WASHINGTON — The Federal Reserve Board is due in 2014 to unveil an initial plan to clamp down on risks tied to financial institutions' reliance on short-term wholesale funding.

Since May, top Fed officials have been making the case for reforming short-term funding markets to eradicate a key vulnerability in the financial system that allowed runs during the 2008 financial crisis.

Fed Gov. Daniel Tarullo, who heads supervision for the central bank, signaled late September that an initial proposal would be out "soon," but hasn't offered any specific time frame.

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Observers said part of the delay thus far is complicated by the number of stakeholders, industries and financial markets.

"It's not a real simple black and white issue," said Kathryn Dick, a managing director at Promontory Financial Group and a former top official at the Office of the Comptroller of the Currency. "There are these pros and cons to think through and the agencies are very thoughtful about unintended consequences."

Karen Shaw Petrou, a managing partner at Federal Financial Analytics Inc., predicted that regulators will likely hold off on releasing an advanced notice of proposed rulemaking until after the first quarter given certain moving pieces that are happening globally.

But when a proposal does come out, observers anticipate that regulators will try to sort through various issues with the industry given how complicated the issue is.

"There is a greater probability there are some unknowns that it will be difficult to quantify what the boundaries will look like," said Dick. "Regulators will want to hear from the industry what are the alternatives and offer a reasonable time to think about change in a meaningful way."

Although the amount of short-term wholesale funding has fallen since pre-crisis peaks, regulators still have large concerns about structural vulnerabilities that remain, especially those related to securities financing transactions, or SFTs.

Tarullo has gone so far as to say it would be premature to call victory on the financial reform effort if regulators fail to address risks to short-term wholesale funding.

"This is the major problem that remains, and I would suggest that additional reform measures be evaluated by reference to how effective they could be in solving it," he said in a speech in May.

Short-term wholesale funding markets provide financial intermediaries with funds that supplement retail deposits and long-term debt issuance. Such funds include large time deposits, certificates of deposit, repurchase agreements, and commercial paper.

The Dodd-Frank Act did not specifically address continued risks related to the so-called shadow banking system, which has typically fallen outside of the bounds of regulation. But regulators have been pushing aggressively to address supervisory gaps when it comes to tri-party repo markets and short-term wholesale funding to prevent potential fire sales from ever crippling the financial system again.

Both the Financial Stability Oversight Council, headed by Treasury Secretary Jack Lew, and the Office of Financial Research have made it a top priority of the 2014 reform agenda.

"We will also prioritize our work with international partners on ways to address the risks from short-term wholesale funding markets and shadow banking, complementing our domestic efforts," said Lew in a speech in December.

But finding the correct path is not simple.

For one, regulators seem to agree that the scope of regulatory tools currently available won't be sufficient to deal with their concern.

Fed Gov. Jeremy Stein has made the case that the risk-based capital, liquidity, and leverage requirements don't go far enough in reducing the potential risk of fire sales created by securities financing transactions.

"While many of these tools are likely to be helpful in fortifying individual regulated institutions — in reducing the probability that, say, a given bank or broker-dealer will run into solvency or liquidity problems — they fall short as a comprehensive, marketwide approach to the fire-sale problem associated with SFTs," said Stein in a speech hosted by the Federal Reserve Bank of Chicago and the International Monetary Fund on Nov. 7.

Secondly, short-term wholesale funding is used in a number of ways by a variety of market participants.

"There is the overarching problem of calibrating the regulation so as to mitigate the systemic risks associated with these funding markets, while not suppressing the mechanisms that have become important parts of the modern financial system in providing liquidity and lowering borrowing costs for both financial and non-financial firms," said Tarullo in his May speech.

Two options have been laid out. Under one, regulators would raise capital or liquidity requirements for assets tied to securities financing transactions.

Another approach would be the creation of a universal minimum margin requirement that could be applied directly to short-term wholesale funding.

The Financial Stability Board has proposed haircut floors for certain SFTs to limit the extent to which banks and nonbanks can obtain leverage through these transactions.

Tarullo has noted that the FSB's plan, which was proposed in August, has some "significant limitations," including that the numerical floors of the haircut were calibrated too low.

Rather, he has suggested one alternative to the FSB's proposal, which would be to apply a "system of numerical floors regardless of the identity of the parties to the transaction."

"Such an approach would at least partially offset the incentive that will otherwise exist to move more securities financing activity completely into the shadows," said Tarullo.

Petrou said it's most likely that regulators will apply a capital surcharge in an effort to avoid "enabling or empowering" the shadow banking system.

In its annual report released in December, the OFR said more analysis on how to implement such a plan is needed, promising to evaluate proposals in 2014.

"As a practical matter, the low proposed levels of such floors make it unclear how much they would deter leverage," according to the report. "Moreover, the scope of the proposed application in the FSB proposal is limited to a subset of institutions and asset classes, so application could promote migration of activity elsewhere in the financial system — in other words, regulatory arbitrage."

The data and research arm of the FSOC instead suggested that minimum haircuts should be "universal" to be effective.

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