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Markets Regulation
Tougher shadow bank rules ‘only the start’
From the Financial Times of Tue, 14 Oct 2014 16:57:20 GMT

Participants in the shadow banking sector were warned on Tuesday that tougher rules being imposed by international regulators were likely to be only an initial step towards more oversight.

Lawyers and money managers said the proposals from the Financial Stability Board governing so-called repurchase, or repo, agreements would only partly tackle excessive leverage in the sector.

The FSB, a group of regulators, on Monday published a framework imposing minimum collateral requirements on shadow bank organisations, such as hedge funds, that borrow money from banks using short-term loans secured by stocks or bonds.

The international standards take aim at the repo market, which plays a big part in shadow banking operations, in the hope of reducing excessive lending to try to avoid a repeat of the behaviour that helped precipitate the financial crisis of 2008.

Specialists said the changes should not cause market disruption and the FSB itself said market participants were expecting “minimal” impact on volumes. But experts warned that regulators were leaving open the option of more regulation in future.

Etay Katz, a partner at Allen & Overy, a law firm, said the regulators were “dipping their toe in the water”.

He added: “If repo is a fundamental pillar of your business, you are going to have to go back to the drawing board and figure out what is coming next, and what your business will look like in three years’ time. This is unprecedented and it paves the way for further interventions by the authorities.”

Neil Williamson, co-head of Emea Credit at Aberdeen Asset Management, said: “The regulators want to stop banks from letting standards slip.”

As hedge funds work out the impact of the reforms, they are also worrying about the effect of increased regulation on their relationships with banks’ prime brokerage divisions, which execute and finance their trades.

The need for banks to set aside more capital is hurting prime brokerage profits. As a result they are re-evaluating their relationship with hedge fund clients, in some cases passing on higher costs and in others, stopping serving clients that produce little or no returns for the bank.

The FSB left sovereign debt out of the collateral rules, focusing instead on private sector assets such as corporate bonds and equities.

This was questioned by some advisers – government bonds form a large part of the repo market. “It is the equivalent of the zero per cent risk-weight – a 1984-style governmental fiction that sovereign debt is free of credit risk and market risk,” said one lawyer.

Some advisers also argued that focusing on transactions between banks and non-banks could push more activity into the shadows, a consequence acknowledged in the FSB’s report.

The chief executive of one advisory firm said: “The FSB is putting rules in place between banks and non-banks but there are no rules for collateral requirements between the non-banks. They’re basically driving another piece of business banks were providing further away into the non-banking sector.”

The FSB paper said regulators would also consult on applying the standards to deals between non-banks. It also discussed the possibility of regulators increasing collateral requirements when indebtedness grew too rapidly.

Adrian Docherty, head of banking advisory at BNP Paribas, said: “This is only the beginning of regulatory action in this area . . . the authorities are worried about people moving more transactions outside the scope of bank regulation.”

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