Confidence in outlook for global property derivatives market undimmed

Posted On Thursday, 19 June 2008 02:00 Published by
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Expanding the property derivatives market beyond its UK stronghold is proving a challenge, real estate industry professionals said this week, but they remained largely upbeat about its prospects

At a property derivatives conference this week, most speakers were cautiously optimistic, pinpointing France as the next big phase in the market's development.

"It is absolutely inevitable that people will embrace property derivatives," said Iain Reid, head of UK-based property funds firm Protego and a pioneer of the market. "Quite how quickly, I can't say."

Guy Marty, head of the Institut de l'Epargne Immobiliere et Fonciere, said the future of the market would be in the hands of long-term investors such as pension funds, which are increasing the amounts they allocate to real estate.

These, he said, would jump at the chance to internationalise and manage their real estate investments using derivatives if a credible global market was available.

"If you have to deal with risk as well as capital, then property derivatives are a necessity," Marty said.

The property derivatives market offers over-the-counter trading mainly in swaps based on the total return on benchmark property indexes for fixed periods and in exchange for fixed or variable interest payments.

Property index swaps are most established in the UK, where they are centred on Investment Property Databank's (IPD) UK All-Property index, a monthly updated benchmark based on collated surveyor valuations. "It is the only derivatives market in Europe which makes sense to look at," said Christophe Schumacher, head of indirect investments and structured products at German insurer unit AMB Generali Immobilien (AMBG.DE: Quote, Profile, Research), which wants to increase its exposure to UK real estate using either property shares or derivatives

British property derivatives dealing volumes, though still puny relative to other derivatives markets, have been rising sharply. They hit a record 3.4 billion pounds ($6.63 billion) in the first quarter, just as other property markets reeled from the credit crunch, including physical property and commercial mortgage-backed securities.

Property derivatives have also spread to France, Germany, Italy, Japan, the United States, Australia, Canada and Hong Kong, but have yet to take off to anywhere near the same degree.


"Liquidity is fragmented across three pools, with little overlap of interests," said Benoit Pinguet, head trader for European property derivatives at Morgan Stanley, who singled out France and Germany as being in a middle group behind Britain's "developed" but still hardly mature property derivatives market.

France has the second-biggest such market after the UK, but according to IPD, the cumulative total traded on the French IPD index derivative market since its inception more than a year ago is still less than 1 billion pounds ($1.95 billion).

That could be partly down to a lack of local players.

Of the 20 banks currently licensed to trade IPD property derivatives, just two are French; BNP Paribas (BNPP.PA: Quote, Profile, Research) and Credit Agricole's Calyon (CAGR.PA: Quote, Profile, Research). Market sources say the latter has been largely inactive but hold out some hope that that could change later this year.

A third French bank, Societe Generale (SOGN.PA: Quote, Profile, Research), has made enquiries but has yet to show its hand, they say.

Overcoming regulatory issues that bar certain French property funds from using derivatives -- especially new open-ended OPCIs (Organisme de Placement Collectif Immobilier) -- could be crucial in helping the market to take off. Pinguet said he was "extremely confident" that the regulatory issues holding up the French market would be overcome, while Pierre Schoeffler, chairman of consultants S&Partners, said he expected a resolution in "not more than three months".

Meanwhile, a ruling last week by the U.S. tax authorities could provide a fillip to the relatively dormant U.S. commercial property swaps market, which has been plagued by intense competition between property index providers.

According to the ruling, property derivatives will not be subject to a non-resident property investment tax, which could spur overseas interest in the U.S. market, interbank broker CB Richard Ellis-GFI said.

"We're going to get there," said Charles Tedstone, a consultant for Guernsey-based Heritage Group, about the property derivatives market generally. "There have been a few false starts, but we're going to get there," he said.

(Reporting by William Kemble-Diaz, editing by Will Waterman) (See for the global service for real estate professionals from Reuters).

Publisher: Reuters UK

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