Friday Letter Down but not out

On Tuesday, the European Parliament’s Economic and Monetary Affairs Committee refused to exempt real estate managers from those financial institutions required to centrally clear and margin their derivatives under the incoming European Market Infrastructure Regulation.

The European Parliament batted away the protestations of property groups like the British Property Federation (BPF), the European Public Real Estate Association (EPRA) and the European Association for Investors in Non-Listed Real Estate (INREV).

What does it matter? A great deal, basically. Now the likelihood of real estate managers being forced to make derivative trades via a central counterparty and not privately or ‘over the counter’, as it is termed, is much stronger.

The regulation, introduced by the European Commission last September, would see companies that use interest rate swaps required to sideline as much as 5 percent of their notional principal, plus a further variation margin where a derivative’s fair value is negative, in cash, to protect the central counterparty against the risk of default.

It would mean significant amounts of inactive capital. That is bad for any business model, real estate or other.

EMIR undermines the very purpose of hedging by property managers, which complements their businesses and is not their main commercial objective. A protective practice is being confused with other managers’ core activity of derivative trading. Of course, the real estate managers in PERE’s readership don’t need to be told that. It’s obvious, no?

But then surely so is the consequence of not screaming for exemption? And so the parliament’s refusal to change its position should be seen as the European property sector’s failure to cry foul widely enough. Quite simply, not enough was done to ensure Europe’s parliamentarians and policy makers understood this is an issue, which will dramatically hit their domestic real estate markets. PERE heard that the UK was vociferous and Germany also made efforts, but which other countries?

While some finger pointing at this stage might well prove sufficient to spur more into action, we need not yet fear financial Armageddon, as some have suggested, come May 2013 when EMIR is slated for implementation.

For one, the European Parliament’s position on EMIR is just one of three European institutions that need to concur before the detail of the regulation is finalised. The European Council (essentially finance ministries and regulators from the EU’s member states) is another, as is the European Commission itself. The Council was due to vote on its version of EMIR on 17 May but its show of hands has been postponed until next month, leaving time for further representations to be made. Failing that, the fact it has been tabled on both the Parliament’s and the Council’s agendas means that even on the final straight, in the so-called trialogue between the three institutions, the notion of a carve-out for real estate managers might still be revived.

Of course real estate may simply be deemed too small and insignificant to make special provisions for. Let’s not forget this all began as a war against hedge funds and so complaints by some property folk may not have enough clout regardless.

It is worth highlighting one silver lining to EMIR’s storm cloud. PERE’s sources say there is strong consensus in both the Parliament and the Council that EMIR should not impose central clearing and margining retrospectively on swaps already in existence, when it comes into force. Had the EC’s initial proposal to apply the rules across the board won the day, it would have been catastrophic.

Some firms have already investigated, some even executed, hedging strategies that would not expose them to margin calls. These firms have used rate caps or fixed rate terms which can either result in a loss of flexibility or carry upfront costs. They lack the hedging effectiveness of swaps.

Instead of settling for second best, far better to make one last effort to force through a more satisfactory result on EMIR. Europe’s managers still have time and opportunity to unite and fight EMIR in its current guise. It will be interesting to see if they have the mettle.

EMIR was one of the main topics discussed at the UK PERE Roundtable, the highlights of which will be published in the June issue of PERE next week.