Financial transactions using shares, or other assets, to secure credit, will come under greater scrutiny after the European Parliament approved a new law on Thursday (29 October) on the ‘shadow banking’ sector.
Shadow banking refers to the creation of billions of euros in credit outside mainstream banking by allowing asset managers, pension funds and others to access secured funding by temporarily lending assets like shares.
Borrowers of securities can include hedge funds, who have sold shares short and need to cover their positions.
The law introduces mandatory reporting of securities financing transactions to help regulators spot the build up of overly risky positions.
“Today’s rules will increase transparency in securities financing markets,” said Jonathan Hill, financial services chief at the European Commission, which proposed the law in 2014.
“They will allow market participants to use them for financing the economy, while making it easier to monitor and assess the risks involved,” Hill argued.
Under the new law, investment funds will have to disclose to investors the returns they make on the transactions.
Member states are due to formally rubber stamp the legislation soon, and it will start taking effect in 2016.
Shadow banking was seen as a problem during the 2007-09 financial crisis, but the sector has since been viewed in a different light.
As banks rein in lending to focus on rebuilding their core capital levels, policymakers like Hill have been promoting markets as a source of funding for the economy.
The European Central Bank stated that shadow lenders, such as investment funds, have driven growth in eurozone financial assets.
“The shadow banking sector is an increasingly important provider of funding to the euro area economy,” the ECB said.