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CRE Finance World, Summer 2014

Sizing Up the Impact of Derivatives Regulation on the European Property Sector he European property sector has long relied on over-thecounter CRE Finance World Summer 2014 36 derivatives (OTCD) to manage interest rate and foreign currency risk. With derivatives regulations under the European Markets Infrastructure Regulation (EMIR) now beginning to take effect, companies have begun to wrestle with new regulatory burdens, including reporting and portfolio reconciliation. Meanwhile, the long reaching nature of US derivatives regulation has also touched many European property funds. And, regulators are not finished: margin, clearing and trading rules are among those yet to come online. With this seemingly unending wave of requirements, property sector finance teams have been stretched to piece together coherent compliance strategies, while simultaneously managing their day-to-day engagements and responsibilities with lenders and investment teams. But, with regulators beginning to dial-up their rhetoric on enforcement, getting derivatives regulatory compliance in order takes on an increasing urgency. Perhaps more importantly, real estate finance teams will also need to consider how the many regulatory changes will affect their risk management and financing strategies. New Regulations — A Look Back It is well known that AIG’s substantial synthetic exposure to the US subprime mortgage sector invited new regulatory scrutiny of the derivatives markets. Of AIG’s $180 billion government bailout, $38 billion went to settle its synthetic bets on the subprime mortgage market. Thus, as policymakers began drawing up their response to the financial crisis, systemic risk mitigation in the derivatives markets emerged as a key theme. To that theme, other priorities were added, including increasing transparency in what has long been considered an opaque market and protecting unsophisticated users of derivatives from abuse. Policy makers globally agreed on several policy mechanisms to address these priorities: Table 1 Key Policy Mechanisms Addressing Derivatives Reform Objectives Reduce Systemic Risk 1. Central clearing Central clearinghouses step in between a swap dealer and its counterparty. The central counterparty, or CCP, collects initial and variation margin daily in the form of cash or liquid securities in order to remove counterparty credit risk from a portfolio of trades. 2. Margin Not all trades are sufficiently standardized to be suitable for central clearing. Thus, regulators are in the process of designing requirements for parties to post collateral when a transaction remains between swap dealer and counterparty (i.e., bilateral swaps). 3. Bank capital requirements Capital requirements serve as a bank’s cushion to absorb losses, including derivatives related losses. Under Basel III, these requirements will increase for derivatives. Increase Transparency 4. Electronic trading Regulators are in the process of implementing, via MiFID II/MiFIR, trading requirements that are aimed at increasing pre-trade pricing transparency for standardized swaps. 5. Reporting requirements Reporting requirements are designed to give regulators a holistic view into derivatives transactions in order to improve their ability to detect risks in the system and compliance with requirements. Protect Unsophisticated Users 6. Disclosure & documentation Many new documentation requirements are aimed at improving disclosure from banks to their end-user customers. These requirements will roughly double the amount of paperwork necessary to complete a derivatives transaction. T Luke Zubrod Director, Global Regulatory Advisory Chatham Financial Phong Dinh Director, EU Regulatory Advisory Chatham Financial


CRE Finance World, Summer 2014
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