Key points to note:
- The proposals will apply to funds domiciled in Ireland which invest more than 50% directly or indirectly in Irish real estate assets
- The proposals include:
- Leverage limits imposed on In-Scope funds; and
- Guidance on how to deal with liquidity mismatches
- Existing In-Scope Funds will have 3 years to comply with the new leverage limits
As readers may know, the Central Bank of Ireland (central bank) has recently taken an in-depth look at the Irish real estate fund industry, with particular emphasis on leverage and liquidity mismatch as two potential sources of financial vulnerability.
On November 25, 2021, the Central Bank published a consultation document (Consultation document) in which he set out proposals to impose
certain leverage limits on Irish domiciled funds which invest more than 50% directly or indirectly in Irish real estate assets (Covered funds). The consultation paper also proposes that funds in scope also comply with additional guidelines to limit liquidity asymmetry. The Central Bank explains in the consultation paper that it believes the proposed measures are necessary to increase the resilience of these funds to ensure that they can absorb rather than amplify any future negative shocks in Irish commercial real estate (CRE) Marlet.
The Central Bank has identified a specific cohort of in-scope funds with what it considers to be high debt levels and has specific concerns about the impact on financial stability if these funds fall in scope. The application are unable to manage their CRE loans and are required to sell significant portions of their portfolios within a short period of time. He notes the risks this poses to the ability of banks to continue to finance the economy, the functioning of the construction sector and the real economy at large.
In light of these concerns, the Central Bank is consulting on a proposed 50% leverage limit for all affected funds, which will be determined by the ratio of total assets to total liabilities ( or its equivalent by applying the raw or engagement methodologies of the AIFMD). The Central Bank proposes the imposition of a debt limit under the current legislative framework of the AIFMD1 and in accordance with related ESMA guidelines2.
Examination of the leverage effect generated by the funds within the scope
In practice, the Central Bank proposes to examine the use of leverage by integrated funds as part of its annual review of funds and on the basis of the information contained in the regular reports it receives regarding these funds. funds. When, during this review, the Central Bank identifies funds within the scope with leverage levels near or above the 50% limit, those funds will be published with notices confirming the application of ‘a specific binding leverage limit. The consultation notes that there may be a number of different measures applied to the fund-specific limit based on those described in the ESMA guidelines and that further consideration of how these measures are calculated and applied will be necessary. It should be noted that the Central Bank considers that the leverage limit applies de facto to all funds falling within the scope. Even if an In-Scope Fund with a low level of leverage is not subject to notification of a specific binding leverage limit in any given year, if it exceeds the limit d leverage, it will be issued with a specific binding leverage limit the following year.
Transition period for existing in-scope funds
The Central Bank recognized that existing In-Scope Funds with leverage levels exceeding the leverage limit will need time to comply in order to ensure that the leverage reduction is effected from orderly manner.
As a result, the Central Bank is proposing a three-year transition period and has indicated that In-Scope funds will be allowed to formulate their own debt reduction plan. The Central Bank has indicated that it is proposed that in-scope funds with leverage limits greater than 50% be subject to valuation in accordance with Rule 26 of the AIFM Regulation at some point after the consultation period and the Central Bank The Bank will then communicate directly with these funds to put in place the required reduction plan. He also indicated that he could impose individual interim limits (on a trajectory towards the 50% limit) during the transition period. Presumably, this is intended to ensure a gradual and targeted unwinding of leverage levels so as to ensure that the 50% leverage limit is reached within the timeframe required for the year, but also to limit the possibility massive sales near the end of the transition. period.
Application of leverage limits on newly established incoming funds
The Central Bank will seek to impose this leverage limit on all new In-Scope funds at the time of authorization and such funds will be subject to an annual valuation beginning the year following their first annual reporting date.
Review of the leverage limit imposed by the Central Bank
Finally, it should be noted that the Central Bank intends to keep the leverage limit under review to ensure that they meet stated targets and that they do not otherwise impose a “burden. excessive ”to participants from the Irish CRE sector. The Central Bank confirms that it will seek to take appropriate measures by increasing or decreasing the leverage limits if market circumstances so require.
Guidance on liquidity asymmetry
The draft guidance on the conditions for reimbursement of covered funds (Draft guidelines). The Central Bank reiterated the importance of taking into account the liquid nature of assets to avoid a possible liquidity mismatch.
The draft guidelines will require integrated real estate fund managers to take into account the liquidity profile of assets under normal and strained market conditions when determining repayment terms. Retention of a liquidity reserve should be considered, if necessary, although the Central Bank indicates that too much reliance on this reserve could be detrimental to investors who submit redemption requests at subsequent redemption dates. .
To date, the Central Bank has authorized real estate funds as closed funds or open funds with limited liquidity. In the draft guidelines, when an integrated real estate fund is formulated as an open-ended fund with limited liquidity, the Central Bank has suggested a liquidity delay of at least 12 months which it believes should help ensure that the repayment conditions, including the notice periods and the settlement periods of the In-Scope real estate fund are aligned with the liquidity of the assets held under normal and exceptional circumstances. This time frame appears to align with the annual trading cycles of many current products on the market. The Central Bank notes that such a proposal would potentially impact 48 real estate funds (less than 33% of the authorized number of real estate funds) which would be required to extend their notice and settlement period to ensure alignment of liquidity and liquidity cycles. repayment.
Notably, although the Central Bank suggested a minimum liquidity cycle of 12 months, it did not rule out the possibility of more frequent transactions. Where a qualifying fund has or intends to have shorter liquidity terms, the manager should be able to demonstrate with sufficient evidence (including periods of tense market conditions where liquidity may be strained due to collective selling activity) as the fund could sell its assets without significant impact on market prices over this shorter period.
The Central Bank proposes that the existing funds within the scope make the necessary modifications to their structure and to the documentation of the funds to incorporate the provisions of the guidelines “as soon as possibleNew funds falling within the scope should comply with the draft guidelines from the date of authorization.
The central bank invited comments on its proposals no later than February 18, 2022, and said any submission suggesting changes to the central bank’s proposals should be supported, to the extent possible, by evidence.
1 Article 25 of the AIFMD, transposed into Irish law via Regulation 26 of the European Union (Alternative Fund Managers) Regulation 2013 as amended, gives the Central Bank the power to impose limits on the level of leverage used by an AIFM in respect of an AIF in order to limit the extent to which the use of leverage contributes to systemic risk in the financial system or to the risk of disorderly markets.
2 https: //www.esma.europa.eu/sit …
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