* Money market funds face stiffer rules
* Reform marks start of clampdown on 24-trillion euro sector
* 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 will regulate money market funds, demandingsome set aside cash buffers to avoid a panic should manyinvestors withdraw their 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 demandingthey 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 that comprisesmoney market funds, some hedge funds, and firms involved insecurities lending and repurchase markets.
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 operate 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 and banks which borrow from them.
For companies, they are an alternative home for short-termcash. Unlike banks, they have no access to support from centralbanks such as the European Central Bank if things 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 have regulated banks and markets comprehensively," saidBarnier, the EU Commissioner who has led a four-year revamp offinancial rules. "We now need to address the risks posed by theshadow banking system."
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.
HEART OF CRISIS
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.
Such funds seek to maintain a stable 1 euro per share wheninvestors redeem or buy shares in them, to keep the value oftheir 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.
The industry says the reform would be too costly.
"Imposing a three percent buffer would make money marketfunds unviable," said Martin O'Donovan, deputy policy andtechnical director at Britain's Association of CorporateTreasurers. "To cover that, their rates would no longer becompetitive."
Funds whose share price floats in line with performance arespared the buffer requirement. Imposing the buffer is meant toprompt CNAV funds to convert to funds with 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.
The European Union's 28 member states and the bloc'sparliament have the final say on the draft law and some changesare likely.
The United States is also discussing new rules for moneymarket funds but has stopped short so far of proposing cashbuffers.
Barnier also published a "roadmap" on how the EU plans tomove ahead with regulating other parts of the shadow bankingsector, including a proposal to boost transparency by collectingand exchanging data among regulators.
Banks could be required to hold more capital to cover risksfrom links to shadow banking. Shadow banking intuitionsthemselves could be required to hold capital, the EU executivesaid.
Legal & General (LGEN)
