Green securitisations could be one of the most effective potential means to harness small scale developments like green mortgages, residential rooftop solar energy and small SME loans for energy storage projects. The aggregation of smaller-scale projects could generate an attractive structure and size for institutional investors, mobilising finance that would otherwise not be available for sustainable purposes. Such aggregation would benefit from the development of a securitisation mechanism for green loans.
The European Green Loan Securitisation Framework could be a powerful tool and act as a multiplier to fund sustainable assets as well as the transition efforts to increase sustainability further. However, the recently revised securitisation framework is not sufficiently attractive to issuers or investors and is unlikely to incentivise securitisation. It needs to be reviewed to encourage financing of sustainable assets and its subsequent refinancing through securitisation.
Further review of the securitisation framework in Europe should, therefore, be anticipated as a priority in future legislation. In order to do that, a regulatory mistrust towards securitisation has to be overcome first. A true political will to develop capital markets by eliminating all the existing barriers is a first necessary precondition for any further progress. Only then can any technical solutions (also “green and sustainable”) be envisaged.
The Simple, Transparent and Standard (STS) Securitisation Regulation, which entered into force in January 2019, aims at creating a label that will give investors more assurance regarding quality. However, the STS Regulation will not help re-launch the securitisation market in Europe. It introduces so many regulatory and operational constraints that it is more likely to disincentivise securitisation issuances further. Issuing an STS securitisation is extremely demanding and operationally constraining. It requires meeting more than 100 criteria with very limited benefits in terms of cost and capital.
In addition, current capital requirements for transactions meeting the “best in class” STS criteria remain significantly higher than those for other high-quality fixed-income investments: if a bank holds a securitised product on its balance sheet, it is extremely punitive to its regulatory Liquidity Coverage Ratio. STS is qualified as HQLA Level 2b, with a haircut of 25% (residential loans, fully guaranteed residential loans, auto loans) or 35% (loans to SMEs, other consumer loans etc.).
Potential of the securitisation in promoting sustainable finance
The volume of loans for sustainable finance will increase and represent a potential for the development of the European securitisation market for green loans, provided that the current regulatory constraints on the use of the STS label are addressed.
Now that the STS regulation is in force, the application of this label should be reviewed and further developed, building on the substantial potential of securitisation in promoting sustainable finance.
Different technical solutions could be envisaged. The development of sustainable finance could be facilitated by the setting up of a European Securitisation Mechanism for Green Loans with an additional Green European modified STS label, in a similar way to the Green Bond label, and a possible guarantee of a recognised public body, for example, the European Investment Bank.
The great advantage of such an initiative would be to allow both the development of a market financing solution, targeted by the Capital Market Union and the support of sustainable finance.
The additional green STS-improved securitisation label would attract investment funds targeting green investments. The public organisation guaranteeing the securitisation could also play a role in certifying that the green securitisation criteria are met. Alternatively, an accreditation regime for external reviewers could be envisaged in the way that it is for the EU Green Bond Standard.
Preferential prudential treatment to support the development of green securitisation market
The merits of securitising a “sustainable” underlying pool should be recognised after the (reviewed) eligibility criteria for obtaining the STS label have been fulfilled. For the qualifying sustainable securitisation, the preferential prudential treatment should be further improved compared to the simple STS label.
We are suggesting adapting the securitisation framework, notably by:
- allowing prudential deconsolidation and capital relief for the originating bank (for both synthetic and cash securitisations), on the basis of reviewed criteria to assess the Significant Risk Transfer;
- removing current disincentives in the regulatory treatment for investors (for instance in the liquidity framework and in Solvency 2).
The improvement of the current securitisation framework will enable banks to securitise a pool of green loans, in order to free up the capital to be used for new green loans’ financing. The proposed European securitisation mechanism for green loans would benefit from an increasing underlying volume of assets in banking balance sheets. This increase should be regarded as a common objective of banks, legislators, regulators and supervisors.