Sustainability & Securitised Product

Sustainability and Securitised Product

There’s not enough of it.

The latent demand for ‘green bonds’ is exceptionally high yet markets globally just can’t get enough of it. The supply limitations may be short-lived and the potential for sustainable ‘product’ is generating excitement beyond traditional asset classes.

“There's a lot of money that's pouring into these types of mandates currently. I think everybody's sensing that there is an opportunity there and the sponsors of the transactions that come to market through the supply pipe are no different. If there's a way that they can label something as being 'green', or being ESG, or being ESG criteria, they will be happy to do it but investors have to kind of make up their own mind as to whether or not they agree.”

- Global Investor

Supply

The practical barriers to supply of ‘green pools’ are easy to see. New sustainable houses and electric vehicles are not plentiful. The difficulty in knowing what is likely to be accepted as a truly sustainable asset may also inhibit issuers in the short term.

A key issue for investors and issuers is the need to validate the ‘green’ credentials of an asset. What exactly can be considered a green asset or a sustainable asset? What criteria needs to be satisfied? Who makes the judgement? With no accepted industry standard, issuers and investors need to rely on their own judgement and, for many assets, opinions differ about the characteristics that make an asset ‘green’.

“What you want is something that's much more rigorous than what we have today. In the future you really want to be able to compare one green bond against another in terms of its performance. At the moment, the problem with green bonds is that a lot of investors are pretty much in the dark.”

- Service Provider

Most believe availability of green assets will increase significantly and the growth in the sector will be sustained and ultimately replace unsustainable investments.

“You only have to look at what the historical level of increase green assets has been over the last five years, it’s only going in one direction. As the economy rotates into more of a green economy you won’t have this distinction between what is a green loan and what is not.”

- Global Investor Similarly, as green-based pools are new, there is no history of performance (although participants cite examples of positive outcomes). This creates uncertainty in relation to pricing, and the expectations of investors and issuers may be poles apart.

'I don't think the Australian market has got to a point where ESG is being rewarded by better pricing. It’s funny, you know, a fund manager will sit there and say, ‘I want an ESG focus’ or ‘I want to be able to tell my investors that we have got a sustainability twist’, but I don't want to give up on pricing. So, until the investing market values, truly values, ESG in terms of improved pricing, it's going to be hard for the market to be drawn to it.

- Service Provider

There is also the difficulty of considering factors that go beyond the asset itself. With the backdrop of their own clients’ expectations, investors are just as interested in the sustainability and corporate practices of the issuer (or originator) as they are in the asset itself. No matter how green a pool, investors are likely to forgo the opportunity to invest in a pool that is offered by an issuer that their end clients would prefer they reject.

“At the moment, it looks like the overwhelming majority of securitisations are just kind of neutral and that's because the thinking hasn't gotten as sophisticated quite yet- because there isn't general agreement on the level of detail at which I should be determining the suitability. Is it at the SPV level, is at a particular level, is it sponsor level, what level is it?”

- Global Investor

Equally there are some investors who thrive on uncertainty and back their own ability to price effectively for risk through their rigorous process and a unique perspective on the weight various factors have in their models.

“The ability for you to make your own ESG assessment is actually fundamentally important in this transition, and where we all end up. There shouldn't be one standard. Ultimately, it comes down to how we assess it, how do we actually implement that from a portfolio construction perspective, and how it’s measured in our net performance at the end of the day? From a volatility risk adjusted returns perspective, if we are really bad at it, we're not going to be producing really good numbers because the volatility in our portfolio is going to be really, really high.”

- Local Investor

Securitised pools

‘Green’ is an easy label for sustainable investments in securitisation because people often think of it from an environmental lens.

In reality, issuers and investors are equally interested in bonds with a social emphasis. Lending to disadvantaged or community groups and particularly to people who struggle to access credit from banks is a key focus for many issuers. Several point out they’ve been doing this for a long time. On the ‘green’ side there is a tendency to focus on sustainable housing, but there is equally a view that the inputs to sustainable housing such as solar panels and batteries are ripe for securitisation. Both ABS and CMBS also have potential for delivering green pools. Some go as far as to claim almost everything is up for grabs.

“Every asset class lends itself to securitisation, excluding coal”

- Global Investor

RMBS

Despite the dominance of RMBS in the Australian securitisation market, the limited number of new homes built in Australia each year (a few participants claimed about 60,000), mean RMBS doesn’t have quite the same dominance when it comes to sustainable investment. These are also spread across a wide range of originators and issuers, making it difficult to form exclusively ‘green’ pools. And not all new homes are equal. While local councils encourage sustainable practices, these are adopted to varying degrees as there is a cost-to-build trade-off to be considered as well.

“The proportion of home loans that are consistent with a trajectory to net zero would probably be 5%.”

- Local Investor

Issuers are responding by including 'green' tranches in their pools and taking into account refinance when it intends to upgrade the sustainability of a home. There are differences of opinion about whether pools should be exclusively 'green' or not.

“The industry is probably better off doing really strong ring fencing of 'green' assets and other ESG as opposed to say, well, around about half this pool is 'green' and therefore around about half the notes that we issue can also be 'green'.”

- Local Investor

And said in another way…

“My late father used to say, life's too short to drink blended whiskey, son! I think life is too short to buy a 'green' asset that is backed by not entirely 'green' loans.”

- Local Investor

Others feel securitisation is an ideal vehicle for transitioning to greener investments. They feel this is realistic given the limited supply of loans that can reasonably be considered 'green'.

“We’ve been able to include structural features, such as revolving aspects, and that allows us to initially fund with light 'green', and then substitute out for dark 'green' whilst we build our dark 'green' program.”

- Non Bank Issuer

ABS and Innovation

The thing getting the market excited about sustainability is the raw potential for new and emerging asset classes. When asked about sustainable assets in ABS many pointed to electric vehicles (EV) as the obvious place to start. Realistically they noted there would need to be a much stronger incentive to encourage the Australian population to adopt EVs in the short term.

In fact, the public is likely to need to see the value of EVs before the sector takes off. “Would I pay a premium for a smaller electric car? Yes. Is that premium, you know, double? I think the answer is no.”

- Local Bank

Nevertheless, there is a quiet excitement in the market about innovation in sustainability-related assets. Energy-related assets, in particular, are capturing attention.

“On the commercial side, for example, I remember hearing about people who were doing efficiency installations where, in a commercial building or a car park, they replace all the lights with energy efficient lights.”

- Global Bank

“In 'green' energy financing, it doesn't need to be a Buy Now Pay Later type product, but any sort of financing arrangement that is specifically tied to 'green' energy. I think there's opportunity there as batteries evolve and there's still a huge opportunity in terms of solar financing. While there's pockets of concentration in terms of panels and take-up of that stuff, there's still obviously a huge way to go in terms of a real push towards more 'green' energy across the country.”

- Non Bank Issuer “If you think about all the sorts of kits that can be financed, both in big business and in the homes as well, I think there's a lot of opportunity there. I think for nimble FinTechs that can see those opportunities and sort of prosecute them, there’s lots of opportunity.”

- Non Bank Issuer

The borrower is very much in mind when issuers think about sustainability no matter what the asset. Whether it’s providing access to credit to people who have traditionally not been able to access it, affordable housing for those in lower socio-economic classes, responsible lending practices or lending to specific communities, this focus on the borrower demonstrates a combination of social conscience and innovation that ensures needs can be met in a sustainable way.

“There's definitely a dislocation in terms of access to finance for certain parts of society. I think that First Nations people struggle to get business finance up and running. I think that there's a certain amount of government support but it tends to be programmatic. I'm not sure how well developed it is, but I think that there's probably a role there for securitisation.”

- Local Investor

“It's about positioning yourself as a responsible lender. There're benefits there both from origination to consumers as well as to your institutional investors and if they choose your program over the next program.”

- Non Bank Issuer

“Are you lending across the spectrum of communities within wherever that portfolio has originated? Are you originating to all communities? That includes high income, low income. Is your product something that impacts the consumer in a positive way? Was that loan something that helps build capital, helps somebody through a difficult time? Was it a responsible loan?”

- Service Provider

The potential for the securitisation industry to use its strength to achieve sustainable outcomes is best summed up in this statement from a local investor. “Securitisation, as a tool or a device, is uniquely placed to further society’s increased appetite for environmentally sustainable parties. I think the ability to ring-fence assets, to be able to follow the dotted line from money going out the door to achieve some outcome through to an investor - I think that is a strength of securitisation. I actually think it's got something to add to society as a whole in terms of sustainability.”

- Local Investor

Greenwashing

While ‘greenwashing’ is not a term that instantly strikes fear into the hearts and minds of securitisation industry participants, it does put people on the alert. How can one tell if a pool is truly 'green'? A lack of industry standards or guidelines and a vast array of often disparate factors used to define an asset’s status, together with an emerging market focus and desire to dive into the ‘sector’ can make it difficult to know just how 'green' a pool really is. There is no shortage of demand for 'green' assets but when there is doubt, 'green' turns to grey. “Even if you issue according to the Green Bond Principles of the ICMA there's a bit of suspicion about the compliance aspect of the 'green' bond that they sell investors. The 'green' bond market still has a lot of evolving to do, but I do think it's got a massive future.”

- Service Provider

“There's no accreditation, there's no global standard. That's coming though as all these investors are waking up.”

- Global Investor

“What troubles us is when people say this is quite 'green'. You look at it and go, actually, that's not terribly 'green'. So provided everybody knows, it's fine, but you get all these people saying, yeah, we're the leader in ESG investment approaches and you drill down on it, and all they're doing is that they're not funding cluster munitions, tobacco or child exploitation, and that's it.”

- Local Investor

There is an underlying belief amongst participants that these issues will eventually come out in the wash. That is, measurement will improve, a common understanding or framework will emerge and that anyone guilty of greenwashing will be ignored by investors.

In the meantime, the industry is going through a transition period where there are valid uncertainties to be considered. Some might arise from differences in opinion; in other cases, issuers will test the water or accept the criteria that may not be acceptable in the future.

“In some cases it will be what you might call “good faith green-washing”. People will be trying to catch up and trying to build the proper framework and in a sense, they'll be desperately trying to make it but also trying to fake it until they can make it, so it's going to be iterative.”

- Non Bank Issuer “I think our industry is very well governed, and I think it is actually so full of responsible, smart people. If I had to make a comment at all here, I'd probably be a little bit critical of the light 'green' style bonds, because I don't believe that those originators have gone out specifically to target or encourage that type of origination, and they're just picking through their pools and saying this will do, let's put those in. I'm not sure if that's necessarily satisfying any objectives in climate change. That's more an issuance of convenience as opposed to a true 'green' bond.”

- Non Bank Issuer “I think it's the vibe. It's what everybody wants to do because it makes them feel good at the moment, because they haven't got any alternative. The ultimate outcome still needs to be measured and this is where I believe that there's going to be a reckoning to pay because, once somebody goes in and starts to audit every dollar that was borrowed on a 'green' basis, where did it actually go? It's going to be really hard to explain.”

- Local Investor