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* Money market funds face stiffer rules
* Reform ignores German, French calls for ban on some funds
* Move is starting shot in clampdown on 24-trillion eurosector
* G20 leaders to tackle shadow banking this week
By John O'Donnell and Huw Jones
BRUSSELS/LONDON, Sept 4 (Reuters) - Special funds used bybig companies to park billions of euros of cash face stricterrules to make them safer, the European Commission said onWednesday, taking a first step to reform unregulated financeknown as shadow banking.
The draft law, criticised by industry as too harsh but byGermany as not strict enough, will regulate the euro moneymarket funds sector, demanding some funds set aside cash buffersto avoid a panic should many investors withdraw money at once.
This would lower what EU financial services chief MichelBarnier said was a risk to the financial system from thetrillion euro sector, but users of the funds warn that demandingfunds hoard more for a rainy day would make them too expensive.
The changes are part of efforts to shine a light on shadowbanking, a 24-trillion-euro industry in Europe - half theworld's total - that comprises money market funds, some hedgefunds, and firms involved in securities lending and repurchasemarkets.
Such groups borrow and lend, just like banks do, but becausethey are not banks they often fall outside the remit ofregulation, which is why they are considered to be in the"shadow" of traditional finance.
In the European Union, money market funds are mainly basedin France, Ireland and Luxembourg and are heavily used bycompanies in Germany, Britain and elsewhere.
For companies, they are an alternative home for short-termcash so that they can spread their reserves rather than leavingthem with one bank. Unlike banks, the funds have no access tosupport from central banks such as the European Central Bank ifthings go wrong.
But the vast unchartered territory unnerves regulators inpart because the sector is closely intertwined with banks, whooften sponsor the funds as well as relying on them for financethemselves.
"We are not pointing an accusing finger at the sector. Wejust want it to work smoothly. There should be transparency andthere should be good supervision," Barnier told reporters."Finance should be serving the economy and not itself alone."
The European plans draw on ideas in a global blueprint thatwill be submitted for approval to the world's 20 leadingeconomies when their leaders meet in Russia on Thursday andFriday. In some cases, the EU reform is more ambitious.
NOT WAGING WAR
The reform is a response to the 2007-2008 financial crisis,which was brought on by the collapse in prices of securitiestied to risky home loans.
"Shadow banking was at the heart of the crisis," saidFrederic Hache, a former derivatives banker who works withpublic-interest group Finance Watch. "As bank regulation hassince tightened, activity may shift into the shadow sector."
The most controversial element in Barnier's proposal is arequirement for one type of money market fund, known as constantnet asset value (CNAV) funds, to hold a cash buffer equivalentto 3 percent of their assets, with a three-year phase in.
Such funds seek to maintain a stable price of 1 euro pershare when investors redeem or buy shares in them, to keep thevalue of their holding steady.
The buffer would provide a safety cushion in case there is arun on the fund, as seen in the United States when the value ofone U.S. fund "broke the buck" and fell below $1 per share.
Funds whose share prices float in line with performance arespared the requirement of maintaining the buffer. Excluding themis meant to prompt funds to adopt the model of floating shareprices, which are seen by regulators as more transparent.
The funds in the EU, which include BlackRock and Legal &General, are evenly split between the two types.
Barnier said he was not "waging a war" on CNAV funds andthat the buffer was a compromise after calls from the EuropeanSystemic Risk Board, a body linked to the ECB, Germany andFrance for an outright ban.
Germany's Finance Ministry said on Wednesday that theCommission's blueprint had not gone far enough.
Industry, on the other hand, argued for a gentler approach.The Institutional Money Market Funds Association, an industrybody, said some of the proposed regulatory changes would makethe market more resilient but that a buffer was inappropriate.
Martin O'Donovan, deputy policy and technical director atBritain's Association of Corporate Treasurers said a threepercent buffer would make funds unviable. "To cover that, theirrates would no longer be competitive."
The United States is also discussing new rules for moneymarket funds but has stopped short so far of proposing cashbuffers.
The draft law also effectively bans credit ratings on moneymarket funds, to stop a potential downgrade sparking panic, aproposal criticised by ratings agencies Moody's and Standard &Poor's.
The European Union's 28 member states and the bloc'sparliament have the final say on the draft law and some changesare likely.
Barnier also published a "roadmap" on how the EU plans toregulate other parts of the wider sector, including a suggestionthat all institutions involved in shadow banking set asidecapital buffers to cover risks.
