Policymakers from the world's top economies meet this weekend in Mexico City to begin finding common ground to tackle the world's economic challenges, which include reining in a $60 trillion financial sector on the fringe of mainstream banking.
Leaders of the Group of 20 asked their task force, the Financial Stability Board (FSB), to come up with plans to regulate shadow banks like hedge funds, money market funds, repurchase agreements and securities lending.
It will be a major point at issue this year. However, we are not at a stage where the FSB will reach some kind of decision to be reflected (in the) G20 debate, a diplomat attending the February 25-26 meeting of G20 finance ministers and central bankers said.
Regulators are still looking into the sector, but say action is inevitable to stop riskier activities from migrating as mainstream lenders become more tightly supervised.
The FSB set up working groups last year to study measures such as limits on exposure to shadow banks and forcing lenders to hold more capital to cover that exposure.
Many of the groups report in July, too late for the June G20 leaders' summit, but they will be given details by then on the design of regulation for shadow banks, a second G20 source said.
The financial sector is watching closely as to how regulators will intervene in an area which was only identified as a sector in 2007.
Some concerns are already being addressed, such as tighter scrutiny of hedge funds, stricter rules on securitization and U.S. plans to crack down on money market funds.
It's a question of how you control and contain risks. How do you address the weakness and keep the benefits? a banking official said on condition of anonymity.
G20 actions would need to cover markets in countries as diverse as China, India and Brazil and not be solely focused on the European Union and United States, the official said.
A big bang approach is not expected as G20 regulators feel their way, using data collection and monitoring.
They could move forward with some actions first as clearly some pieces of work are going to be finished before others, a third G20 source said on condition of anonymity.
The G20 could go ahead with initial steps if regulators felt they are comfortable, have covered the terrain and understood the phenomenon well enough.
SIFIS AND DERIVATIVES
G20 leaders agreed last year to impose a capital surcharge on the world's biggest banks and the FSB is now turning its attention to extending this framework.
Ministers will receive an update on progress toward fleshing out a tougher supervisory framework for big insurers, systemically important domestic banks and institutions like clearing houses.
Other regulatory topics include meeting the end-2012 deadline for regulating the $700 trillion derivatives market.
It involves forcing many contracts now traded between two banks through central clearing backed by a default fund, with each transaction reported to a repository.
The European Union has just approved its framework law for this - some 18 months behind the U.S. Dodd-Frank legislation - though regulators on both sides of the Atlantic are trying to put rules in place to implement the decisions by the year-end deadline.
Market operators worry the EU and U.S. rules will overlap to trigger compliance headaches, but G20 sources insist these fears are overblown and that regulators will eventually find solutions.
There will be a delay in the timeline for delivering reforms on financial market infrastructure and over-the-counter derivatives because of the complexity of the issue, a G20 source said.
There will be an update on reducing the reliance among banks and others on credit ratings for calculating their capital buffers with concrete proposals due by the June G20 summit.
Finance ministers will also look at how the FSB could be beefed up to make sure all G20 countries implement agreed rules like the Basel III tougher bank capital requirements from 2013.
There is concern that new financial sector regulations are not being equally implemented around the world and some concerns over the liquidity impact of Basel III on the interbank market, a European official said. A working group is due to make proposals to G20 finance ministers in Washington in April.
European, Canadian, Chinese and Japanese concerns about what they see as overreach by the new U.S. Volcker Rule banning proprietary trading at some banks may be discussed as well, a European G20 official said.
The rule will apply to foreign banks' U.S. subsidiaries as well as to domestic institutions and critics are concerned it may crimp trading in other countries' domestic government bonds.
(Additional reporting by Daniel Flynn in Paris, Louise Egan in Ottawa and Tetsushi Kajimoto in Tokyo; Editing by Gary Crosse)