ESMA reports on shadow banking, leverage and pro-cyclicality

The European Securities and Markets Authority (ESMA) has issued today a report on securities financing transactions (SFTs), leverage and pro-cyclicality in the EU’s financial markets. ESMA’s report assesses whether the use of SFTs leads to the build-up of leverage which is not yet addressed by existing regulation, how to tackle such build-up, and whether there is a need to take further measures to reduce its pro-cyclicality.

SFTs allow market participants to access secured financing. SFTs involve the temporary exchange of cash against securities, or securities against other securities – such as securities lending, repurchase transactions, buy-sell/ sell-buy back transactions, or margin lending transactions.

On the other hand, SFTs also contribute to the build-up of leverage in the financial system, which is relevant from a financial stability perspective. A leveraged financial system can be vulnerable to “runs”, generate contagion risk and increase pro-cyclicality.

While remaining cautious when considering the introduction of new quantitative regulatory requirements on SFTs, ESMA recommends to:

  • introduce the Financial Stability Board’s (FSB) qualitative standards in the methodology used to calculate haircuts;
  • address the pro-cyclicality of collateral haircuts in central counterparties in the context of the European Market Infrastructure Regulation (EMIR) review;
  • assess the possible extension of the FSB’s scope for numerical haircut floors, in particular to government bonds, and the calibration of these floors using SFTR data which will become available in 2018; and
  • assess pro-cyclicality and the potential need for further policy tools once sufficient data becomes available.


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