As 2016 opens, the commercial real estate sector has
many regulatory changes to look forward to in addition
to rising rates, peaking refinance needs and geopolitical
challenges. The following represent some of the weightier
regulatory agenda items anticipated in 2016 and beyond:

Larger banks will face greater capital charges through the Total
Loss Absorbency Capital (TLAC)1 and changes to risk-based
capital rules,2 at the same time they are likely going to be asked
to absorb additional liquidity charges in the form of the Net
Stable Funding Ratio (NSFR)3;

Medium and smaller banks will be absorbing a host of shifts,
including implementation of stress testing requirements, High
Volatility Commercial Real Estate (HVCRE)4 reporting and new
protocols for booking loss reserves;

Asset managers of varying types are being considered for activity and
entity-level regulations that seem to be aimed largely at
deleveraging short-term funding strategies and tightening up
liquidity management;

Insurers have been considered for holding company-level
capital assessment;

Private label commercial mortgage backed securities (CMBS)
will be subject to Risk Retention, Regulation AB II, as well as new
capital requirements for bank-related trading desks and possibly
real time trade reporting dissemination; and

• The SEC and FINRA may finalize a set of margin rules that
would apply to GSE multifamily deals requiring broker dealers
to collect initial and ongoing margin against advance-purchase

In sum, the whole loan and CMBS markets will feel a greater weight
of regulation starting in 2016 with full implementation late in the
decade or early next. The CRE Finance Council study “Regulatory
Design, Real Outcomes” assessed the impact on the CRE market
using as its central assumption the idea that regulation would be
absorbed without causing market stress. However, top regulators
around the globe are signaling varying appetites for new rules in
reaction to concerns that requirements may themselves be the
source of market dysfunction and new structural risks.

At times, two of the top regulators have indicated opposing sentiments.
Mark Carney, the Governor of the Bank of England and the head
of the Financial Stability Board (FSB) gave a speech in late 2015
in which he challenged, “authorities must have the courage to
listen, the honesty to admit our mistakes and the confidence to
set them right.” Carney did so after lauding the virtues of regulation
in addressing the excesses of the “Age of Irresponsibility”, but he
is one of the first global leaders to openly question the lengths to
which regulation may have gone in impacting market infrastructure
and function. Closer to home, Federal Reserve Governor Daniel
Tarullo, who is also second in command at the FSB, continues
to press for higher capital requirements and a more aggressive
regulatory framework across the banking and the nonbank sectors.

As market fundamentals naturally turn more challenging in the cycle,
even with emerging forecasts of a 2016 recession in the U.S.,5
regulation will increasingly be a source of risk to the system. Amongst
the more serious concerns that have surfaced, capital charges and
other rules are widely associated with the dramatic contraction in
secondary market making. In December, the Bank of International
Settlements published a paper that cautioned mandatory swaps
clearing may actually represent a structural weakness, in that central
clearing entities may amplify market shocks.6

Tom Flexner, Global Head of Real Estate at Citigroup, has framed
the issue through another lens. For some time, the industry leader
has been asking whether regulation and other forces that have
reshaped trading and financing dynamics have permanently and
fundamentally altered financial institutions’ appetite for risk. On
a recent occasion, Flexner tightened the lens specifically on
the potential for risk aversion to dampen the markets’ ability to
climb out of a recession, suggesting that the cumulative effect
of regulation could actually lengthen downturns and deepen
economic hardships.

In conducting research for the CREFC study, a review of academic
literature suggested a generalized belief that regulation often
overshoots its targets, affecting a wider group of assets and entities
more deeply than intended. To tie this back to Mark Carney’s view
that the regulatory agenda was broad enough to include certain
missteps, it makes sense to potentially slow the proposal of new
requirements. Instead, 2016 will see an acceleration of regulatory
implementation in the banking sector and the development of
new rules for the nonbanks. The most robust financial model, even
one approved by the regulators, could not predict the results of
so many changes occurring at once.

1 TLAC applies to global systemically important banks as one measure
intended to ensure an end to too-big-to-fail by requiring higher capital
and some component of convertible debt.
2 The Basel Committee on Banking Supervision is finalizing several work
streams that will apply to CRE portfolio loans and CMBS that are expected
to be finalized in early 2016, and then will require U.S. rulemaking.
3 The NSFR, which has yet to be proposed in the U.S., will require banks
to hold a certain amount of stable debt and deposits depending on the
perceived riskiness of the assets generated by the business line.
4 HVCRE applies to acquisition, development and construction lending
and requires that all banks hold 1.5 times as much capital as in the past
against such loans.
5 Citigroup published a 2016 outlook, which reportedly included this
point: “The cumulative probability of U.S. recession reaches 65
percent next year. Curve inversion will likely come more quickly than
the consensus thinks.”