending were similar to its better-publicized losses from credit default swaps.)

Securitization

“The securitisation market needs a detox” by Ben Wright, Financial News, April 2:

As the opiate high induced by the European Central Bank’s liquidity injection starts to wear off, the economy is left groggily peering into the vast funding chasm that bars its route to a genuine recovery. What we badly need is for the financial industry to come up with an innovative way to bridge the gap.

“Private-Label MBS Market Is Showing Signs of Life” by Bonnie Sinnock, National Mortgage News, March 30:

Private-label residential mortgage securitizations continue to be relatively scarce, but the market keeps coming up with creative ways to issue them from time-to-time that are worth noting as investors continue to hunger for yield.

“Report recommends ways to boost non-bank business finance” by Kylie MacLellan, Reuters, March 16:

Britain should look at creating a body to bundle loans to small and medium sized businesses and sell them on to investors, a government-commissioned taskforce looking to boost alternatives to bank funding recommended on Friday.

“Jumbo Production Shows Strong Growth” by Paul Muolo, National Mortgage News, March 16:

RepoWatch summary: Mortgage bankers, led by Wells Fargo, Chase and Bank of America, funded 28 percent more large home loans in the fourth quarter than in the same period in 2010. They appear to be holding onto the loans rather than selling them to be securitized. A number of companies created to securitize jumbo home loans (conduits) have recently folded.

“Moody’s attacks rivals on debt risks” by Nicole Bullock, Financial Times, March 16:

Moody’s has taken a public shot at its rivals, warning that some of their credit ratings do not reflect rising risks in the securitisation markets….

Moody’s Investors Service said that while the overall risk in the securitisation market remained low, it was inching up as lending conditions eased after a period of tight credit….

The rating agency singled out a recent deal from Exeter Finance, a speciality auto finance company.

“Based on our review of publicly available information, we would not have assigned a high investment grade rating to the subprime auto [asset-backed securities] transaction recently issued by Exeter Finance Corp, which received high investment-grade ratings from two other rating agencies,” Moody’s said.

“Fitch Ratings Global Structured Finance 2011 Transition and Default Study” by Fitch Ratings, March 16:

This study analyzes the rating transition and default experience of global structured finance securities rated by Fitch Ratings in 2011 and over the longer term, covering the 1990–2011 period. Rating migrations are examined across the major structured finance sectors, including asset-backed securities, commercial mortgage-backed securities, residential mortgage-backed securities and structured credit (collateralized debt obligations and collateralized loan obligations). …

Global structured finance rating activity remained negative in 2011, with downgrades outnumbering upgrades by an 11 to one margin. However, the number of negative rating actions declined 22% year over year, while positive rating actions rose 58% from the prior year’s level.

The ‘AAA’ and ‘AA’ rating categories exhibited heightened levels of downgrade activity in 2011, 18% and 33%, respectively. The majority of these negative rating actions came from the North American RMBS sector, where Fitch implemented a new U.S. prime RMBS loan-level loss model.

Peak-year origination vintages accounted for fewer overall downgrades than in previous years, with 2005-2007 deals representing approximately 50% of the downgrade total. However, the vintage effect was more pronounced for impairments compared with 2010, as the 2005–2007 vintages accounted for 68% of the impairments recorded in 2011.

“Fannie Economist: Time to Figure Out the GSEs is Now” by Brad Finkelstein, Origination News, March 15:

It is better to address the future of the Government-Sponsored Entities now rather than wait for stability in the market because if it is done at that time, it would reintroduce instability, Fannie Mae chief economist Doug Duncan told the Regional Conference of the Mortgage Bankers Associations in Atlantic City….

There is a consensus in Washington that securitization must be part of the solution. But there is less consensus regarding if the 30-year fixed rate prepayable mortgage should be included, he said….

While some type of secondary market mechanism needs to be carried over from the GSEs, there quite likely will be the “extinguishment” of the Fannie Mae and Freddie Mac names, Duncan said.

“Asset-backed securities seek new look to shed bad image” by John O’Donnell and Paul Carrel, Reuters, March 12:

Asset-backed securities, blamed for triggering the financial market chaos that has toppled banks and sucked in countries, are undergoing a brand makeover but they may find it hard to shake off their old image.

Financial lobby groups are working on a new ‘quality label’ for bonds secured against bundles of assets including credit card debt and car loans, with the aim of rekindling demand.

In future, they hope top-notch ABS will be known as PCS, or Prime Collateralised Securities. …

The PCS project is being organised by a Brussels-based lobby group chaired by Swiss Re chairman Walter Kielholz, the European Financial Services Round Table, and the Association for Financial Markets in Europe, representing investment banks including Deutsche Bank and Goldman Sachs.

Banks are also hoping to persuade European regulators to include high-quality securitised debt among the assets they can use in their liquidity buffers.

“Trial of asset securitization” by Wang Xiaotian, China Daily, March 9:

China is conducting a new pilot program that allows some commercial lenders to securitize assets, said a senior central bank official on Wednesday. …

Li Daokui, a professor at Tsinghua University and academic adviser to the PBOC’s monetary policy committee, said it is wrong to see asset securitization as the root cause of the financial crisis.

“Asset securitization is the road one must follow to achieve modern finance. The key is how to regulate it in a proper manner.” …

But officials at the China Banking Regulatory Commission were less positive about the benefits of securitization. …

“They may mix bad assets with those assets that meet regulators’ requirements (together) in a package, because to banks, the most creditworthy assets actually don’t need to be securitized.”

“Esoteric bonds tempt yield-starved investors” by Adam Tempkin, International Financing Review, March 8:

With interest rates and benchmarks tighter than ever, asset-backed securities investors are flocking to bonds backed by unusual collateral in a hunt for higher yields.

At least five so-called “esoteric” ABS transactions have either been sold to investors over the last three weeks or are in the pipeline, backed by untraditional debt such as cell tower site lease payments, franchise fees, timeshare receivables, drug-royalty cashflows, and structured settlement payments.

Even typically staid investors such as insurance companies have been willing to diversify away from”traditional” commoditized consumer ABS – such as bonds backed by auto loans, student debt, and credit card payments – into “off-the-run”, or less typical, collateral that may be harder to understand, but much higher-yielding.

Shadow banking

“The Age of the Shadow Bank Run” by George Mason University economics professor Tyler Cowen, The New York Times, March 24:

I recently asked a group of colleagues — and myself — to identify the single most important development to emerge from America’s financial crisis. Most of us had a common answer: The age of the bank run has returned.

Since the end of World War II, economists have generally thought that runs on banks were dead, at least as a phenomenon in advanced nations. In the United States, for example, bank deposits are insured by the Federal Deposit Insurance Corporation, and, as a last resort, the Federal Reserve can back deposits by printing money.

The new complication is that bank deposits are no longer the dominant form of modern short-term finance. The modern bank run means a rush to withdraw from money market funds, the disappearance of reliable collateral for overnight loans between banks or the sudden pulling of short-term credit to a troubled financial institution. But these new versions are in some ways still similar to the old: both reflect the desire to pull money out of an endeavor — and to be the first out the door. And both can set off a crash.

These newer forms occur in the so-called shadow banking system, involving short-term financial credit not guaranteed by the deposit insurance umbrella. According to the Federal Reserve Bank of New York, shadow banking accounts for about $15 trillion in assets — more than the traditional banking system. But as recently as 1990, the shadow-banking total was much lower, at less than $4 trillion. The core problem is that the growth of short-term credit has been outracing our ability to protect it, and since 2008 most investors have realized that these shadow-banking transactions are not risk-free….

It now seems that the 21st century will resemble the 19th and early 20th centuries, with periodic panics and runs on financial institutions, perhaps followed by deflationary collapses….

In short, no promising financial path is before us. It’s good that the American economy seems to be recovering, and this may shove some problems into the future. But banking and finance remain a mess at their core. Welcome to the 21st century.

“Shadow Banking and Repo” by Richard Comotto, ICMA European Repo Council, March 20:

It is clear that shadow banking performs an important role in enhancing the efficiency of financial markets and reducing the cost to and risk on borrowers and lenders, and that it can reinforce the stability of the financial system. Regulatory initiatives to contain risk in shadow banking therefore need to target specific problems and avoid indiscriminate constraints that could damage its many desirable functions. …

This paper is intended to inform the regulatory discussion on repo by addressing the various issues and, in particular, is intended to correct apparent misunderstandings about the structure and operation of the repo market. The points made in this paper also apply to securities lending, in as much as it is an analogous instrument to repo, but not to cash reinvestment by securities lenders.

“Green Paper on Shadow Banking” by the European Commission, March 19:

The Commission considers it a priority to examine in detail the issues posed by shadow banking activities and entities. The objective is actively to respond and further contribute to the global debate; continue to increase the resilience of the European Union’s financial system; and, ensure all financial activities are contributing to the economic growth. The purpose of this Green Paper is therefore to take stock of current development, and to present on-going reflections on the subject to allow for a wide-ranging consultation of stakeholders.

“UK’s FSA wants radical rules for shadow banks” by Huw Jones, Reuters, March 14:

Regulators won’t fully understand the complexity of “shadow banks” and should therefore opt for radical rule changes, Britain’s Financial Services Authority said on Wednesday.

Policymakers say the opaqueness of the $60 trillion shadow banking system – a web that includes money market funds, securities lending and repos — which operates alongside mainstream lenders contributed to the financial crisis.

Leaders of the world’s top 20 economies have called on their regulatory task force, the Financial Stability Board, to come up with draft rules by the end of this year.

‘Turner calls for radical action on shadow banking” by Brooke Masters, Financial Times, March 14:

Shadow banking poses a constantly changing threat to broader financial stability and has to be closely supervised and regulated to ensure it does not foster “unsafe” borrowing and exacerbate economic boom and bust cycles, the UK’s leading financial regulator has said.

The sprawling array of non-banks that extend credit and provide other bank-like services are “not something parallel to and separate from the core banking system, but deeply intertwined with it … We need to ensure that our regulatory response appropriately covers shadow banking as well as banks,” Lord Turner told an audience at the Cass Business School in London. …

Lord Turner’s views are closely watched because he heads a group of global regulators charged with coming up with plans to make the sprawling $33tn sector safer. Working under the auspices of the Financial Stability Board, Lord Turner’s committee aims to produce by the end of the year both an analysis of shadow banking and a package of regulatory reforms to address the risks the sector poses….

Lord Turner said the committee was looking at how to make safer the many different financial products that mimic banking services, including securitisations – the process of bundling individual loans and selling slices to investors – and money market funds that promise investors instant access to cash.

The group may also propose minimum haircuts and margins for “repo” and other secured lending to minimise their pro-cyclical effect in falling markets. …

Securitisations, the type of shadow banking that proved particularly toxic in 2007 and 2008, may have fallen by as much as 90 per cent, but “we should not take the decline in some specific indicators of shadow activity … as suggesting that the risks have gone away,” Lord Turner warned. “Any system this complex will defy complete understanding.”

Tri-party repo

“Tri-party repo risk stirs debate” by Ellen Freilich, Reuters, March 7: 

If prime funds are increasing their structured finance repo and the total volume of paper being financed is unchanged, then another repo market cash provider must be lowering its exposure to this collateral type, said Abate ( Joseph Abate, market analyst at Barclays Capital in New York).

Who that cash provider might be is hard to figure out because money market funds are not the only cash lenders in the repo markets, he said.

Securities lenders, insurance companies, and others are important sources of collateral financing but unlike the money funds, data on their holdings “are not reported on a granular or frequent basis.

“Indeed, as noted by others, this is a reason for expanding data collection in this market,” Abate said.