Security That Triggered a Recession Reworked to Green the Earth

(Bloomberg) -- 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 securitize bank loans for sustainable infrastructure, creating a new way to attract private sector funds for projects that aims to rein in global warming. If it works, they say that 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," said Michael Sheren, co-chair of the G-20 Sustainable Finance Study Group. “By doing this, sustainable investments can be ramped up at pace and scale."

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’s 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 securitized bad loans, particularly mortgages in the U.S., 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, 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 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 pact 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 percent higher than the $1.8 trillion 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 $100 trillion.

“The $100 trillion -- who has that money? If you have to mobilize it and for long term, the best tool is institutional investors,” said Vikram Widge, global head of climate finance and policy at the International Finance Corp. “The huge pool of global savings, we can’t do this without it.”

Green Investment

That’s 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 onto project finance loans until they mature, which can often be at least 15 years for infrastructure such as solar and wind farms. The long tenors and space they take up on balance sheets can limit the number of projects they’re able to finance.

“If the economics stack up, having a ready market for these loans would certainly increase the banks’ appetite to underwrite,” said Lisa McDermott, executive director of project finance at ABN Amro NV.

In the U.S., securitization has already become a go-to funding source for rooftop-solar companies including Tesla Inc. and Vivint Solar Inc. More than $1.3 billion in solar asset-backed securities was raised last year alone, demonstrating that the U.S. residential solar industry became large enough for installers to monetize long-term consumer contracts by refinancing them in the capital markets.

Sheren is currently putting together a white paper on the topic with ratings agency S&P Global, law firm White & Case LLP, Skandinaviska Enskilda Banken AB and Och-Ziff Capital Management Group LLC. 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 program. The partners are also discussing what kind of regulatory environment could be shaped to push this new market.

"Ideally, we’ll see favorable treatment of sustainable securitizations under existing regulatory capital and liquidity rules for example," said Chris McGarry, partner at White & Case. "That could involve treating sustainable securitizations 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 penalizing factor being applied to the underlying sustainable loans.”

This wouldn’t 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 $171 billion last year. Although it’s growing quickly, it still make up less than 1 percent 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,” Sheren said.

--With assistance from Lars Paulsson and Brian Eckhouse.

To contact the reporters on this story: Anna Hirtenstein in London at ahirtenstein@bloomberg.net;Sarah Husband in London at shusband@bloomberg.net

To contact the editor responsible for this story: Tom Freke at tfreke@bloomberg.net

©2018 Bloomberg L.P.