Accidental heroes

IPD has grown to become the main index provider for property derivatives. The company's story points to some of the obstacles facing this developing market, writes Rob Mannix

Property derivatives can only extend into new markets as fast as the indexes on which they are based. And the evolutionary approach at IPD, the UK-based information provider at the heart of the market, suggests the process will take time - no matter how desirable it might be.

Although IPD's profile has risen quickly in the derivatives market, the company is familiar with a more measured pace of progress. In fact, IPD first published indexes only as an offshoot of its long-standing work providing data and portfolio analysis to property investors.

"In the early years of IPD's business, we didn't anticipate that the index would generate its own revenue stream," says co-founder Ian Cullen. By the time it did, in 2005, the company had already been in business for 20 years.

Even now, Cullen says, the index business does not dictate IPD's strategy, but follows the growth of its core business. "Index licence revenues are not free money but fees for the provision of a new information service," he says. The index business (which requires a full-time staff of five) became profitable only in 2007.

The growth of the business has been driven by its attractiveness to investors as a means to gain exposure to property markets where direct investment might be difficult or costly. For lenders, the market offers a way to hedge property risk on their portfolio.

Investment banks that trade the index sign up for a licence but pay fees only when they execute trades. "We think the licence terms are fair at the moment but don't expect them to remain the same forever," says Cullen. "We have to behave like a partner to the industry. We're only a small but important piece of the jigsaw."

Slow process

So far the company has expanded to operate in over 20 countries including most of Europe, the US, Canada, Australia, South Africa, New Zealand and Japan. But the creation of indexes in less mature markets is a process that cannot easily be rushed, he says.

"Banks have come to us asking for quotes to provide an index for several emerging markets," explains Cullen.

Mainland China, India and Russia are examples. But even the process of providing quotes is heavily theoretical, he says, since a legitimate index requires data feeds from a broad cross-section of property investors in ach of the home markets.

IPD is considering expansion to cover central and eastern Europe, Hong Kong, Singapore and Mexico. But doing so depends on investors' willingness and ability to provide the necessary information.

Even when a new index is established, Cullen expects it to be traded only two to three years later, when the quality of information and a reasonable track record have been established. "Investment banks have talked about breaking that logic," he says. "But it has not happened to date and is unlikely to happen in the foreseeable future."

Impressive growth

In established markets, however, growth in property derivatives is impressive. The fourth quarter of last year saw a record 236 trades in the UK, up from the previous quarterly high of 164. The fall in commercial property returns is encouraging investors to use derivatives as a quick and inexpensive means to manage their exposure, says Cullen.

"The increase in the number of trades in the fourth quarter, which pushes the total number over the 1,000 mark since December 2004, indicates that this interest is now being translated into action," he says.

Cullen remains conservatively optimistic about the outlook for the market as a whole, saying it will either go on growing steadily or fizzle out, but that both options still remain possible. The least likely outcome would be for property derivatives to tick over at low levels for years to come, he believes.

The total amount traded on IPD index property derivatives is more than £13.3 billion, with 21 banks licensed to date. How long before they can trade an index for mainland China or India is harder to say.

- Ian Cullen is head of systems and information standards at IPD and a founding director of the company. He is responsible for all technical aspects of the delivery of client information services, the production of IPD's indexes and the related performance measures. He is also an economist and specialist in property market research and portfolio analysis.