The green asset-backed securities (ABS) market is evolving and growing rapidly. It sparks the imagination of those working in finance, and it's helping restore the reputation of the wider ABS market.
Representatives from Clifford Chance, TMF Group and the Ygrene Energy Fund came together recently to discuss the status of green ABS during a live webinar hosted by Structured Credit Investor. The recording, along with a joint report titled "Impact Investing and green ABS", can be downloaded from our dedicated green securitisation webpage, which provides a useful introduction to this exciting asset class.
A maturing market moving into the mainstream
Green Bonds have just celebrated their 10th birthday. The first green bond was issued back in 2007 by the European Investment Bank (EIB). It was called the Climate Awareness Bond and it financed renewable energy and energy efficiency projects.
The market now boasts over US$200bn in outstanding bonds. Barclays launched the first green bond (€500m) from a UK bank using UK assets at the end of 2017 - a further sign of the growth in climate-related debt issuance. In the US, solar ABS and Property Assessed Clean Energy (PACE) bonds, which allow property owners to finance environmentally-friendly upgrades, have grown significantly in terms of issuance.
We anticipate that green bonds and securitisation will become a trillion-euro market by 2020. Here are three key trends and developments, touched on during the webinar, that will facilitate this growth.
Europe is going green
Commercial PACE bonds are capturing the imagination in the US, but markets in Europe are developing as well. The question is what needs to happen to develop them further?
Solar securitisation seems established in the US, for example, but not yet in Europe. Ticket sizes are small, typically with terms of 15-20 years. The originator, or seller, of the panels is often also the servicer, responsible for the more technical reporting and maintenance of the panels.
We might have a monetary union in Europe, but we do not have a fiscal union. That makes things more difficult. The EU needs to invest €100bn per year in building renovations just to meet energy and climate goals. On one hand this can result in green mortgages, but it can also offer separate financings for energy efficiency improvements, which can be bundled and securitised like PACE bonds. These transactions would need to sit within the simple, transparent and standardised (STS) framework.
The European Parliament and Commission should actively support green ABS and PACE issuance, and even green collateral loan obligations (CLOs), by reducing risk retention for qualifying transactions. CLOs are excluded from STS, but static or green CLOs should be able to apply for STS treatment.
The standardisation of technology and agreements can pave the way for pooling bundles of loans or leases and securitising them as ABS/CLOs. There is also a potential use case for blockchain technology, with Smart Contracts one way of verifying and then scaling green securitisation.
Harmonisation will give a further boost to green securitisation
We need more universal clarity on what qualifies as 'green', as we have seen some bond issuers using the green label simply for PR purposes - this is called 'green-washing'.
The industry needs a unified set of rules to follow when it comes to determining how green a green bond and securitisation (or the project financed by the bond) really is. This requires the harmonisation of existing guidelines and regulations within and between regions, for example between Europe and China.
There are a number of competing, voluntary standards, but investors want independent certification. China's entry into the market with their own standards has not necessarily helped the matter. We have seen Chinese bonds linked to the coal industry classified as green, which is hard to understand. But an encouraging sign is that the EIB and the Green Finance Committee (GFC) of the China Society for Finance and Banking are working together.
There are also usable standards at the asset level, such as energy performance certificates (EPCs) for properties, or emission information for cars. The 2017 Green Storm deal, for example, had a third party to verify the EPC. The originator gave certain representations that the properties involved had a certain EPC. There were set repercussions if it turned out that it was inaccurate; there was an obligation to buy back assets.
Agreeing common definitions and standards is undoubtedly a challenge, but it will evolve as technology advances.
Driving forward with green auto ABS
An ABS can either have green underlying collateral, or it can have non-green collateral but use the proceeds to invest in green technologies.
Auto ABS stands out as a source of green collateral deals. It's an area that has been receiving more attention since Citi underwrote the auto industry's first-ever green bond in 2014.
Many jurisdictions have already committed to moving away from petrol or conventional cars and transportation in the next couple of decades, so we should see auto move further into the ABS space seamlessly.
There is a lot more flexibility for deals with non-green collateral where the proceeds are used for green technology or research. The main issue there is how you label those transactions as being green, because their scope is so wide. Structurally, those transactions should not look any different from existing securitisation deals; it is more about how you use the proceeds and monitoring this during the term of the transactions.
There are certainly issues to resolve, but the industry is working together to realise a bright future for green securitisation. TMF Group have been involved with green securitisation since the sector was established, so you can talk to us to find out more.
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