EU executive cautious on shadow banking controls

By Huw Jones LONDON (Reuters) - The European Union's executive has ruled out hasty curbs on "shadow banking", or simplistic trading restrictions on mainstream lenders, in case it ends up crimping finance for the economy. Testimony to Britain's parliament from Patrick Pearson, a senior official at the bloc's European Commission, signaled the latest softening in tone among regulators, fearful of unintended consequences of new rules for the flow of credit to companies. Shadow banking refers to the opaque $70 trillion sector that includes money market funds, securities lending, repurchase agreements and other forms of short-term borrowing and lending outside the main banks, which helps grease the economy. Regulators worry that as mainstream lenders are more tightly regulated, risky activities will shift to the shadow banking sector. They are therefore looking at what steps should be taken to contain risks. Pearson said there was already evidence that as banks focus on building up their capital buffers, hedge funds and other unregulated firms were offering liquidity to markets. The European Commission has the sole right to propose EU laws and had aired possible curbs, but Pearson downplayed any imminent proposals to ban or restrict shadow banking activities. "The priority at this point is transparency, transparency, transparency," he told a House of Lords economics committee on Tuesday. "Regulators are quite aware not to squeeze out an important source of liquidity." The emphasis will be on collecting data to find out what was going on before jumping to regulatory conclusions, he said. The Commission is also running out of time to propose major, controversial measures as the European Parliament goes to the polls next May and a new line up of commissioners will be appointed in October. In addition in faces a slew of banking union and market rules to approve ahead of next year's parliamentary polls. LIIKANEN LIGHT? Standalone EU shadow banking legislation was not on the Commission's work program and improving transparency, such as in securities financing transactions, will be looked at before any significant restrictions or curtailments, Pearson said. Trade repositories, already in place to record financial derivatives transactions from February, could also be used to record transactions in shadow banking, Pearson added. The banking sector is also waiting to see what the Commission will finally propose to further curb risks among lenders following recommendations from the Liikanen report. That report recommended mandatory separation of a bank's proprietary trading operations, along with higher capital requirements on trading assets. Pearson said there would be a legislative proposal on bank structural reform shortly, but in effect dismissed the extreme option of banks having to fully hive off risky activities from retail deposit-taking arms. Hiving off risky activities might sound simple and appealing but there was a need to strike the right balance between curbing risks and not damaging how banks finance the economy, he said. Such a balance also needed to make sense on a global basis and what Europe will do would depend on what the United States decided on the so-called Volcker Rule, Pearson said. U.S. regulators are due to vote on the final Volcker Rule this week to force banks to curb proprietary trading and significantly scale back investment in hedge funds. Britain, France and Germany have already announced plans for curbs on the level of trading risks taken by banks, pre-empting the Commission. (Editing by David Holmes)