A statement and report issued Friday by the Financial Stability Board entitled, "FSB publishes progress reports to the G20 on the financial regulatory reform programme" says, "The FSB published on 20 April a letter from the Chairman to the G20 Finance Ministers and Central Bank Governors describing progress on the financial regulatory reform programme, and three progress reports on specific aspects of the programme: extending the G-SIFI framework to domestic systemically important banks; strengthening the oversight and regulation of the shadow banking system and a joint report from the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board on their progress in converging their standards."

The FSB's second report, "Strengthening the Oversight and Regulation of Shadow Banking: Progress Report to G20 Ministers and Governors," comments, "At the Cannes Summit in November 2011, the G20 Leaders agreed to strengthen the oversight and regulation of the shadow banking system, and endorsed the Financial Stability Board (FSB)'s initial recommendations with a work plan to further develop them in the course of 2012.... The "shadow banking system" can broadly be described as "credit intermediation involving entities and activities outside the regular banking system". It has become an integral part of the modern financial system that has an important role in supporting the real economy. For example, the shadow banking system provides market participants and firms with an alternative source of funding and liquidity. Furthermore, some non-bank entities may have specialised expertise to assess risks of borrowers and hence can spur competition in the allocation of credit in the economy."

It continues, "However, the shadow banking system can also pose risks to the financial system, on its own and through its links with the regular banking system. These risks can become acute especially when it transforms maturity/liquidity and creates leverage like banks. For example, short-term deposit-like funding of non-bank entities can easily lead to "runs" in the market if confidence is lost. The use of collateralised funding (secured financing) techniques such as repos (repurchase agreements) and securities lending can exacerbate such "runs" and boost leverage, especially when asset prices are buoyant and margins/haircuts on secured financing are low. Moreover, the risks in the shadow banking system can easily spill over into the regular banking system as banks often comprise part of the shadow banking credit intermediation chain or provide support to non-bank entities."

The report explains, "The FSB issued initial recommendations in its report "Shadow Banking: Strengthening Oversight and Regulation" (hereafter October 2011 Report) 3 to address such risks posed by the shadow banking system. It has adopted a two-pronged approach. First, the FSB will enhance the monitoring framework through continuing its annual monitoring exercise to assess global trends and risks, with more jurisdictions participating in the exercise. Second, the FSB will develop recommendations to strengthen the regulation of the shadow banking system, where necessary, to mitigate the potential systemic risks with specific focus on five areas: (i) to mitigate the spill-over effect between the regular banking system and the shadow banking system; (ii) to reduce the susceptibility of money market funds to "runs"; (iii) to assess and mitigate systemic risks posed by other shadow banking entities; (iv) to assess and align the incentives associated with securitisation to prevent a repeat of the creation of excessive leverage in the financial system; and (v) to dampen risks and pro-cyclical incentives associated with secured financing contracts such as repos, and securities lending that may exacerbate funding strains in times of "runs". The proposed policy recommendations in all five areas will be developed by the end of 2012. The rest of this report details the FSB’s progress to-date in response to the request from the G20."

The section on "Money Market Funds" says, "The International Organization of Securities Commissions (IOSCO) is developing policy recommendations related to money market funds (MMFs) by July 2012 through its Standing Committee on Investment Management (SC5). IOSCO aims to publish a consultation report shortly. The consultation report provides an analysis of the systemic importance of MMFs and their key vulnerabilities, including their susceptibility to runs. It also highlights some of the issues which have to be considered, such as the impact on short-term funding and effects on investor behaviour, implementation challenges as well as other potential disruptive effects. It also clarifies the role of MMFs during the crisis and describes the changes introduced in MMF regulation following the crisis. The report then analyses the characteristics and benefits of MMFs in various jurisdictions (with a focus on Europe and the US, but also including Australia, Brazil, Canada, China, India and Japan) and the particular regulatory arrangements which have influenced their role and risks."

The FSB adds, "Based on such analysis, the draft consultation report sets out possible policy options that could reinforce the soundness of money market funds and address the identified systemic vulnerabilities such as the following: (i) Mandatory move from constant to variable net asset value (NAV) -- this may include other structural arrangements that may reduce susceptibility to runs caused by sudden fluctuations in the "true" price of MMFs, such as introduction of "NAV buffer" if constant NAV is maintained. (ii) Enhancement of MMF valuation and pricing framework -- this may include restricting the use of amortised cost accounting by MMFs. (iii) Enhancement of liquidity risk management -- policy measures such as liquidity buffer, redemption restrictions and establishment of private liquidity facilities will be considered as tools to improve MMFs' management of redemption pressures. (iv) Reduction in the importance of ratings in the MMF industry -- policy measures such as removal of references to ratings from MMF regulations and improvement of MMF ratings would be considered to reduce the herding and "cliff-effects" associated with the use of ratings in relation to MMFs."

Finally, the report says, "These options are not mutually exclusive and some may be considered in combination. Pursuant to IOSCO Technical Committee approval, the consultation report will be published to obtain inputs from the stakeholders in assessing the different policy options. IOSCO envisages using the outcomes of the consultation to narrow down the policy options into policy recommendations by July 2012. FSB will separately provide its members' views on the consultation report to IOSCO to facilitate its preparation of policy recommendations."

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