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 National - News - - BUSINESS MONEY&MARKETS -

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

AFP

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

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