The U.K. government has boosted the embryonic market by announcing draft legislation for a model of property derivatives taxation. The market will likely take off when this legislation comes through, said Paul McNamara , director and head of research at Prudential Property Investment Managers . Simon Young , a partner acting for pension funds at King Sturge , added, "If the government welcomes property derivatives as a tax-transparent investment vehicle, we will be very enthusiastic about using them."
McNamara explained the nascent market was given a push last year when the Financial Services Authority allowed life assurance companies to use property derivatives. The life companies are expected to be both buyers and sellers in the potential market.
The four-fold increase in Stamp Duty in the U.K. since 1997 provides another reason for growing interest in property derivatives noted McNamara. Neil Cosburn , global head of options and exotics at Royal Bank of Scotland in London, said, "We have a number of customers who are extremely interested in property hedging." He declined to name the customers.
Nick Cooper , head of indirect investment at ING Real Estate in London which has GBP1.8 billion (USD3.3 billion) under management, said ING would welcome a market for property derivatives, but would need to see how liquid the market could become before advising its clients to invest in derivatives.
The banks are likely to use the monthly statements of Investment Property Databank as an index. "The monthly index measures unitized funds and represents a market now approaching a value of GBP20 billion (USD36 billion) measuring 2,800 retail and commercial properties," said Ian Cullen , founding director of IPD in London.
In a hypothetical trade a bank would receive the total return on the IPD index and would typically pay LIBOR. A bank receiving property risk in a swap likely would repackage it as a bond. Paul Coleman , director of solution sales at Barclays Capital in London, noted that the bonds would be settled against IPD's annual index which covers 75% of the total property assets of U.K. institutions and listed property companies, but this would limit the maturity profile of the note. Banks involved in these transactions would not be taking any risk because these are matched trades.
