European money market funds face cash buffer rule - EU document
* EU readies first shadow banking reform
* Some funds face cash buffer requirement
* Funds could get time to build up buffer
* Industry says buffer won't bolster financial stability
By Huw Jones
LONDON, May 23 (Reuters) - About half of the European Union's trillion euro money market funds would have to set aside a chunk of cash under a proposed EU reform to make a run on a fund in rocky markets less likely.
Money market funds (MMFs) hold short term financial instruments such as deposits and commercial paper. They are used by big companies to park money and manage cash flows.
Until the 2007-09 financial crisis, they were seen as a safe place to place cash that could be withdrawn quickly.
The sector drew the attention of policymakers with a run on the Reserve Primary Fund in the United States, which "broke the buck" in 2008 when its net asset value fell below a dollar a share. This indicated a loss at what was seen as a safe investment vehicle and sparked runs in the wider sector.
The draft EU law, a copy of which was obtained by Reuters, calls for a major type of fund to have a cash buffer to help keep the financial system stable.
The industry is hoping for a last minute change of heart by the EU's European Commission, which is writing the draft law that will need approval from EU states and the European Parliament to take effect.
A Commission spokeswoman said the proposal is likely to be published in late June.
The buffer requirement would be for so-called constant net asset value funds (CNAV) whose share price shows little change over time, like the U.S. fund that broke the buck.
"These CNAV funds must establish and maintain at all times a buffer amounting to at least 3 percent of the total value of their assets," the EU document said.
An EU official said on condition of anonymity the 3 percent buffer proposal is likely to remain in the final proposal but funds could be given time to reach that level.
The London-based Institutional Money Market Funds Association (IMMFA), an industry body, said a requirement for a cash buffer won't improve stability of the financial system.
"We support changes which make these products more robust, but don't support those which seek to address a perceived risk rather that an actual one," IMMFA said in a statement.
Money market funds in the EU hold a trillion euros and are mainly domiciled in France, Ireland and Luxembourg, with investments and investors from across the 27-nation bloc. Banks issue 85 percent of financial instruments held by the funds, with the rest coming from big companies and governments.
The United States is also reforming its $2.6 trillion money market funds sector and has faced push-back from industry.
The Financial Stability Board, the regulatory task force for the G20 group of economies, is due to report in September on its recommendations for supervising so-called shadow banks, including MMFs.
The EU reform is the bloc's first in the shadow banking sector which lies outside mainstream banks and handles credit. Regulators worry that as mainstream banks become more regulated, risky activities will shift to less supervised shadow banks.
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