Warning over EU regulation for property and banking sectors

In a letter to members of the European parliament, the German property federation (ZIA) and the British Property Federation (BPF) have teamed up to warn that draft EU regulation intended to inject greater transparency into the Over The Counter (OTC) derivatives market, could result in ‘market instability and systemic risk’ for both the property and banking industry.

The EU regulation aims to tackle risk taking in the OTC derivatives market which it believes contributed to the economic crisis. The draft regulation requires financial businesses to clear their derivatives centrally and provide cash collateral (or ‘margin’) to cover their exposure under those derivatives.

Most ordinary businesses that use derivatives simply to protect themselves against risks like rising interest rates or currency movements are exempted from that requirement but property businesses are set to be treated in the same way as banks or derivatives dealers.

The joint letter from ZIA and the BPF, addressed to German and UK members of the European Parliament’s economic and monetary affairs committee, argues that systemic risk in the property finance market would increase if property businesses were forced to provide cash margin on interest rate swaps and other hedging derivatives.
 
It says that firms would be forced to adopt different hedging strategies that did not expose them to the risk of needing to fund margin calls, and those strategies would almost certainly be less safe and efficient than the swaps currently used in the market.

‘This regulation could result in greater and less transparent levels of risk for property firms. That, in turn, could affect the banking sector which provides finance to property businesses.

Property businesses use derivatives in exactly the same way as other non financial businesses: to hedge against market risks affecting their commercial activities, and not to generate returns to investors,’ said Peter Cosmetatos, director of finance at the British Property Federation.

‘A consequence of the new regulation could be that property firms can no longer afford to use interest rate swaps, the most efficient and reliable way of providing stability and security against rising interest rates or fluctuating exchange rates. The market uses a model that works well, with real estate assets usually providing security for a property firm’s financial obligations. There is no sense in forcing the market to find other models, the implications of which have not been analysed or understood by policymakers,’ he added.

The letter is supported by all three pan European real estate industry bodies: the European Property Federation (EPF), the European Public Real Estate Association (EPRA) and the European Association for Investors in Non-listed Real Estate Vehicles (INREV).