European Union legislation on OTC Derivatives will lead to serious property and debt market instability, the European Property Federation has warned. In its input to European Parliament Rapporteur Werner Langen on the European Commission's proposed Regulation on OTC Derivatives, EPF pointed out that specific and precise modifications and clarifications are needed if the Alternative Investment Fund Managers Directive (AIFMD) is used to set the distinction between financial and non-financial businesses.

European Union legislation on OTC Derivatives will lead to serious property and debt market instability, the European Property Federation has warned. In its input to European Parliament Rapporteur Werner Langen on the European Commission's proposed Regulation on OTC Derivatives, EPF pointed out that specific and precise modifications and clarifications are needed if the Alternative Investment Fund Managers Directive (AIFMD) is used to set the distinction between financial and non-financial businesses.

EPF stated that it should be made clear that the business of real estate development and investment is intrinsically non-financial. Real estate businesses create places, build and look after buildings and sell accommodation to the occupier market - their core business is to invest in land, buildings and places, not financial instruments.

This distinction is particularly important if there is no exemption in the EU Derivatives Regulation for pre-existing contracts like interest rate hedges, as very serious property and debt market instability could result if margin had to be posted for such contracts. The estimated potential cash requirement today is more than EUR 60 bn across Europe.

In addition. non-financial businesses (including real estate) must not be treated as financial simply by virtue of the fact that they are owned by a fund whose manager is regulated under the AIFMD. That would produce arbitrary and undesirable consequences, with the treatment of a business’s commercial hedging derivatives depending not on the nature of the business, but rather on the way in which the business happens to be owned from time to time, the EPF warned.

EPF further emphasised that, where real estate businesses are treated as non-financial, risk mitigation requirements should recognise collateral provided in the form of security over underlying real estate. There should generally be no need for cash collateral or more capital - and the imposition of such requirements could itself destabilise the sector.

EPF said that a clear and coherent approach to territorial scope is needed. Territorial limitations should relate to the regulation's overall scope; they should not determine whether a business is treated as financial or non-financial.

Finally, EPF emphasised that exposing the property sector to the risks described above by imposing margining requirements would indirectly affect the financial system as well, with a danger of damaging market stability and increasing systemic risk because of the substantial exposure that many European financial institutions have to real estate.

John Frederiksen, EPF President, said: 'The fallout from the failure to understand the fundamental differences between property investment and development activity on the one hand and financial services on the other has spread from the AIFMD to the Derivatives Regulation and soon to the Financial Activities and Financial Transactions Taxes. EPF will continue to explain to the EU authorities that this conceptual amalgamation has no basis in fact and is causing great harm to the property industry precisely because of its very different nature and business practices.'