By Huw Jones
LONDON (Reuters) - The European Union's 1.1 trillion euro ($1.19 trillion) real estate funds sector faces multiple risks related to leverage, valuations and liquidity, requiring "stepped up monitoring", the bloc's securities watchdog ESMA said on Tuesday.
"ESMA confirms the risks posed by real estate (RE) funds, in a context of declining volumes of transactions and falling prices in several jurisdictions," the watchdog said in a report on the alternative investment funds sector.
RE funds with pan-European exposures are concentrated in countries like Germany, Luxembourg and France, it said.
"The main vulnerability of RE funds relates to liquidity mismatches in jurisdictions with a high share of funds offering daily or frequent redemption."
Germany's markets watchdog BaFin said earlier this month that real estate was an increasing risk as Europe's biggest economy undergoes its biggest property crisis in decades.
ESMA said it would step up monitoring of alternative investment funds, including liability-driven investment funds (LDI), which are exposed to Britain's government bond market.
Regulators in Luxembourg and Dublin, where many LDI funds are listed, and in Britain, where pension schemes use them to manage long term payouts to pensioners, had to intervene after rates on UK bonds rocketed in September 2022.
The funds now have to hold much larger liquidity buffers.
"Risks have remained elevated, and the limits set after the severe stress experienced in September 2022 remain appropriate," ESMA said.
Leverage for hedge funds remains very high, and this may pose a risk of market impact, the watchdog said.
"However, most of them also dispose of large levels of cash to address potential margin calls, which limits the risk of fire sales," it added.
The alternative investment fund sector declined slightly in 2022 to 6.8 trillion euros, although still accounting for 36% of the EU fund industry.
($1 = 0.9216 euros)