Speaking last Friday at a European Union conference on Shadow Banking, Bank of England Deputy Governor Paul Tucker began to put some flesh around the bare skeleton of what Shadow Banking regulation might look like. This is the first time that we have seen ideas move out of the “maybe, how about this one” and into the “we propose” phase of regulation. Mr. Tucker’s role in the global financial community has been previously noted in articles on this site, hence his comments should be considered carefully.
From Mr. Tucker’s published speech on the matter, his main points were:
– Shadow banks funding activities that are part of a bank should be consolidated on a bank’s balance sheet. This should include SIVs, ABCPs and money market funds that benefit from an implicit reputational guarantee.
– Banks should hold more assets for credit lines to financial companies than for non-financial companies. This would reduce systematic risk in financial markets.
– Money market funds should have a choice between moving to a Variable NAV or staying as a Constant NAV. If a Constant NAV, then the fund should have a capital reserve requirement. Mr. Tucker also thinks that both kinds of funds should have gates that make runs on the fund less likely. VNAV supporters would welcome the elimination of a capital requirement but we suspect will find the gating requirement still daunting to running a successful fund. Arguable, the VNAV provides enough transparency that gates should be left to a CNAV only.
– Regulators should limit the amount of short-term funding they get from money market funds. This is a very tough nut to crack. How will banks know who is buying their short-term debt in the open market, and how does a bank tell a US or Argentinian or Japanese money market fund that they overbought (compared to a global standard) and have to sell?
– Any business, whether a bank or not, that funds itself primarily from short-term debt should be regulated like a financial services company. Fair enough – if it walks like a duck and acts like a duck, then regulate it like a duck.
– Only banks should be able to rehypothecate assets. Non-banks should not rehypothecate but can lend on margin. We can see the bank prime brokers salivating already.
– More market transparency in the form of a Trade Repository. See our article placing bets on a trade repository in securities lending and repo here.
– No acceptance of collateral that a firm or fund would not buy outright.
– Non-bank financial firms should be regulated in how they use cash collateral.
– Minimum haircut or margin levels for collateralized financing activity.
We have more substantial, long and windy comments on each one of Mr. Tucker’s ideas, but these are more suited to a report and not an article. Suffice to say, Mr. Tucker has drawn a new line in the sand on Shadow Banking regulation. These are worth discussing.
On another Shadow Banking front, the Financial Stability Board released an interim report on Shadow Banking last week. This is more of an update on what the FSB has learned so far than any real new information for the market. We didn’t find much to discuss. For those interested, the report is here.