Building a climate-neutral, green, fair and social Europe is one of the four main priorities set out by the European Council in its strategic agenda for 2019-2024 (the EC Agenda). According to the EC Agenda, the success of the green transition "will depend on significant mobilisation of private and public investments, on having an effective circular economy, and an integrated, interconnected and properly functioning European energy market".
The main green initiatives in Europe
Both stakeholder associations and the European Union have introduced various initiatives to facilitate the green transition in the financial markets.
- the market conventions adopted over time aimed at enabling access to debt capital markets in order to fund projects with a positive environmental impact (Green Projects). The main market convention is the Green Bond Principles adopted by the International Capital Markets Association (ICMA) and built on best market practices (GBP);
- the nomination by the European Commission of a technical expert group on sustainable finance (TEG) to assist it in developing, inter alia, an EU classification system (EU taxonomy) to determine whether particular economic activity is environmentally sustainable, and an EU Green Bond Standard (EU GBS)1; and
- the publication on December 11 2019 by the European Commission of the European Green Deal (EGD) which aims for the EU to become the first climate-neutral bloc in the world by 20502. In order to achieve this, the European Commission envisages, inter alia, the implementation of the Sustainable Europe Investment Plan (SEIP) 3 which will mobilise at least €1 trillion in sustainable investments over the next decade in Europe4.
The Securitization market
As regards securitizations, in January 2019 the new regulatory framework for securitizations in the EU5 came into force (the Securitization Framework), setting common standards for all securitizations and defining criteria for "Simple, Transparent and Standardised" securitizations, thus confirming the European regulator's confidence in securitizations as a key tool for the growth and development of the European economy within the capital markets union.
The new Securitization Framework may have an important role6 in developing securitizations aimed at financing Green Projects (Green Securitizations) and convincing investors to invest in environmental projects to achieve the EU's green targets.
To date, however, the demand for asset backed securities issued within the context of Green Securitizations has not been developed at the same level as the growing market for green, social and sustainability bonds.
One of the main problems in developing the Green Securitization market seems to be the lack of incentives in establishing or investing in Green Securitizations (and green finance in general) and of an agreed definition of Green Securitization.
Types of Green Securitizations
There are three main types of Green Securitizations that can be identified in the market.
The first type of Green Securitizations is securitizations with "green" collateral, i.e. where the asset backed securities are backed by portfolios of green assets (e.g. mortgages to finance energy‑efficient homes, electric vehicle loans/leases, solar leases and SME loans to fund environmental projects, etc.).
The second type is securitizations with "green" use of proceeds, i.e. where the proceeds of the asset backed securities are used for investment in Green Projects.
The third type is securitizations where the originator uses freed-up capital or leverage from a capital relief or synthetic securitisation to invest in "green" projects.
The second and third types of Green Securitizations are more similar to ordinary green bonds as the main requirement is that the proceeds or capital relief are utilised for green purposes, meaning that the securitised portfolio can be composed of non-green assets.
Developing a Green Securitizations market: the AFME Position Paper
With the aim of outlining the key factors needed to boost the development of a Green Securitizations market, on September 11 2019 the Association for Financial Markets in Europe (AFME) published a position paper on Green Securitizations (AFME Paper) which sets out the following observations below.
Definition of Green Securitization
The GBP defines a "Green Securitised Bond" as "a bond collateralised by one or more specific Green Projects, including but not limited to covered bonds, ABS, MBS, and other structures; and aligned with the GBP. The first source of repayment is generally the cash flows of the assets".
The GBP definition of "Green Securitised Bond" needs certain refinements to reflect, inter alia, the limited recourse nature of securitizations and the differences between covered bonds and securitizations. Moreover, as some green investors may have flexibility but many will only have a mandate to invest in securitizations collateralised exclusively by green assets, the definition of "Green Securitization" should exclusively refer to transactions collateralised by green assets, thus excluding securitizations where the proceeds of the securitization are applied towards, or regulatory capital or liquidity relief achieved is allocated to, Green Projects and the underlying collateral is not green7.
The GBP requirements relating to the Green Projects selection and the use of proceeds would be satisfied in Green Securitizations by applying the proceeds arising from the issue of the asset backed securities to purchase portfolios of assets that comply with the relevant eligibility criteria meeting the requirements set out under the applicable green principles/framework8.
The introduction of tax incentives, a preferential regulatory framework and other initiatives9 will be fundamental to support the development of the Green Securitization market. For example, the introduction of improved regulatory capital treatment for green asset backed securities or tax incentives (to be introduced at national level) for investing in Green Securitizations could help promote Green Securitizations to all investor categories, not only to those with a green mandate.
Disclosure and reporting
With respect to green bond transactions, under GBP and the TEG report on EU GBS, monitoring and reporting on the compliance with the relevant green requirements are key elements to ensuring the development of the green bond market. However, since the Securitization Framework already sets out high disclosure requirements for securitizations10, AFME does not consider it necessary to introduce specific additional monitoring and reporting obligations for Green Securitizations 11.
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1 On June 18 2019, the TEG published its report on EU GBS. The TEG proposes that the European Commission creates a voluntary, non-legislative EU GBS to enhance the effectiveness, transparency, comparability and credibility of the green bond market and to encourage the market participants to issue and invest in EU green bonds.
3 In this respect, please see the European Commission's communication on the SEIP https://ec.europa.eu/commission/presscorner/detail/en/fs_20_48.
4 In particular, the SEIP pursues three main objectives: (i) increase funding for the green transition - mobilise at least €1 trillion to support sustainable investments over the next decade through the EU budget and associated instruments (in particular through InvestEU); (ii) create an enabling framework for private investors and the public sector to facilitate sustainable investments; and (iii) provide support to public administrations and project promoters in identifying, structuring and executing sustainable projects.
5 Regulation (EU) 2017/2402 of the European Parliament and of the Council of December 12 2017.
6 The new Securitisation Framework already introduces a light attention to green securitisation. According to paragraph 4 of Article 22 (Requirements relating to transparency) of Regulation (EU) 2017/2402, if the securitisation's underlying exposures are residential loans, auto loans or leases, the originator/sponsor shall publish the available information on the environmental performance of the assets financed by such loans or leases.
7 In any case, according to AFME, a securitisation transaction with non-green underlying collateral where the proceeds are invested in, or regulatory or liquidity capital relief allocated to, Green Projects, could qualify as a green bond under the GBP.
8 E.g. the eligibility criteria on a green RMBS transaction would typically include the minimum requirements relating to Energy Performance Certification (EPC) and on an auto loan transaction the minimum requirements relating to emissions standards.
9 According to the AFME Paper, other potential incentives could include:
(i) reduced hair-cuts for central bank eligibility schemes;
(ii) bespoke LCR limits;
(iii) ongoing governmental and regulatory support by way of guarantees and the related regulatory benefit; and
(iv) subsidies for establishing new Green Projects.
10 E.g. information related to environmental performance of "residential loans or auto loans or leases".
11 The repercussions of any breach of a green asset warranty would be limited to the usual repurchase obligations of an originator and the ongoing reporting would be no different from that of a standard securitisation transaction.
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