As outlined in our previous advisory 'Central Bank's property fund proposals', the Central Bank of Ireland (the "Central Bank") has recently been consulting on two key proposals:
- a proposal to introduce leverage limits on certain funds domiciled in Ireland, authorised under domestic legislation, and investing over 50% of their portfolio in directly directly or indirectly held Irish property assets ("Property Funds"); and
- proposed guidance relating to liquidity mismatches in Property Funds.
On 24 November 2022, the Central Bank published (i) its Feedback Statement in response to consultation paper 145 ("CP145") (the "Feedback Statement"), and (ii) its Macroprudential Policy Framework for Irish Property Funds containing its final guidance on redemption terms for Property Funds (the "Guidance").
Introduction of 60% Leverage Limit
To address perceived risks stemming from leverage in Property Funds, a 60% leverage limit (total debt to total assets) (the "Leverage Limit") is being introduced by the Central Bank with a five-year implementation period for existing Property Funds. The Leverage Limit includes all sources of debt including shareholder loans. The Central Bank expects that existing Property Funds will make gradual and orderly progress towards lower leverage levels over the implementation period. The Central Bank also acknowledges that its approach to enforcement of the Leverage Limit will be cognisant of the fact that forced asset sales run contrary to the underlying objective of the limit itself.
Those Property Funds which have leverage close to or above the Leverage Limit will be required to submit plans to the Central Bank on how they will deleverage or maintain leverage below 60% throughout the implementation period in a gradual and orderly manner. During this implementation period, the Central Bank has noted that it does not expect Property Funds with leverage above the Leverage Limit to increase the quantum of their debt. The implementation of the Leverage Limit will be assessed annually by means of a tailored regulatory return, in a format to be finalised in the first half of 2023 and filed with the Central Bank. The Central Bank will be actively monitoring and following up to ensure appropriate progress is being made throughout the implementation period and expects that deleveraging should be significantly progressed by the end of year three.
ESMA has also issued its accompanying formal advice to the Central Bank on the Leverage Limit measures pursuant to Article 25 of AIFMD. ESMA's advice concludes that the Leverage Limit is appropriate to address the concerns relating to the stability and integrity of the financial system.
Guidance on Liquidity
The Guidance on minimum liquidity timeframes seeks to address perceived risks stemming from liquidity mismatches observed in Property Funds. The Central Bank has set out its expectation in the context of the settlement of redemption proceeds that Property Funds should generally provide for a minimum liquidity timeframe of 12 months, taking into account the nature of the assets held. With respect to liquidity, the Central Bank is providing an 18-month implementation period for existing Property Funds to take appropriate actions in response to the Guidance (i.e., 24 May 2024).
The Central Bank acknowledges that there are circumstances where the liquidity timeframe would not be required. In particular, and subject to prudent liquidity management by the alternative investment fund manager (the "AIFM"), the liquidity timeframes may not be required in circumstances where (i) the designation of a redemption dealing day is at the discretion of Directors (and not at the option of investors); and (ii) the Property Fund has sufficient liquid assets not generated by disposal of Irish property assets for the purpose of funding any redemptions. The terms on which redemptions will be satisfied must be set out in the Property Fund's prospectus. In operational terms, the Feedback Statement notes that the minimum liquidity timeframe will apply to the whole portfolios of funds meeting the definition of Property Fund, not just related to the property assets in the portfolio.
The Central Bank expects that Property Funds authorised on or after 24 November 2022, will adhere to the Guidance from inception.
In its Feedback Statement, the Central Bank has judged that it is appropriate to make certain adjustments to its original proposals in CP145, including:
- recognising that Property Funds may seek to operate in practice with a buffer below the Leverage Limit to provide capacity to avoid breaches due to normal market movements, the Central Bank has decided that the Leverage Limit will be set at 60%, instead of 50%;
- extending the implementation period for the Leverage Limit from three years to five years to allow for the gradual and orderly adjustment of leverage in existing Property Funds;
- Property Funds that borrow on a loan-to-cost basis to fund development activities can use a different methodological framework for the purpose of calculating leverage on those assets. This is a methodological accommodation for development activities, reflecting the fact that the cost-based valuation does not account for the value added of a completed asset that development activity generates. Once a development asset becomes an investment asset, the standard calculation framework in-line with the Leverage Limit applies; and
- Property Funds that hold at least 80% of their total assets under management in social housing will not be considered in scope for the Leverage Limit subject to compliance with certain criteria.
Conclusion
It is clear from the Central Bank's announcement that these policy tools are considered important to maintain momentum in strengthening the resilience of the Property Fund sector and to guard against the potential risk that vulnerabilities in the sector can lead to forced selling behaviour in times of stress. In turn, these enhanced liquidity management measures are intended to better equip the sector to continue to serve as a sustainable source of financial intermediation in the future
Accordingly, now is an opportune time for AIFMs to critically assess their framework for employing leverage and for managing redemptions and liquidity within Property Funds with a view to ensuring compliance within the timeframes outlined by the Central Bank.
Key points of focus initially for AIFMs should be:
- identifying whether funds invested in Irish property assets are in scope for the Leverage Limit and the extent to which leverage in Property Funds exceeds or may exceed the Leverage Limit;
- in a case where the Leverage Limit is exceeded, identifying remediation steps to bring the Property Fund back in line with the Leverage Limit within the targeted timeframe; and
- if in scope, consider whether a relevant Property Fund's redemption and liquidity framework aligns with requirements set out in the Guidance. The Central Bank has noted that the outcome of the Guidance is that Property Funds may need to extend their notice and/or settlement periods, to better align with the liquidity profile of their assets. This will be particularly relevant for open-ended with limited liquidity funds.
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