Macroprudential Measures for Property Funds

Irish authorised funds investing in Irish property (“property funds”) have become a key participant in the Irish commercial real estate (CRE) market, holding approximately €22.1bn of Irish property or about 35 per cent of the Irish ‘investable’ CRE (as at mid-2022). This growing form of financial intermediation entails potential benefits for macroeconomic and financial stability. Often established and funded by overseas investors, property funds provide an alternative channel of financing for investment in the CRE market, reducing reliance on domestic sources of capital.

This changing nature of financial intermediation also raises the potential that new vulnerabilities could emerge, so it is important that the macroprudential framework adapts accordingly. Given the growth in the property fund sector, the resilience of this form of financial intermediation matters more today for the functioning of the overall CRE market than it did a decade ago. In turn, dislocations in the CRE market have the potential to cause and/or amplify adverse macro-economic consequences, through a range of channels. These include potential losses on lenders’ CRE exposures; funding constraints for borrowers using CRE as collateral; and potential adverse implications for activity in the construction sector.

Excessive leverage and liquidity mismatch are potential sources of vulnerability in property funds. The presence of high leverage and liquidity mismatch increase the risk that – in response to adverse shocks – some property funds may need to sell property assets over a relatively short period of time, causing and/or amplifying price pressures in the CRE market. Central Bank analysis highlights that there is a cohort of Irish property funds that have high levels of leverage and, to a lesser extent, liquidity mismatch. Leverage in Irish property funds is – on average – higher than leverage in EU property funds. Irish property funds have a low dealing frequency, but liquidity mismatch is still evident in a subset of these funds. Risks posed to financial stability by property funds were laid out in this Financial Stability Note (PDF), and the need to develop macroprudential policy was identified.

The Central Bank is introducing measures on Irish property funds to mitigate these vulnerabilities. The main risk that the Central Bank’s interventions seek to guard against relates to the potential that financial vulnerabilities in the property fund sector lead to forced selling behaviour in times of stress. The proposed measures aim to safeguard the resilience of this growing form of financial intermediation, so that property funds are better able to absorb – rather than amplify – future adverse shocks. In turn, this would better equip the sector to continue to serve as a sustainable source of investment in economic activity. The new macroprudential measures for property funds will enhance the resilience of property funds, with broader benefits for macroeconomic and financial stability.

Background

These measures on Irish property funds are the first macroprudential policy measures to be introduced under the third pillar of the Central Bank’s macroprudential policy framework, which covers non-banks. The Central Bank is particularly focused on ensuring that the overall macroprudential framework continues to evolve and adapt, to respond to the evolution of the financial system itself. One of the most pronounced changes observed in recent years at a global level has been the growth in the non-bank sector, including the investment fund sector. Given that Ireland has one of the largest investment fund sectors in the world, it is a priority for the Central Bank to develop and operationalise the macroprudential framework for the non-bank sector, safeguarding the resilience of this form of financial intermediation.

“Who invests in the Irish commercial real estate market? An overview of non-bank institutional ownership of Irish CRE” Central Bank of Ireland, Financial Stability Note Vol. 2019 No. 6 (PDF).

Measures in Other EU Countries

As of November 2022, Ireland is the first country to activate the leverage limits provided for under Article 25 of AIFMD. Article 25 of the AIFMD provides for the imposition of leverage limits that AIFMs are entitled to employ with respect to the AIFs they manage, where the use of leverage by those AIFs contributes to systemic risk or disorderly markets. In December 2020, ESMA released guidelines as to how National Competent Authorities should interpret Article 25.

While Article 25 is not activated elsewhere presently, most jurisdictions in Europe have regulation that addresses leverage and liquidity mismatch in property funds in some form. Many countries have leverage limits in place, although they often vary depending on the types of investor. To manage liquidity mismatch, many jurisdictions (Germany, France, Luxembourg, Hungary, Portugal and Slovakia) use liquidity buffers or minimum notification periods. Others (Belgium, Italy, the Netherlands and Poland) have only closed-ended property funds (ESRB Non-bank Financial Intermediation Monitor 2021 (PDF).