Leverage measures
The Central Bank identified a specific cohort of In-Scope Funds with what it considers to be elevated levels of leverage and has specific concerns as to the impact on financial stability should such In-Scope Funds for any reason be unable to service their loans and be required to quickly divest significant portions of their portfolios. The Central Bank emphasizes the risks this poses to the ability of banks to continue to provide finance to the economy, the operation of the construction sector and the wider real economy.
Leverage Limits
Consequently, the Central Bank has since been consulting on the proposed 50% leverage limit for all In Scope Funds to be determined by the ratio of total assets to total liabilities (or its equivalent applying the AIFMD gross or commitment methodologies). The Central Bank is proposing the imposition of the leverage limit through the existing AIFMD legislative framework and in line with the related ESMA Guidelines.
Brian Dillon
Review of Leverage generated by In-Scope Funds
In practice, the Central Bank is proposing that it will review the use of leverage by In-Scope Funds as part of its annual review of funds and based on the information contained in the regular reporting it receives with respect to such funds. Where, in the course of that review, the Central Bank identifies In-Scope Funds with levels of leverage close to, or above the 50% limit, such funds will be issued with notices confirming the application of a specific binding leverage limit. The Consultation notes that there may be a number of different metrics applied to the fund specific limit based on those outlined in the ESMA Guidelines and further consideration of how those metrics are calculated and applied will be required.
It is worth noting that the Central Bank considers that the leverage limit applies de facto to all In-scope Funds. Even if an In-Scope Fund with a low level of leverage is not subject to notification of a specific binding leverage limit in any given year, if it breaches the leverage limit, it will be issued with a specific binding leverage limit the following year.
Transition Period for Existing In-Scope Funds
The Central Bank has acknowledged that existing In-Scope Funds with leverage levels in excess of the leverage limit will need to time to comply in order to ensure the reduction of leverage is effected in an orderly manner.
The Central Bank is proposing a three year transition period and has indicated that In-Scope Funds will be allowed formulate their own plan for reducing leverage. Presumably this is intended to ensure a gradual and targeted unwind of leverage levels in a way that will ensure the 50% leverage limit is met within the required three year timeframe but also to limit the possibility of large scale sell offs towards the end of the transition period.
Application of Leverage Limits on Newly Established In-Scope Funds
The Central Bank will seek to impose this leverage limit on all new In-Scope funds at the time of authorisation and such funds will be subject to the annual assessment commencing in the year following their first annual reporting date.
Review of Leverage Limit imposed by the Central Bank
The Central Bank intends to keep the leverage limit under review to ensure they are achieving the stated aims and are not otherwise causing “undue burden” on participants in the Irish CRE sector. The Central Bank confirms that it will look to take appropriate action by either increasing or decreasing the leverage limits should market circumstances require.
Guidance on Liquidity Mismatch
In addition, the Consultation Paper also proposes that In-Scope Funds should further comply with additional guidance to limit liquidity mismatch. In keeping with the Central Bank’s long established principle of alignment of the liquidity profile of the relevant AIF and the redemption cycle, the Central Bank has again stressed the importance of considering the liquid nature of the assets to avoid a potential liquidity mismatch when markets are challenged.
Action
The Central Bank has sought feedback on its proposals with regard to both leverage and liquidity mismatch by no later than 18 February 2022 and I would urge those interested to do so. If readers would prefer to contact me with comments that can be included with the Dillon Eustace LLP submission, please let me know at brian.dillon@dilloneustace.ie.