UPDATE 1-BoE's Tucker wants powers to cool unruly markets

Fri Apr 27, 2012 12:22pm EDT

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* Tucker wants capital buffers on shadow banks

* FSB sees risks in securities lending, repo markets

* FSB to finalise policy recommendations by year end

* IOSCO mulls new rules for money market funds

By Huw Jones

LONDON, April 27 (Reuters) - Supervisors should have powers to demand more collateral in financial transactions in order to cool down overheated markets, Bank of England Deputy Governor Paul Tucker said on Friday.

He and other regulators from across the world are looking at how to rein in the multi-trillion dollar "shadow-banking" sector which handles credit and leverage outside traditional banking.

It includes money market funds, and securities lending and repo markets which use collateral to underpin short-term financing for banks and brokers.

Global regulators outlined on Friday their thinking on new rules, such as tougher collateral requirements on securities lending and capital buffers on money market funds.

"The authorities should be able to step in and set minimum haircut or margin levels for the collateralised financing markets, or segments of them," Tucker told a European Commission conference on regulating shadow banks.

Higher margins would dampen volume and size of transactions as more securities would be needed to manage the transaction.

"That would need to be pursued at international level," Tucker said, adding that shadow banks can play a useful role.

Industry officials say that such intervention in margins would be a major change as there are no margins on many contracts currently.

Other steps could include greater transparency by using a trade repository to record transactions, and clamping down on how non-bank financial firms use cash collateral.

Tucker wants to force banks that sponsor or operate off-balance sheet vehicles to consolidate them onto their balance sheet so they would have to hold bigger capital cushions.

Banks should also hold more liquid assets against their financing lines to financial companies, he suggested.

Supervisors could limit how much banks can fund themselves short term from U.S. money market funds and other "fragile, flighty sources", Tucker added.

Non-bank financial firms which raise short-term debt on markets should also face "bank-type regulation and supervision of the resilience of their balance sheets".

From next year the BoE's Financial Policy Committee will have powers to directly order banks to increase their capital levels in overheated markets.

Tucker is seen as a front runner to become the BoE's next governor in 2013.

The European Commission will propose EU-wide shadow bank regulation next year after a global regulatory body, the Financial Stability Board (FSB), completes work on policy recommendations for world leaders by November when G20 leaders meet.

MONEY MARKET FUNDS

The FSB, of which Tucker is a member, said in an interim report on securities lending and repos on Friday there was a lack of transparency, potential risks from firesales of collateral assets, and insufficient rigour in collateral valuation and management practices.

"These finiancial stability issues will form the basis for the next stage of the workstream's work, which is to develop appropriate policy measures to address risks, where necessary, by the end of 2012," the FSB said in a statement on Friday.

The board set up five workstreams last year to look at different aspects of shadow-banking.

The fear among regulators is that as mainstream banking is more tightly regulated, risky activities will migrate into shadow banks which are far less regulated at the moment.

One workstream is looking at money market funds - pooled investments that are important players in repo markets. Global securities watchdog IOSCO began consulting on Friday to help the FSB design rules for the $4.7 trillion sector.

It is looking at whether to encourage a shift to valuing funds on a more transparent net asset value (NAV) basis whereby shares reflect rises or falls in performance.

Most funds use constant net asset value (CNAV) whose shares have an unchanging face value, with income is used to buy more shares or paid out to investors.

IOSCO said it could also impose capital and liquidity buffers to make the funds more resilient in rocky markets and avoid taxpayers having to help out again.

Regulators were alarmed at big losses in money market funds, especially when the Primary Fund "broke the buck" in 2008, a rare occurrence which refers to when the fund's NAV drops below $1 and fails to cover operating expenses or losses.

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