Regulation: A market shaped by red tape

In the wake of the financial crisis, efforts to reform financial markets have had a profound effect on real estate lending.

The question of how best to regulate real estate banking has hung over the industry since the global financial crisis.

Although bankers tend to view regulation as red tape, most in property lending – publicly at least – acknowledge the need for reform, given its role in the 2008 crash. In the UK alone, there was £83.9 billion (€94.4 billion) of real estate debt origination in 2007, almost double 2016’s £44.5 billion, the most recent full-year figure.

In 2013, an independent industry paper, A Vision for Real Estate Finance in the UK, called for greater transparency and industry/regulator co-operation, among other recommendations. It also highlighted perceived shortcomings in the reform efforts:

“Regulatory response to the GFC has reflected a blend of expedient short-term objectives, the fragmentation of regulatory regimes (UK, EU, US and international) and public/political reaction to the crisis.”

Speaking to Real Estate Capital last autumn for a review of the past decade, Peter Denton – former real estate banker and debt fund lender, now group finance director of The Hyde Group, argued that regulators are not trying to prevent the property cycle occurring. “Within reason, I don’t see a problem with lenders taking risks. The problem is that, historically, those risks impacted everyone because they exposed our banks.”


Wider attempts to reform banking have affected real estate. The UK’s ‘slotting’ regime, which allocates loans to a selection of buckets with set capital reserves, is widely considered to have clipped clearing banks’ wings, steering them away from riskier deals.

On a global level, the Basel Committee on Banking Supervision has attempted the most ambitious reforms of the financial system, with the latest iteration of its third accord, known colloquially as Basel IV, unveiled in December. The banking reforms could prove to be the most extensive since the crisis, standardising how banks allocate their risk-weighted capital.

The common implementation of Basel IV globally will be crucial, argues Christian Schmid, executive vice president for real estate at Helaba: “In a global market, it would not be helpful for competition if some regions adopt it faster than others. I’d hope it will bring common rules to the market.”

The final iteration of Basel IV allows banks to use internal methods of calculating risk, provided total assets weighted for risk using their own models are no less than 72.5 percent of the amount calculated using the Basel standard formula. Retaining an element of internal ratings would be important, Schmid argues: “If every loan is treated the same way, lenders stop thinking individually about their deals.”

Day-to-day, regulation has forced higher reporting standards on the industry. “German bankers talk about the huge costs of hiring new teams that do nothing but focus on compliance,” says Frankfurt-based lawyer Thomas Flatten, partner with White & Case. “However, three or four years into this, they have built internal resources, have lived with the cost burden and continue to make profits.”

Sabine Barthauer, a member of Deutsche Hypo’s board of directors, argues that banks have adjusted to the new regime: “We don’t see it restricting overall transactions across Europe. Banks have to deal with regulatory requirements and have taken the last few years to adjust their balance sheets.”

A consequence, she adds, is greater transparency and clearer lending strategies. “Banks are concentrating on their key competencies, such as Pfandbrief banks sticking to cash-flow driven financing. There is more teaming up with partners on the institutional side to put their competencies and balance sheets to work together.”

Most agree that European banks’ loan books are in better shape than in 2007, with leverage far lower. Opinions differ as to whether regulation, or the fact that investors are keen to put larger volumes of equity into deals, is the main reason for this.


Perhaps regulation’s greatest impact on Europe’s real estate finance space is the emergence of the alternative lending sector; organisations not subject to banking regulation and therefore able to make a play for the loan deals banks have pulled back from since the crisis. With an institutional capital base, debt funds are subject to far less regulation than bank lenders, although sections of the alternative market, including peer-to-peer and online platforms which raise retail money, are coming under increasing scrutiny.

The treatment of real estate debt holdings by insurers under Solvency II regulation has been cited as a factor in the relatively modest revival of the European CMBS market and has also encouraged insurance companies to increase their direct lending activities.
Regulatory pressure has been a factor in the deleveraging of European banks’ toxic loan books. The pace of deleveraging has been criticised across certain countries, although pressure from the ECB has resulted in a greater pace of activity in the past year, particularly in Spain and Italy, with vendors using methods such as securitisation and forming joint venture agreements with private equity investors in a bid to finally tackle debt piles and retain an element of upside.

A lot of work lies ahead, PwC’s loan sales specialist Richard Thompson wrote in the firm’s Restructuring Europe’s banks report from Q3 2017: “Almost a decade after the onset of the crisis, barely a handful of European banks are covering the cost of equity and delivering an economic profit. This underperformance is not only testing shareholders’ patience, particularly in circumstances where calls for further capital keep coming, but it is now also an increasing concern for regulators and policymakers.”


Efforts from within the industry to effectively self-police lending practises demonstrate the belief within the industry that banks need to take responsibility for their real estate portfolios as the market progresses to the end of the cycle.

In the UK, a working group established by the Property Industry Alliance, in a bid to take forward recommendations from A Vision for Real Estate Finance in the UK, has put forward what it says is likely the best metric available – adjusted market value – for monitoring how overheated real estate debt markets are. Whether and how such a metric is applied by the UK regulator is yet to be determined, but the PIA’s efforts show that there is willing from the industry to develop a through-cycle approach to lending, in line with regulators’ objectives.

The future turn of regulation is unclear. Brexit’s impact on European regulation is the great uncertainty; the future of EU financial passporting rights remains unclear and until Brexit negotiations progress further, all market participants can do is speculate.

“CRE lenders will need to comply with the regulations that apply in each country where a borrower is located, even in the case where multiple borrowers are subsidiaries of a holding company located in a particular jurisdiction,” says Jeffrey Rubinoff, a London-based partner with White & Case.

Further afield, banking regulation in under fire from US president Donald Trump, who has vowed to roll back the Obama-era Dodd-Frank act. The implications of the US potentially bucking the global trend towards further bank regulation as efforts are made to implement Basel IV globally will be watched carefully.