Even Europe was dealt with in the recent economic recession. And with the real estate market only starting to recover, the European Union is aiming to lower economic risks that were already seen when contracts insuring mortgage-backed bonds led to losses. The EU plans to do this through law changes that would force commercial real estate owners to pay billions of cash in euros that will be used as hedge funds.

Europe’s commercial real estate owners are currently strapped with a 1.9 trillion euro ($2.5 trillion) debt and they may soon face demands for cash collateral for interest-rate movement bets. The European Commission is proposing to regulate the derivatives industry. In a De Montfort University study, it was found out that of the UK real estate debts by the end of 2009, 130 billion pounds ($204B) were from interest rate swaps – and in the proposal, most will be subject to such collateral payments.

British Property Federation finance director Peter Cosmetatos says, “There is a perfectly genuine risk at this point that the commission will win the day and, not only real estate funds, but also European real estate investment trusts will be caught.”

The current European Union proposals will affect businesses like real estate, private equity, and hedge funds.

Currently, real estate buyers who are taking out floating-rate loan in buying a building use swaps to secure a fixed interest rate. This give the assurance that loan can be serviced by rental income amidst unexpected rise in rates. Not all floating-rate loans though go up, some may go the other way – and that is what the European Union wants to target.

If rates go the opposite way versus what the swap anticipates, then demand for payment or margin call will be made. If businesses are unable to pay, then they will be considered in default.

The European Property Federation, which looked into the proposals, thinks the said proposal may be a catastrophe for property businesses relying on interest-rate swaps or even other derivatives. The federation explains, “Some would be unable to fund margin requirements and could default on their borrowings and risk insolvency.”

Further clarifications will be made when the members of the commission and real-estate industry representatives meet in the next few weeks. One concern they would need to address is the British Property Federation’s question as to whether European property companies, including REITs such as Unibail-Rodamco SE and Land Securities Group Plc, are covered in the proposals.

If approved by the European Parliament and member states, the new laws will take effect by end of this year.