News analysis: Are regulators denying real estate's long-term credentials?
Long-term investments could be recalibrated under Solvency II, but property might miss out, says Richard Lowe
The German fund management association BVI this week illustrated how the uncertainty surrounding Solvency II was proving a disruptive influence on institutional investors. According to its survey, many German pension funds and insurers want to increase their exposure to real estate from 6% to 14%, but are being put off by the likelihood of prohibitive capital-reserve requirements.
'Uncertainty' is very much the key term at the moment. Speaking just before the start of INREV's Winter Seminar in London on Wednesday, Jeff Rupp, INREV's public affairs director, described Solvency II as being "thrown into a state of near-chaotic uncertainty".
Grabbing most of the headlines has been the directive's ongoing catalogue of delays regarding the implementation date. Despite determination in some quarters to push Solvency II through on track no matter what, regulators seem to have allowed for yet a further delay, which could extend its inception to January 2016.
The current focus of deliberation relates to the capital requirements for what the European Commission's Jonathan Faull has described as "long-term finance". The director general for internal market and services wrote a letter in September 2012 urging EIOPA to consider recalibrating the capital requirements for investments in long-term assets in "growth and job-enhancing areas" in Europe.
Faull put forward the following four examples of "long-term finance" that EIOPA should examine: "infrastructure financing and other long-term financing through project bonds, other types of debt and equity; SME financing through debt and equity; socially responsible investments and social business financing through debt and equity; and long-term financing of the real economy through securitisation of debt serving the above mentioned purposes".
What was missing was from the list was any mention of real estate. The omission did not escape the attention of Europe's real estate associations, and in December Faull received a letter signed by INREV, EPRA and 11 other organisations highlighting their concern that real estate's status as a long-term asset class was being overlooked – potentially to an unfair disadvantage. "It is inconceivable to us that a review of the impacts of Solvency II calibrations focused on long-term physical assets would not consider real estate," it stated.
INREV received a response from Faull on Thursday, suggesting that the four categories he originally outlined were "an open list" and that real estate should be included in any reassessment if EIOPA deems it to constitute "investments that provide long-term financing".
In short, it does not make for reassuring reading for real estate lobbyists. Faull indicates no intention to champion the cause of the asset class. He also attributes the omission of real estate from his list to a lack of historical data. "The shorter the data history, the more likely it is that the risk is underestimated," he wrote. "It is due to the scarcity of data that EIOPA based its calibration recommendation on the commercial real estate market of the UK."
The final point has been a particular bugbear for INREV and other European real estate groups and investors. A study by IPD, commissioned by INREV, showed that using UK market data to calibrate capital requirements would overstate the shock factor for real estate. The UK market is typically more volatile than many continental markets, the study concluded, and so the solvency capital requirement (SCR) for pan-European property should be closer to 15%, not 25%.
However, Faull makes a valid counter argument. "Several national real estate markets have shown more stability than the UK real estate market during recent years," he said in this week's letter. "However, this observation may not imply that a steep fall in real estate prices, such as has occurred in the UK during the banking crisis, is not possible in those markets in the future."
It should be noted there is currently no official definition of 'long-term investment', according to the European Union, but this will be addressed in a green paper scheduled for early 2013. The paper will prove instrumental in how the asset class is treated under Solvency II, and the real estate industry should therefore engage as fully as possible.