While sustainability has become an established focus for the financial industry, the development of the EU sustainable securitisation market is still in its early stages, although it faces increasing demand from institutional investors. With no regulation or framework defining what “green securitisation” is or can be, advocates are looking at international practices and evaluating how European financial legislation can be adapted.
Developments in this area were the subject of a panel discussion moderated by Cathrine Foldberg Møller, a partner at the Simmons & Simmons law firm at Luxembourg Capital Markets Day, a 21 June event organised by LuxCMA, which represents Luxembourg’s primary capital markets industry.
Laetitia Hamon, the Luxembourg Stock Exchange’s head of sustainable finance, presented three different approaches to green securitisation. One requires that the collateral used in the transaction leading to issuing a securitisation bond be 100 percent green. A second approach focuses on the “use of proceeds” of the transaction, with green status requiring the proceeds to be used to finance new green assets.
A third approach is rare here, but common in China. To be considered a green securitisation, the company holding the assets at the outset, as the originator, would have to get most of its revenues from green activities.
China is flexible
Martin Vojtko, senior counsel at the European Investment Fund, or EIF, explained that China allows significant flexibility in green securitisations. While in Europe, 100 percent green is the standard, “in China, you can be 70 percent and that number can even significantly drop to 30 percent” in certain situations, he explained. The United States, unsurprisingly has so far taken a market-based approach, with the US residential mortgage-backed security standard being set by Freddie Mac and Fannie Mae, two federally-backed home mortgage companies.
In Europe, green securitisation advocates are keen to develop a EU green bond standard, which may partially integrate aspects of bond securitisation. According to Hamon, “it remains very focused on the green use of proceeds and the … issuer being a proper corporate entity.”
The absence of a proper framework is reflected in the general state of the green securitisation market. Miguel Solana, co-founder and managing partner at financial technology platform Alter5, mentioned securitisations in the areas of energy efficient mortgages, electric vehicles and solar and wind generation project finance. However, according to recent EBA data, only 2 percent of total ESG bond issuance was securitised, representing 6 percent of overall securitisation. This however has translated into only 13 transactions.
Limited attractiveness
Its development is overshadowed by the limited attractiveness of securitisation products in general. Following the Great Financial Crisis, the EU securitisation market has faced reduced annual issuance, with 2020 seeing the lowest since 2013. Most available green mortgages are used to issue green covered bonds, while green securitisation lags behind the longer-established EU sustainable covered bond. Also, the complexity of securitisation products and of EU securitisation regulation has limited investor interest.
Solana explained that the current level of development in green securitisation goes along with how much “less developed capital markets are in comparison to the US.” He added that this “affects the type of product that the sponsors of these projects receive and the capabilities of institutional investors to enter the market.”
Insufficient bank capital
The panellists agreed that green securitisation will play a key role in the green transition. Solana explained that “there are not sufficient bank capital facilities” and that securitisation will have to make up the difference. He added that “not all bank financing responds to the sponsors’ needs, in particular SMEs and smaller developers.” Hamon, for her part, said “we need more money to finance climate change, for example, and the big challenges of these days, and banks cannot finance that alone . They need capital markets, so it’s good that there are those possibilities of securitisation.”
One major issue holding back green securitisation is the “lack of assets” upon which to develop securitisation products. Solana mentioned the significant delay in permitting affecting many European renewable energy projects. He also mentioned the supply chain crisis. Vojtko mentioned the still small take-up of electric and plug-in hybrid cars – amounting to 1.2 percent, he said.
Classification scheme
The panel discussed a recent European Banking Authority report (see attached) on sustainable securitisation which included a possible way to classify them, with “light green” being green collateral only, medium green allowing mixed green and brown collateral and use of proceeds, with the thresholds not yet defined. The dark green approach requires that both collateral and use of proceeds be 100 percent green. The panellists agreed that this scheme would be very complex and likely put off investors.
The EBA report recommended against developing a dedicated framework for aspects for green securitisation that isn’t covered by the EU green bond standard given the low level of market development.