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SEC's Stein calls for more reforms to short-term lending market

Representative Mel Watt (L), nominee to be the regulator of mortgage finance firms Fannie Mae and Freddie Mac, shakes hands with Kara Stein,
Representative Mel Watt (L), nominee to be the regulator of mortgage finance firms Fannie Mae and Freddie Mac, shakes hands with Kara Stein,

By Sarah N. Lynch

WASHINGTON (Reuters) - The short-term lending market is in need of reform to improve its transparency, a top U.S. regulator said on Wednesday, saying that the lack of public information on how much financial firms rely on such borrowing could lead to another financial crisis.

"We should be doing more to improve large financial firms' disclosures about how reliant they are on short-term funding, and how susceptible they may be to liquidity crises," Kara Stein, a Democratic commissioner at the Securities and Exchange Commission, said in an interview with Reuters.

"Improving disclosures about short-term funding will empower the markets to help prevent the next liquidity crisis," said Stein, who joined the SEC last summer.

The short-term lending market is a part of the financial sector known as "shadow banking," a loosely defined set of lending activities that occur outside of banks.

In securities lending arrangements, mutual funds, insurance companies and other large investors typically lend out their securities to earn extra money.

Brokerages such as Goldman Sachs or Morgan Stanley borrow those securities and then pledge them as collateral to money market funds in exchange for cash, in a financing transaction known as a "repurchase" or "repo" agreement.

During the financial crisis, the short-term lending market temporarily dried up after Lehman Brothers collapsed, stoking fears among banks and decreasing lending activity.

Money market fund investors who had exposure to Lehman and other banks fled for the exits, causing one prominent fund to "break the buck" -- meaning that its net asset value dropped below $1 a share -- and prompting the federal government to offer a financial backstop for money funds to stop the bleeding.

The 2010 Dodd-Frank Wall Street reform law does little to address risks to the short-term lending market. Stein's comments come as several regulators including the SEC and the Federal Reserve are eyeing their own reforms.

The Fed is drafting a proposal that would force banks that rely on such short-term funding to hold more capital. Federal Reserve Governor Dan Tarullo has often spoke about the need for more oversight to protect against runs on banks.

The SEC, meanwhile, is working to complete a rule that aims to reduce investor run-risk on money market funds.

One option on the table is to force some prime money market funds to have their share prices float, rather than stay fixed at a dollar per share.

In addition, the Office of Financial Research, which was created under the Dodd-Frank law to do more sophisticated monitoring of the financial system, recently raised concerns about systemic risks that could be posed by securities lending and other short-term borrowing activities.

"Lack of data related to securities lending transactions and the reinvestment of cash collateral limit the effective monitoring of securities lending activities," the office wrote in its 2013 annual report.

Stein did not describe how a final money market fund rule should be drafted.

However, she said the rule targeting fund run risk is "just one part of the short-term lending market" and should not be all that regulators do in this space.

She urged the SEC to work more closely with other regulators on the issue.

"We need to be thinking about other parts of this market that should be reformed to prevent another financial crisis," she said.

"The SEC oversees the broker-dealers who are integral to securities lending and the corporate issuers doing the borrowing, so we need to be working with our fellow regulators to address the risks of short-term funding."

(Reporting by Sarah N. Lynch; Editing by Karey Van Hall and Leslie Adler)

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