UK property derivatives under spotlight

Though the UK commercial property derivatives market appears to be finally taking off, barriers to liquidity and efficiency remain, said derivatives professionals at a seminar held by law firm Field Fisher Waterhouse earlier this week.

Currently, activity is focused on total return swaps linked to the UK Investment Property Databank (IPD) commercial property indexes. The IPD has licensed four indexes for use in derivative contracts: the UK annual index; UK quarterly valued funds; UK annual index estimate; and the UK monthly index.

Liquidity in the market remains limited and banks currently have to match buyers and sellers on deals they transact. This reduces the speed of transactions, which further constrains liquidity, claimed seminar participants.

Mark Herne, a member of Deutsche Bank’s UK institutional client group in London, believes that once demand rises, banks will be able to warehouse risk. This will allow property risk to be sold on demand. And this in turn would reduce the need to match all buyers and sellers, increase price transparency, and result in even greater investor appetite, Herne said.

Charles Clark, a director at Atisreal, a UK-based consultancy which provides real estate investment advice to institutional investors, is dubious about whether liquidity is what the market needs. Illiquidity, he argued, differentiates property from other asset classes - making it attractive from a portfolio diversification perspective.

Gary Walker, a partner specialising in derivatives at Field Fisher Waterhouse, pointed to documentation as a major constraint on the market's development. Current contracts use standard International Swaps and Derivatives Association (Isda) terminology, but market participants say full Isda documentation would be a great boost. “Once an ISDA working group has been set up, the market will have arrived,” Walker said.