Shadow Banking in Europe: Idiosyncrasies and Their Implications for Financial Regulation

Abstract

This paper studies the specificities of the regulation of shadow banking in the EU. It argues that the idiosyncratic features of the EU shadow banking sector call for a different (or indigenized) regulatory approach from that of the U.S. It highlights striking differences between the EU and the U.S. shadow banking sector based on both the market structure and the legal micro-infrastructure of the shadow banking sector in these two jurisdictions. These different institutional and legal infrastructures of the shadow banking activities, instruments, and entities, as well as the different trajectories of the evolution of development of the banking and the shadow banking sectors in terms of business models, size and composition of actors and transactions can be the driving force behind the differential regulatory treatment of shadow banking in the EU and the U.S. In highlighting the differences between shadow banking in the EU and the U.S., this paper focuses on the repo markets, securitization and derivatives markets as the main instruments and activities that play significant roles in credit intermediation (maturity and liquidity transformation) outside the regulatory perimeter of the traditional/regular banking system. It then discusses shadow banking entities, especially Money Market Funds (MMFs) as typical shadow banking entities and highlights the fundamental differences in the structure and functioning and existing regulatory treatment of the MMFs in the U.S. and the EU. In the end, the paper underscores the main structural and regulatory differences in the Alternative Investment Fund (AIF) industry across the Atlantic and argues that there is no homogeneous population of such funds and why they need to be treated differentially. The paper concludes that the market structure, business models, as well as legacy regulatory framework of shadow banking (as well as banking), display substantial differences in the U.S. and the EU. The findings in this paper rally against one-size-fits-all proposals to address the problems of the shadow banking system worldwide and require considerably differentiated regulatory approaches to regulating shadow banking across the Atlantic. Therefore, any adoption of the U.S. regulatory framework for the shadow banking sector by the authorities regulating the European shadow banking sector should be cautiously undertaken.