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Brussels - Special funds used by big companies to park billions of euros of cash faced stricter rules to make them safer, the European Commission said on Wednesday, taking a first step to reform unregulated finance known as shadow banking.
The draft law will regulate money market funds, demanding some set aside cash buffers to avoid a panic should many investors withdraw their money at once.
This would lower what EU financial services chief Michel Barnier said was a risk to the financial system from the trillion euro sector but users of the funds warn that demanding they hoard more for a rainy day would make them too expensive.
The changes are part of efforts to shine a light on shadow banking, a €24trn industry in Europe that comprises money market funds, some hedge funds and firms involved in securities lending and repurchase markets.
Intertwined
Such groups borrow and lend, just like banks do, but because they are not banks they often fall outside the remit of regulation, which is why they are considered to operate in the 'shadow' of traditional finance.
In the European Union, money market funds are mainly based in France, Ireland and Luxembourg and are heavily used by companies and banks which borrow from them.
For companies, they are an alternative home for short-term cash.
Unlike banks, they have no access to support from central banks such as the European Central Bank if things go wrong.
But the vast unchartered territory unnerves regulators in part because the sector is closely intertwined with banks, who often sponsor the funds as well as relying on them for finance themselves.
"We have regulated banks and markets comprehensively," said Barnier, the EU Commissioner who has led a four-year revamp of financial rules.
"We now need to address the risks posed by the shadow banking system."
The European plans draw on ideas in a global blueprint that will be submitted for approval to the world's 20 leading economies when their leaders meet in Russia on Thursday and Friday.
In some cases, the EU reform is more ambitious.
Requirement
The reform is a response to the 2007-2008 financial crisis, which was brought on by the collapse in prices of securities tied to risky home loans.
"Shadow banking was at the heart of the crisis," said Frederic Hache, a former derivatives banker who works with public-interest group Finance Watch.
"As bank regulation has since tightened, activity may shift into the shadow sector."
The most controversial element in Barnier's proposal is a requirement for one type of money market fund, known as constant net asset value (CNAV) funds, to hold a cash buffer equivalent to 3% of their assets.
