Framework

A total debt to total asset value limit is the simplest, most direct approach to guard against the risk of excessive leverage in property funds. Property funds borrow from a number of sources, including banks, other financial institutions and their own shareholders. Limits on total debt to total asset values act to restrict this type of on-balance sheet leverage. Rather than focusing on one type of loan or lender, which could increase the risk of regulatory arbitrage, the Central Bank has determined that a leverage limit covering all sources of debt is most aligned with the macroprudential purpose of the measures.

To guard against excessive levels of leverage across the property fund sector, the Central Bank has calibrated the leverage limit for property funds to sixty per cent of total debt to total assets. This limit applies to all in-scope property funds. Based on feedback received to CP145, the Central Bank anticipates that to avoid breaches of the leverage limit, property funds may seek to maintain a leverage ratio below sixty per cent in order to manage idiosyncratic variations in property prices. The Central Bank considers that maintaining such buffers would be prudent.

Consistent with other macroprudential requirements, the leverage limit would be subject to regular monitoring and review by the Central Bank. Regular monitoring would aim to ensure that the leverage limit is achieving its macroprudential aim and that it is not imposing undue burden on market participants or the broader economy. The Central Bank does not intend to recalibrate the leverage limit regularly. These measures are intended to deliver a structural level of resilience for the property fund sector to adverse shocks. Nevertheless, to achieve its macro-prudential objective, there will be flexibility to respond to material changes in the macro-financial environment.

Funds that are predominately invested in social housing assets will not be in scope of the leverage limits, subject to certain criteria. This is due to the unique characteristics of these funds that make them less systemically risky as a cohort. In particular, to be considered out of scope from the leverage limits, the properties of a fund must be leased to a Local Authority (for the purpose of social housing) using long term leasing models where the income is guaranteed for a fixed period of time (depending on the specific lease). Further, there should be no LTV covenants or repayment on demand features associated with the debt raised by the fund. Property funds pursuing development activity will be permitted to apply a margin to the value of development assets (which are usually accounted for at cost) for the purposes of the calculation of the leverage limit. This is a methodological accommodation for development activities, reflecting the fact that the leverage limit as proposed would be even more restrictive for development assets given the LTC basis on which development is currently accounted for, without changing the overall leverage limit of sixty per cent. Once an asset which had been the subject of development activity becomes an investment asset, the standard calculation framework, in-line with the sixty per cent limit would apply. Based on a range of data sources, the Central Bank has judged that this margin be set at twenty per cent. This estimate holds across industry reported data, publicly available information, and proprietary data.

As of the announcement of these measures, 24th November 2022, the Central Bank will not authorise new property funds with leverage in excess of sixty per cent.  The Central Bank will provide a five year implementation period to allow for the gradual and orderly adjustment of leverage in existing property funds. The Central Bank expects that funds will make early and steady progress towards lower leverage levels over the implementation period.

In relation to Irish AIFMs with existing Irish property funds, the Central Bank will impose the leverage limit by way of condition of authorisation under Regulation 9 and Regulation 26 of the Irish AIFM Regulations. Where a non-Irish AIFM is managing an existing Irish Property Fund, the condition will be imposed under the relevant domestic funds legislation.

The regulatory framework for AIFMs already includes provisions to limit the degree of liquidity mismatch in funds. Regulation 18 of the Irish AIFM Regulations outlines (inter-alia) fund managers’ obligations with respect to liquidity management in the funds that they manage. When applied appropriately by a fund manager, this should result in the investment strategy, the liquidity profile and the redemption policy of the AIF being consistent. In practice, however, the Central Bank has observed significant variation in how property funds align redemption policies with the liquidity profile of the assets, particularly in periods of market stress.

Given the above, and in the context of the very illiquid nature of property assets, the Central Bank is issuing Guidance with respect to how Regulation 18 of the Irish AIFM Regulations should be applied for property funds in the context of liquidity timeframes. The outcome of the Guidance is that Irish property funds may need to extend their notice and/or settlement periods, to better align with the liquidity profile of their assets. This is consistent with the Central Bank’s expectation that property funds ensure there is alignment between the investment strategy, liquidity profile and redemption policy of funds under management.

In order to determine the appropriate liquidity timeframe for Irish property funds, the Central Bank considered the length of time it takes Irish property. Based on the Central Bank’s analysis, in general, property funds should provide for a liquidity timeframes of at least 12 months, taking into account the nature of the asset held.

The Guidance also outlines the Central Bank’s judgement that longer notice periods are better able to guard against ‘first mover advantage’ dynamics than longer settlement periods. Property funds should appropriately balance their notification and settlement periods. There should be sufficient time after the notification of an investor’s intention to withdraw funds for both the liquidation of property assets held by the fund and the settlement of redemption proceeds with the underlying investor. The use of longer notification periods would help to prevent the development of misaligned incentives that can contribute to first-mover advantage dynamics.