Pending Financial Reforms: Different Approaches From Fed, EC

The disparate views among Federal Reserve officials often commands the market's attention. Yet there is one area in which all the regional president agree and this will move into the spotlight tomorrow.

The Federal Reserve presidents have endorsed the idea of moving institutional money markets away from the fixed $1 a share approach and toward a variable pricing model. Tomorrow the Securities Exchange Commission will likely formally endorse it as well. Such funds currently hold some $2.6 trillion.

EC is trying a different approach. It is debating how much of a cash buffer fixed share price funds should maintain. The current proposal of 3% met industry objections. There is almost 500 bln euro in such funds. The collateral requirements for funds' repo operations are also being re-examined. The EC has indicated it is willing to soften its initial stance that funds should not accept maturities of longer than almost 400 days to back repo trades. Such maturities now account for the overwhelming majority of such collateral.

When it comes to addressing financial institutions that are regarded as systemically important and too big too fail, the US and Europe seem to have two fundamentally different approaches. The Federal Reserve's stance was reiterated yesterday by Yellen, who most see as Bernanke's likely successor. Like Bernanke previously, Yellen argued against restricting the size of the financial institutions. Instead, Bernanke and Yellen want to force such institutions to hold greater capital reserves. Yellen was open to a sliding scale.

Several European countries seem more intent on limiting the size of financial institutions, but it is not clear that sufficient political will. The UK, for example, will soon begin debating the fate of the Royal Bank of Scotland. UK tax payers, through the government, own 81% of RBS. The BBC reports that a draft proposal by the Parliamentary Commission on Banking Standard calls for splitting RBS into a good and bad bank.

Yet, both the Chancellor of the Exchequer Osborne and Prime Minister Cameron have not been supportive of such efforts, but to go against the recommendation of the commission that they set up is simply bad form. Perhaps the draft can be modified, though there has been much technical work already done on the practicalities. Osborne will deliver the annual Mansion House address on June 19 and is expected to speak to the too-big-to-fail issue.