A Game of Shadows: Why Does the
EU Attempt to Regulate Shadow
Banking while Canada Does Not?
Sebastien Labrecque
School of Political Studies
Nassiba Idebdou
Graduate School of Public and International Affairs
BACKGROUND INFORMATION
•
The 2008 financial crisis exposed problems and risks associated with various sectors
and actors of the global financial system which had remained hidden until then.
– Example: shadow banking and the potential systemic risks associated with it.
•
First set of more pressing financial reforms after the crisis mostly targeted banks, but
shadow banking eventually got on the agenda on the Financial Stability Board (FSB).
•
The European Union (EU) began to work on the issue of shadow banking relatively
early.
•
While usually at the forefront of international financial regulation, Canada has been
surprisingly quiet on the issue and has yet to formally implement the FSB’s
recommendations.
RESEARCH QUESTION
• Why is the EU trying to regulate shadow
banking while Canada is not, in spite of the
fact that they are both members of the
Financial Stability Board?
OUTLINE
• What is shadow banking?
• The FSB’s recommendations
• The EU and shadow banking
• Canada and shadow banking
• Conclusion
WHAT IS SHADOW BANKING?(1/2)
• Financial Stability Board: “credit intermediation involving entities and
activities (fully or partially) outside the regular banking system” (Financial
Stability Board 2013a, iv).
• Broadly defined, shadow banking includes entities such as:
– non-bank loan originators;
– private-label securitizers;
– investment banks;
– structured investment vehicles;
– hedge funds;
– various finance companies;
– different types of funds (private equity, mutual, pension, investment, etc.)
(Blinder 2013, 60).
WHAT IS SHADOW BANKING? (2/2)
• Shadow banking’s main markets encompass:
– (Blinder 2013, 60)
Asset-backed
securities
(including
mortgagebacked)
Commercial
paper
Repurchase
agreements
(repos)
Derivatives
THE FSB’S RECOMMENDATIONS (1/3)
• G20 Seoul Summit 2010
• G20 Cannes meeting 2011
• 2013: FSB published three final policy documents
– An Overview of Policy Recommendations;
– Policy Framework for Addressing Shadow Banking Risks in Securities
Lending and Repos;
– Policy Framework for Strengthening Oversight and Regulation of
Shadow Banking Entities.
• Using an activity-based approach, the documents focus on five areas for
which shadow banking can present potential systemic risks if not regulated
THE FSB’S RECOMMENDATIONS (2/3)
The five areas identified by the FSB:
• to mitigate the spill-over effect between the regular banking
system and the shadow banking system;
• to reduce the susceptibility of money market funds (MMFs) to
“runs”;
• to assess and align the incentives associated with securitisation;
• to dampen risks and pro-cyclical incentives associated with
securities financing transactions such as repos and securities
lending that may exacerbate funding strains in times of market
stress; and
• to assess and mitigate systemic risks posed by other shadow
banking entities and activities. (Financial Stability Board 2013b, i)
THE FSB’S RECOMMENDATIONS (3/3)
• What is next?
– Member states can begin the implementation of the
recommendations
– Progress will be monitored by the FSB and reported at the
G20 Brisbane Summit this Fall
– Peer review starting in 2015
HOW DID SHADOW BANKING GET ON
THE EU’S AGENDA?
• Spring 2012: Green Paper and a public conference on shadow
banking are organized by the European Commission.
– European Parliament, via the “own-initiative procedure”, also
took a closer look at shadow banking in 2012
• October 2012: Final report of the High-level Expert Group on
reforming the structure of the EU banking sector (“Liikanen
Report”)
• 2013-2014: Roadmap and first set of “proposals for a
regulation”
2 PROPOSALS FOR A REGULATION
• Proposal for a Regulation of the European Parliament and of the
Council on Money Market Funds (2013)
• Proposal for a Regulation of the European Parliament and of the
Council on reporting and transparency of securities financing
transactions. (2014)
EC’s PROPOSALS VS FSB’s
RECOMMENDATIONS
• In line with certain areas of focus of the FSB (MMF, securities
financing transactions)
• Some discrepancies (especially on MMFs)
– EC’s constant net asset value MMFs versus FSB’s variable
net asset value MMFs
– 3% liquidity buffer
Why has the EU been so proactive on
the issue of shadow banking?
•
EU started working on shadow banking before the FSB was done writing its final
policy documents
– Canadian authorities were still officially waiting in 2013 for the reforms to be
agreed at the international level before acting and deciding how (and which)
measures targeting shadow banking should be implemented (Lane 2013, 8).
•
Three reasons
– Size of the shadow banking sector in the EU
– Shadow banking system and the rest of the financial system are highly
interconnected
– Stricter rules for the banking industry could lead to a “move to the shadows”
•
The EU and its “global leadership in implementing its G20 commitments” (European
Commission 2012, 2)
OPPOSITION TO THE PROPOSALS (1/2)
• The regulation of MMFs has drawn the most attention so far.
– Most of the MMFs operating in the EU are based in France, Ireland and
Luxembourg.
– France and Germany VS Ireland, Luxembourg and the MMF industry
• Explaining the position of France on MMF. Three factors:
– Size of MMFs vis-à-vis total banking system
– Variable net asset value MMFs in France
– Recent history tends to show that financial interests in France do not
have the same influence on the government than in other countries like
the United States and the United Kingdom.
OPPOSITION TO THE PROPOSALS (2/2)
•
The United Kingdom in the debate on shadow banking
– Ever since the regulatory push that followed the 2008 crisis, the UK has proven
reluctant at times in its efforts to enhance the regulation of financial activities and
entities.
– 2009: UK’s opposition to the EC directive on Alternative Investment Funds
Managers
– Since this event, the position of the UK on shadow banking has been relatively
nuanced.
• British government claims to be fully supportive of the work of the FSB on
improving the oversight and regulation of shadow banking (Leadsom 2014,
10).
• However, it is still possible to see that the United Kingdom remains very
close to the financial sector’s positions on some specific issues, such as
liquidity buffers for MMFs and securities financing transactions
SHADOW BANKING IN CANADA
• 40% of traditional banking sector;
• Using an activities-based approach, it can be divided
in 5 categories;
Private-Label
Securitization
10%
NHA
MBS/CMB
60%
Repos
10%
Other
20%
MMF
5%
BA/CP
15%
Source: Gravel, Grieder and Lavoie 2013, 57, Bank of Canada.
SHADOW BANKING IN CANADA
Why is it important
• Between 2007 and 2012:
– Important increase in mortgage-backed securities;
– Shift away from private-label securitizations;
• Increase in the growth of credit lending activities;
• The growth of repo market
– $48 billion and $75 billion during the third quarter
of 2012
CANADA’S LEADERSHIP IN FINANCIAL
REGULATION IN THE WAKE OF THE
2008 CRISIS
Strong economic performance
Quality of regulatory system and
regulators
Full compliance with Basel III ahead of
time
4 FACTORS TO EXPLAIN CANADA’S
RESPONSE TO THE FSB-EU PROPOSALS
Canadian
Banking
System
Canadian
Market-Based
Finance
Sector
Financial
Regulation
Proactivity
Securitization
Transactions
1 – CANADIAN BANKING SYSTEM
Concentration: Big Five absorbed many
sources of systemic risk through time
Risk kept under the “regulatory umbrella”
and tight enforcement of regulations by OSFI
Less non-bank financial intermediaries than in
the EU
2 – CANADIAN MARKET-BASED
FINANCE SECTOR (MBF)
Expansion of MBF in the last 15 years
Good performance in most of securitization
markets despite the crisis (i.e. MBS, repos)
Canadian financial infrastructure helped
sustain the adverse impact of the crisis
3 – FINANCIAL REGULATION
Major reform after the crisis in two riskier markets: repos
and mortgage-backed securities
Limit on government lending exposure (securities
guaranteed by the government cannot be used as
collateral in securities transactions)
Increase in Bank of Canada’s legal powers on repo markets
and over-the-counter derivatives
4 –SECURITIZATION TRANSACTIONS
Support to the sector rather than complete restriction
• i.e. repo market and CPPs
Risk measurement mechanisms to mitigate systemic risks
• High leverage ratios in place
• Higher risk-based capital requirements for liquidity lines
Continuous efforts to collaborate domestically
WHY THE CANADA-EU PARTNERSHIP
IS IMPORTANT
Regulatory arbitrage between countries can lead to
competitive imbalances
Multiple burdens on banks
Allow for similar reforms in shadow banking
Jurisdictions are not immune to the vulnerabilities of the
global markets
REDUCING THE RISKS OF SHADOW
BANKING - WHAT IS NEEDED
Credit Rating Agencies Oversight
• Consistency in evaluating financial instruments
• Fostering confidence between nations
Money Market Mutual Funds
• Liquidity levels of assets
• Maturity of investment portfolios
WHAT’S NEXT FOR CANADA
Focus on monitoring of expanding new securities
(CPPs and ACBPs)
Limit the risks of rising demands of credit lending
via shadow banking activities
Look at non-bank entities to complement the analysis
of market-based credit-intermediation activities
CONCLUSION
•
Shadow banking has been on the international agenda since 2010.
•
It is now up to national governments to implement the recommendations that were
made by the FSB in 2013.
•
EU moved early on the issue.
•
To the second part of our research question (i.e. “why is Canada not regulating
shadow banking despite its FSB membership”), we find that
– Canada has regulated some aspects of shadow banking (before and after the
crisis).
– Some aspects of the financial architecture and the banking system in Canada did
not require further regulations after the crisis.
– Canada will have to collaborate with the EU (and others) to prevent the
fragmentation of the global financial system (and the consequences it would
have on Canadian financial actors)
THANK YOU