The European Union is pushing for a more stable financial system by clamping down on "shadow banking" — the high-finance sector that handles trillions of dollars but isn't bound by the same rules as banks.
The Commission, the EU's executive arm, said Wednesday that while investment vehicles such as money market funds or hedge funds are welcome because they provide extra sources of financing for companies and the economy, they can also pose serious threats to long-term financial stability.
Analysts and economists have argued that the lack of oversight in the shadow banking sector played a major role in the global financial crisis of 2008.
The global shadow banking sector was estimated to hold assets of about 51 trillion euros in 2011 (currently $67 trillion), or almost a third of the total financial system and half the size of bank assets, according to the latest figures available from the Financial Stability Board. About a third of the sector's assets are held by firms in the U.S. and some 45 percent in the 28-country European Union.
The Commission's new set of rules targets the 1 trillion euro ($1.3 trillion) money-market fund sector. The funds are an important refinancing tool for Europe's economy, currently holding almost a quarter of short-term debt issued by banks, governments or companies in Europe.
Commissioner Michel Barnier said many of the funds resemble banks in their operations by taking deposits and lending money, but aren't subject to the tough oversight banks face. That's why they are considered to operate in the "shadow" of traditional finance.
"That means we need transparency, a sound oversight and that the risk taken on by the players of this banking sector be subject to precautionary measures," Barnier told reporters in Brussels.
"The goal remains to draw the lessons from the (financial) crisis which we owe to the citizens, as we owe it to taxpayers and companies," he said, to ensure governments no longer have to bail out financial institutions in time of crisis. "No financial market, no financial product, no financial player will escape efficient rules and oversight."
Big companies often use the funds, each of which can have a value of up to 50 billion euros ($66 billion), to park billions of euros in cash there since they provide better returns than bank accounts while promising almost the same flexibility.
"The problem is that these funds aren't that stable and in case of (market) tensions, they can put the entire financial sector at risk, particularly the banks," Barnier said.
The proposed legislation will force the funds to hold a minimum of 10 percent of assets maturing overnight, and 20 percent within one week, to guarantee they have sufficient liquidity to pay back investors at any point in time. The issue is important because if a fund isn't able to pay out its investors, it has to suspend its operations, a move that — given such funds' size — can disrupt the wider financial system.
The new rules will require approval from the EU's member states and the European Parliament. The Commission says its proposals are broadly in line with similar recommendations drawn up by the Financial Stability Board due to be presented to the leaders of the world's largest economies at the G-20 summit later this week in Russia.
However, the Commission stopped short of forbidding one category of those funds which guarantee investors a fixed payout despite the fluctuating prices of their underlying assets, which makes them more vulnerable in times of turmoil.
The Financial Stability Board has recommended prohibiting them, and the finance ministers of Germany and France, Europe's two biggest economies, appealed in a letter to Barnier this week to beef up his proposal and force those funds to change their business model.
"Their potential for systemic risk has been amply demonstrated during the 2007-2008 crisis, some (of them) experienced investor runs that necessitated large-scale support from sponsors or the public sector to maintain stability in the money market fund sector and the financial system as a whole," ministers Wolfgang Schaeuble and Pierre Moscovici said in the letter obtained by The Associated Press Friday.
The Commission proposal, however, only foresees forcing them to build up a small capital cushion, even though critics say that might still leave taxpayers exposed to footing the bill for new costly bailouts once things go wrong.
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