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Shadow banking and the funds sector

Nick O’Neill, Partner (London), Jeff Berman, Partner (New York) and Mark Shipman, Partner (Hong Kong)
Clifford Chance LLP
September 2011

Shadow banking is one of those terms, along with bail-ins, living wills, CoCos and alternative investment funds, which has crept into our vocabulary since the onset of the global financial crisis. Like many of these terms, it can mean different things to different people. As regulators begin to consider what regulatory measures to put in place to address the perceived risks arising from shadow banking, we consider how funds and fund managers may be caught up in the rush by regulators to close a perceived regulatory loophole and how the funds industry might respond to proposals specifically designed to regulate shadow banking.

The role of funds in credit markets

Funds are already important participants in the credit markets and they are likely to fulfil an increasingly significant role in the future. Following the international credit crisis, with banks’ appetite for lending significantly reduced, there is no doubt that funds — with the appropriate strategy and structure — have taken up some of the slack. In our view, it is likely that more funds will seek out these opportunities. With their heterogeneous risk appetites and sheer variety and diversity, funds are often more adaptable than the major banks — particularly now that many of these banks have severely constrained risk appetites and will be subject to higher capital and liquidity requirements (e.g. under Basel III). This inevitably means that bank lending will become more expensive for borrowers. However, currently, most funds do not have either the strategy or structure to focus on the credit markets in the same way as the major banks. To the extent this changes — in what undoubtedly is a constantly changing business and regulatory environment - means that some funds will likely fulfil at least some of the role of banks. This in turn leads regulators to consider whether these types of funds should be regulated like banks, but of course how do you define them?

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