BRAVE NEW ROLE FOR THE FUNDS THAT SHOOK THE GLOBAL ECONOMY
▶ Asset-backed securities were largely responsible for the last financial crash. Now they are being used to encourage green projects
The financial instrument that nearly collapsed the global economy is being re-engineered to create a new market with a lofty goal: to save the planet. The chairs of a group set up by G-20 nations are kicking off an initiative to securitise bank loans for sustainable infrastructure, creating a new way to attract private sector funds for projects that aim to rein in global warming.
If it works, they say it could channel trillions of dollars to the cause, by connecting the capital markets to underlying green investments.
“The G-20 can’t create a market, but working with the private sector we can illustrate how a mechanism can be developed to allow the institutional investor access to this sustainable investment market,” says Michael Sheren, co-chair of the G-20 Sustainable Finance Study Group.
Asset-backed securities are loans supported by collateral such as property, vehicles and credit cards. In this case, it’s the debt in the infrastructure projects that has been pooled into a security that is sold off to investors in the form of bonds. The interest payments made by the borrowers typically pass through as coupons to the holders of each ABS.
This class of securities played a part in triggering the financial crisis of 2008. Banks securitised bad loans, particularly mortgages in the United States, trusting that diversification would cancel out the risk. When some of the securities lost their value, the ensuing panic roiled financial markets worldwide.
A decade later, Mr Sheren and his G-20 team are hoping that these types of securities can be created with loans to sustainability projects. The goal is to establish a market that Mr Sheren believes could be a significant contributor to the transition to a lower-carbon economy.
It would support ambitions set out in the Paris Agreement, the 2015 deal where almost 200 countries pledged to limit fossil-fuel emissions everywhere for the first time. A report from the UN Intergovernmental Panel on Climate Change estimated $2.4 trillion a year would need to be invested in green energy every year until 2035, more than 40 per cent higher than the $1.8tn invested in the industry last year.
Add in other forms of infrastructure including water and waste treatment, and estimates for the sums needed to green the economy have reached $100tn.
“The $100tn – who has that money? If you have to mobilise it and for long term, the best tool is institutional investors,” says Vikram Widge, global head of climate finance and policy at the International Finance Corporation. “The huge pool of global savings, we can’t do this without it.”
That is where this new market comes in. It would create a channel between lenders and institutional investors, allowing the underwriters to transfer sustainable infrastructure project debt to insurers and pension funds.
Banks typically hold on to project finance loans until they mature, which can often be at least 15 years for solar and wind farms. The long tenures and space they take up on balance sheets can limit
the number of projects they are able to finance.
“If the economics stack up, having a ready market for these loans would certainly increase the banks’ appetite to underwrite,” says Lisa McDermott, executive director of project finance at ABN Amro.
In the US, securitisation has already become a go-to funding source for rooftop-solar companies including Tesla and Vivint Solar. More than $1.3 billion in solar asset-backed securities was raised last year alone, demonstrating that the US residential solar industry became large enough for installers to monetise long-term consumer contracts by refinancing them in the capital markets.
Mr Sheren is putting together a white paper on the topic with ratings agency S&P Global, law compoaWhite & Case, Skandinaviska Enskilda Banken and Och-Ziff Capital Management Group. He expects it to be endorsed by the G-20 presidency by the end of the month. S&P is developing a ratings methodology for the programme. The partners are also discussing what kind of regulatory environment could push this new market.
“Ideally, we’ll see favourable treatment of sustainable securitisations under existing regulatory capital and liquidity rules and li for example,” says Chris McGarry, a partner at White & Case.
“That could involve treating sustainable securitisations like sovereign paper for central bank repo purposes, holding back parts of Solvency II, as well as potentially seeing the emergence of new regulatory incentives to support this new market such as a green supporting factor or a brown penalising factor being applied to the underlying sustainable loans.”
This would not be the first time that financial engineering has been employed to try to raise money for environmentalism. Green bonds are one example, with issuance rising to a record of $171bn last year. Although it’s growing quickly, it still makes up less than 1 per cent of the global bond market.
“A large proportion of sustainable debt is written in the form of loans, so to underwrite at pace and scale, the banks will need off take investors, and asset-backed securities are a way to repackage these loans in a format acceptable to institutional investors,” Mr Sheren says.
We’ll see favourable treatment of sustainable securitisations under existing regulatory capital and liquidity rules CHRIS McGARRY White & Chase
The Rhone Glacier near Gletsch in Switzerland. The G-20 team hopes the new financial product could be a significant contributor to a lower-carbon economy