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“Silo” regulation not helping Europe’s CRE debt markets

New policies since the global financial crisis have created “silos” which have limited the ability of regulators to maintain an overview of their regulations’ effects on the European commercial real estate debt market says a paper published today.

Commercial Real Estate Debt in the European Economy 2016 is aimed at Europe’s policymakers and – Brexit vote notwithstanding – is the first piece of joint work on the debt markets put out by a coalition of UK and European associations: the UK-based Association of Property Lenders; CREFC Europe; INREV; and ZIA, the German Property Federation.

Citing CBRE figures that estimate that 47 percent by value of Europe’s €2.1 trillion of invested commercial real estate stock (as at end of 2014) is financed by debt, the paper extols the contribution of CRE leverage in the European economy and the part it plays supporting investment, employment and business development.

But it also says that new regulations for banks and debt investors designed to ensure financial stability have had “unintended consequences” as well as “some positive impacts.”

The paper says: “One such consequence is the different regulatory silos that have been developed independently, as a result of the urgency to put in place separate regulation for individual components of the financial system”. This, it continues, has “limited the extent to which regulators are able to maintain an overview of the interaction of separate regulatory changes”.

The regulatory challenges, it explains, have been exacerbated by the otherwise welcome “dramatic reshaping of CRE debt markets”, with banks no longer as dominant, and new sources of non-bank capital entering and taking market-share.

This “relatively sudden diversification of CRE debt provision has also created unresolved challenges for regulators who need to ensure regulation is appropriate for each different type of lender, but also fair so that competition is not distorted unnecessarily”, the four associations say.

Different regulatory silos

Bank lending is regulated by the Basel committee, insurers by Solvency 2 and debt funds by AIFMD. Jeff Rupp, director of public affairs at INREV, told Real Estate Capital: “Policy making is undoubtedly being done in silos: there is banking regulation; there’s insurance company regulation; there’s debt fund regulation. Securitised products are also being regulated differently.

“This paper is an attempt to explain the benefit that CRE debt is bringing to the broader economy. We’re not saying it should be unlimited, we’re not saying it should go crazy, but debt has an appropriate role. Its provision has evolved since the financial crisis in ways that regulators might not be aware of, and that should be understood in the context of the bigger picture”.

Rupp added that rules which tend to put certain kinds of debt investments into certain buckets has resulted in lenders to real estate clustering around the margins of the rules to get the highest returns possible within the given regulatory treatment “rather than the provision of debt being priced rationally by the risk profile of the activity.”

He said other effects had been to price banks out of “the kinds of projects which they would otherwise be rationally very pleased to provide capital for,” and to make securitised loans too expensive for insurance companies to hold.

Brexit vote

Speaking in a personal capacity about the vote by the UK to leave the European Union, Netherlands-based Rupp said: “We are all trying to get our heads around this.. but we are about to embark into an era of volatility both of markets and regulation. The currency fluctuations are some of the biggest concerns and the impacts on banks, at least in the first instance, seem to be quite big in terms of their share prices.

“There isn’t a single answer for every bank or CRE lender. UK banks with a loan book that’s predominantly in the UK are not exposed to currency fluctuation and they’re not exposed to some of the other risks that are arising from the Brexit vote. Other lenders with a more European portfolio have got the currency risk and there’s the regulatory treatment which will likely change for at least some of the portfolio. The more of these risks that fall into a particular business model, the more challenging it’s going to be navigating the course.”

He suggested that the UK’s “clear and consistent moderating influence” on overall EU policymaking in the financial area would be missed.

The CRE debt paper, which was written by independent researcher Brenna O’Roarty, will be presented and discussed by a c 140-strong cross-section of the industry in London this week on Weds morning, 29 June.