CFA Institute study calls for standardisation, simplification and transparency within the shadow banking sector to support the healthy functioning of the capital markets

As banks address new capital regulatory requirements and slow balance sheet growth, a new global study on alternative channels for capital from shadow banking – a broad activity relating to all nonbank credit intermediation – provides a unique investor perspective on what it will take for these financing vehicles to take hold and support economic growth. The report makes recommendations for improved transparency and simplification in securities financing, including management of collateral and reforming the securitisation market. The study also includes the results of a CFA Institute member survey which finds that 55 per cent of professional investor respondents globally identified a need for greater standardisation and simplification of issuance structures in securitisation markets.

Shadow Banking: Policy Frameworks and Investor Perspectives on Markets-Based Finance (Shadow Banking) is unique in its global analysis of regulation as it applies to the different entities and activities within the shadow banking system across regions, and its subsequent exploration of risks and investor perspectives.

In the wake of the financial crisis, shadow banking – in the form of opaque or lightly regulated financing vehicles – was seen as a potential systemic risk for the finance and investment industry. Against a backdrop of constrained bank lending, markets-based finance is now being viewed as a potential solution to help channel capital to productive enterprises in order to revive the real economy; in the broadest terms, the shadow banking sector globally is estimated to be approximately $75 trillion by the Financial Stability Board. The policy recommendations contained in the study have particular relevance for Europe and the Capital Markets Union initiative as they relate to the broader policy agenda of how to enable markets-based finance to revive the economy. In particular:

1. Securitisation: policy initiatives should focus on increasing standardisation and simplification of issuance structures as well as improving transparency via initial and ongoing disclosures to investors. Standardisation of legal frameworks across markets would also improve the ease and certainty of enforcing ownership rights and creditor protections.
2. Securities financing transactions and collateral: a robust framework surrounding the reuse of collateral is needed to mitigate the build-up of excessive leverage and to prevent associated financial stability risks. Key elements include greater transparency for securities financing transactions via reporting transaction data to trade repositories and to investors

Rhodri Preece, CFA, head of Capital Markets Policy EMEA at CFA Institute and author of the study, commented: “Amid the myriad of shadow banking policy initiatives, the challenge facing regulators is to achieve coherence in the implementation of these measures and to minimise regulatory gaps and overlaps. Shadow banking feeds directly into the capital markets union agenda because there is a desire from the policy perspective for markets-based finance to flourish and deepen the sources of finance available for European companies. Nonbank finance has the potential to deliver many benefits to the financial markets in Europe and indeed globally if the right measures are put in place to stimulate demand and justify investor confidence.”

Shadow Banking is informed by a CFA Institute member survey which identifies the perspectives of more than 600 investment professionals globally on the risks and policy priorities surrounding shadow banking. Key findings include:

• The potential default of Chinese trust and wealth management products poses the greatest potential systemic risk according to 25% of members, followed by collateral management risks as cited by 23% of members
• Improving transparency and disclosures over shadow banking activities should be the highest priority for regulators, according to respondents in APAC and EMEA
• 55% of survey respondents globally identified a need for greater standardisation and simplification of issuance structures in securitisation markets
• 47% of survey respondents globally agree that the risks associated with securities financing transactions would be mitigated most effectively with greater transparency, through reporting of transactions to trade repositories and to investors.

Shadow Banking examines the perimeter of shadow banking – the entities, activities and components within the shadow banking system – and how they vary across different jurisdictions. The analysis covers the United States, the European Union, and Asia-Pacific (focusing on China) and illustrates that the concept of shadow banking differs across regions. In developed financial markets, the term is synonymous with “markets-based finance” such as certain types of investment funds and securitisation vehicles, as well as activities such as securities financing transactions, whilst in other jurisdictions, “shadow banking” largely comprises alternative lending channels such as peer-to-peer lending and other forms of nonbank direct loan provision.

The survey of the CFA Institute membership was conducted in April 2014 to obtain the perspective of investment professionals on the risks and policy issues concerning shadow banking. The survey examined issues related to securitisation and securities financing in particular, given their relevance to