Green and social securitisation transactions are starting to break through. Is this market on the cusp of taking off?
Securitisation with a sustainable flavour is far from new. In the US, for instance, portfolios of property-assessed clean energy loans — loans to fund energy efficiency and renewable energy upgrades to properties — have been securitised since 2014. However, it is a market that has been slow to grow.
For example, there was just €845m worth of sustainable securitisation issuance in Europe in 2020, according to the Association for Financial Markets in Europe (AFME), compared with €256.2bn worth of environmental, social and governance (ESG) bond issuance.
Rising up the agenda
But could this be about to change? Creating a sustainable global economy will require massive investment, and the Covid-19 pandemic, which has pushed social causes higher up this agenda, has only increased those funding needs. The bond and loan markets alone clearly cannot do all the heavy lifting. Investor appetite for ESG-linked assets also continues to outstrip available investment opportunities.
As sustainability has risen up the agenda and regulators, particularly within Europe, are increasingly bearing down on asset managers and other institutional investors to better understand and disclose the ESG credentials across their portfolios, securitisation may naturally find itself under the ESG spotlight.
As Anna Bak, an associate director in AFME’s securitisation division, observes: “Firstly, this is an area that is quite high on the political agenda. It’s also high on the investors’ agenda, and if there is interest and potential demand from investors, then there will, of course, also be interest from issuers. Finally, given the economic situation, with the impact from Covid-19, there are some considerable funding requirements to be met alongside a drive to transition to a more sustainable economy as part of that recovery.”
The very nature of securitisation could also enable it to make a significant impact, says Ms Bak, “precisely because securitisation allows banks to remove certain assets from their balance sheets, increasing their capacity to lend, including for sustainable projects. Securitisation as a product is very well suited for enabling the transition to a more sustainable economy.”
Issuer interest
There does appear to be substantive issuer interest in this area, even if it has not yet translated into action. For instance, a member survey from securitisation trade association, the Structured Finance Association, published in late 2020, found that while only 13% of issuers currently sponsor an ESG-focused securitisation programme, 43% were developing one. At a broader level, 73% of issuers already incorporate ESG considerations into their wider asset origination and underwriting practices. Although the survey had a small sample size of 49 firms, the results appear to be in line with broader market sentiment.
Alexandre Vigier, global head of financial and operating asset securitisation at Crédit Agricole CIB, believes that while many issuers are interested in this area, they will first need to invest in technology and other areas. He says: “When we speak to clients, many of them are very motivated by the idea of this kind of issuance, such as green asset-backed securities (ABS), in the future. But in terms of being able to assess and track the exact ESG credentials of their portfolio, that typically will require some investment and IT development, and it is not something that can be completed immediately.”
If it’s a public company, quite a lot related to ESG credentials is either mandated by regulation or by convention
His colleague, Richard Sinclair, global co-head of conduit funding and management, adds: “There is a question for sellers about what the ‘reward’ is for engaging in this kind of transaction. As on the one side it requires investment and IT development in disclosure and reporting, but at the moment there is not a material price incentive, making it a cheaper source of funding. There is a lot of investor demand, but we are only starting to see some efforts on the investors’ side to reduce the cost of funds they offer.”
Definition debates
Indeed, aside from questions around pricing, there are several notable hurdles facing the development of this market. One of the most fundamental being a lack of clear agreement on what qualifies as a “sustainable” securitisation transaction.
In a similar fashion to the regular bond markets, where a deal’s use of proceeds is typically the main determinant of whether it can be labelled green or social, some have argued that securitisation should have to fund environmental or social projects in order to attract such a label.
However, given the fundamental role of the underlying collateral in any securitisation transaction, others have argued this is the more relevant area for measurement — that a sustainable securitisation should be based on assets that can demonstrate ESG credentials, such as mortgages for energy-efficient properties.
AFME in its recent discussion paper, ‘ESG disclosure and diligence practices for the European securitisation market’, suggests that the assets should be the primary focus. As, along with weighing up the governance provided by the originator and servicer, this is main area of focus for investors when making ESG assessments of securitisations.
Krista Tukiainen, head of research, market intelligence at the non-profit Climate Bonds Initiative, states that its position is that both the use of proceeds and the assets should be considered.
Lack of appropriate assets
In either case, given this is such a nascent market, there are concerns that there are not yet enough green or sustainable assets available to enable meaningful activity.
As Mr Vigier comments: “Asset availability remains an issue. For instance, if we look at the auto sector, although the electric vehicles sector is growing considerably, it still remains a relatively small share of the overall market. So it is a trend which will grow, but we are not quite there in a number of sectors in terms of having the assets to issue against.”
Steve Gandy, managing director and head of private debt mobilisation, notes and structuring at Santander, suggests that a transitional approach could be helpful in the short term. “We believe there should be a transition phase in this nascent phase of the market,” he explains. “It would be good to have arrangements where, at least for the first, for instance, five years, deals don’t have to be based on 100% ESG collateral, but they have to have a certain minimum level. That kind of arrangement could spur the market to develop more quickly.”
Anna Bak, AFME
This mixed approach has been successfully implemented on some transactions. National Australia Bank (NAB), for example, has led on several securitisations where only part of the collateral was comprised of green assets. In 2018, it issued an A$2bn ($1.55bn) residential mortgage-backed securitisation (RMBS) deal, with an A$300m green tranche secured against mortgages on low-carbon properties.
David Jenkins, global head sustainable finance, corporate and institutional banking at NAB, says: “It was important for us to test investor appetite for this kind of structure and, from a treasury team perspective, to find out if it led to greater investor diversity.” He acknowledges that he has had conversations with some market participants who believe that 100% of the collateral should be ‘green’ or ‘social’; however, investors with public commitments to invest in sustainable assets also engaged with these ‘hybrid’ transactions. NAB has since led on 100% green/social collateral backed securitisations in both Australia and the UK.
NAB’s experience in 2018 also highlights the difficulties that can arise in identifying green or sustainable assets — inconsistent standards and patchy data can make it very challenging. In this case, Mr Jenkins points to the difficulty of identifying low-carbon properties in Australia, where there is no universal system for measuring the energy efficiency of properties. Because of these challenges, in collaboration with the Climate Bonds Initiative, it had to devise proxy standards based on alternative data sources, which had some limitations.
Additional clarity
In the EU, work is underway to address some of these issues. The European Banking Authority (EBA) has been mandated to produce proposals for a sustainable securitisation framework by November 2021, which are expected to include a definition of “sustainable securitisation”. Along with the EU’s sustainable finance taxonomy, this should provide greater clarity about which assets and activities could qualify as sustainable. However, even if the requirements are clear, the challenge of sourcing appropriate data to make such judgements remains.
Aware of these challenges, buy-side group, the International Capital Market Association’s (ICMA’s) Asset Management and Investors Council is currently working on key performance indicators (KPIs) for use within three common securitisation sub asset classes — auto-loans, RMBS and collateralised loan obligations. The idea here is that the KPIs will provide common standards by which investors can judge the ESG credentials of securitisations, based on available data.
Arthur Carabia, director of market practice and regulatory policy at ICMA, says such standards benefit both issuers and investors, and the exercise is not about creating additional requirements for issuers. Rather, he says, “it’s about making the most of the information that is already there, and making that available to enable good investment decisions.”
“There is a clear focus on how to ensure such KPIs can be future proof, but also on what is feasible now,” he adds. “For instance, in the auto industry, in the future the issue of the recyclability of batteries from electric vehicles is likely to be a growing area of focus. And I expect there will be big shifts on this in the coming years, but this isn’t something that can easily be factored in right now. But what is already available, and could be really useful, is for instance the information about carbon dioxide emissions from vehicles.”
Notably, the KPIs are not being created in the context of securitisation transactions that are specifically labelled as green or social. They are being designed for use across all securitisations, reflecting the growing importance of ESG considerations for investors across their portfolios.
Investor judgement
There are some within the industry that believe that ultimately it is down to investors to decide on whether a deal meets their ESG criteria, particularly as they form an ever-greater backdrop to activity across the capital markets and investment landscape, and understanding of this area becomes more sophisticated.
Jay Steiner, managing director of asset-backed financing and capital markets at Deutsche Bank, says: “The way that this area is developing is interesting because it’s expanding from beyond the pure ‘E’, and also how investors’ approach it is evolving. For instance, Tesla’s ABS deals didn’t obtain a second-party opinion or have green labelling, but as it was based on a portfolio of 100% electric vehicle leases, many investors placed it into their ‘E’ bucket.”
Disclosure requirements
However this market progresses, it is clear that investor demand for ESG data from originators will only continue to grow. As well as verifying individual transactions, investors are also increasingly keen to understand issuers’ wider sustainability strategies and how ESG fits into their broader operations.
Emile Boustani, head of asset-backed products at Société Générale, says: “We are seeing an increased focus from investors — not only on verifying information about an issuance itself and its use of proceeds, but on an issuer’s wider sustainability strategy — to ensure there is coherence between the two, and what the wider impact of a transaction will be.”
Securitisation as a product is very well suited for enabling the transition to a more sustainable economy
However, as Ms Tukiainen highlights, accessing information about the entities involved in securitisations is not always straightforward. “If it’s a public company, quite a lot related to ESG credentials is either mandated by regulation or by convention, and is included in annual reporting. But that isn’t necessarily the case for entities in a securitisation,” she says.
As the sector evolves, it is likely that any entity wishing either to issue securitisations with an ESG label, or to attract investors that prioritise ESG considerations (an increasingly broad group), will need to reach a relatively high threshold of disclosure. Florence Coeroli, head of asset-backed products for Asia-Pacific at Société Générale, says: “Governance and transparency is really vital to the credibility of this world...[and] for issuers in terms of achieving their ESG ambitions.”
But this still leaves the sensitive issue of investors being able to validate data provided by issuers. Mr Steiner suggests that second-party opinion providers could play a key role in the ongoing monitoring of both the performance of specific issuances, as well as originators going forward in this respect.
Ms Tukiainen also suggests there could be a role for regulation, to mandate entities to provide data they otherwise may not, which is something that the EBA is considering as part of its review. Within the industry, while the need for high-quality disclosure is accepted, there is also wariness around adding too many additional requirements to an area they feel is already highly regulated. Several bankers are of the view that what is required is fine-tuning of existing disclosure requirements.
This is a view echoed by Ms Bak, who says: “I think any additional, specifically ESG-focused disclosure requirements should be complementary to what already exists. There are already considerable disclosure requirements as part of the existing regulation. So, perhaps some additional fields, but certainly not a new regime. The risk is that if you add a lot of additional ‘sustainable’ criteria on top of the existing simple, transparent and standardised securitisation requirements, it could make it difficult for any single transaction to meet all of the criteria.”
While there are certainly challenges to overcome before ESG can become a mainstream force within securitisation markets, there is considerable optimism about what the coming years will bring.
