At its simplest, securitisation is the creation of an investment product – a security – by bundling a number of different assets together. These assets can have various degrees of risks associated with them and a range of expected rates of return. The theory behind the bundling is safety in numbers – the chances of all or a majority of the assets in the bundle underperforming is quite low. That’s the theory anyway, but the global financial crash showed that it doesn’t always work out in practice.
You can securitise just about anything that has the potential to produce income. The concept first came to wider public attention with the issuance of what became known as Bowie bonds in 1997. Rock star David Bowie partnered with Prudential Insurance Company to securitise the future royalties on his back catalogue of 25 albums and raised $55 million in the process.
In effect, investors got a share of the royalties generated by the albums for the lifetime of the bond – 10 years in that case.
The concept is now being applied to green investments. For example, electric vehicle loans of varying terms and interest rates can be securitised with the investors benefiting from the repayments made by the individual car owners. It can also be done with home-retrofitting loans or wind farm loans or even completed renewable energy developments or any mix of green assets.
One of the key advantages of securitisation is the way it can be used to broaden investor interest in assets that might otherwise be viewed as too small or risky on their own. “By bundling small loans or projects together as an investment product you can widen interest among investors,” explains Grit Young, M&A partner with EY Ireland.
Investors usually have selection criteria including size, expected rate of return and risk profile, she adds. Bundling lots of small products together can help meet those criteria.
Pool of investors
The risk profile of assets can also change over time, Young notes. “You can have projects at various different stages of their life cycle. The easiest to explain is a wind farm project. In one case, you might have a site but no planning permission which needs to be financed. In another case, you might have a site and planning permission, and in another you might have an operational wind farm which is generating revenue. Investors require different rates of return at different stages of a project as the risk decreases.”
“You can use securitisation to invest in smaller local projects,” Young continues. “You don’t necessarily have to invest in a massive offshore wind farm. You can invest in microgeneration and small wind farm projects. It opens those projects to a wider pool of investors.”
And those investors can be quite varied, according to Young. They include financial institutions seeking to fund green initiatives and fund managers with sub-funds specifically geared towards environmental, social and governance investing. “At the moment it’s mainly banks, private equity houses, insurance companies,” she adds.
Stephen McLoughlin, head of finance at the Maples Group in Dublin, sees green securitisation as a growth area. "Growth of green products and the green securitisation industry will continue, not only as a response to commercial forces, but also as a consequence of international governmental policy which has placed sustainable development goals at the centre of policy initiatives," he says.
Young agrees. “Green finance overall is growing at a massive speed,” she says. “It is growing exponentially and there are a number of reasons for that. A lot of government actions in future are expected to penalise polluting industry. Investors look at future cash flow versus risk and green investments typically had less cashflow and governments had to subsidise them. As governments start penalising polluting industries, cash flow is tilting in favour of green investments.”
Scramble to diversify
That will have an impact on financial institutions and investors who find themselves holding brown portfolios and who haven’t already priced in the risk-government penalties. “There is a bit of a scramble among all investors to diversify with a lot of competition for green assets.”
There is also growing demand from retail investors. “These products make people feel better and there is increased demand from investors generally to diversify,” says Young. “All of that is creating demand. The price of green assets is high at the moment. Getting a good yield from green investments is going to be harder.”
Early-stage assets will be cheaper than later-stage and that will make it easier to securitise those at the earlier stage.
But there are challenges to be overcome, according to McLoughlin. “Standardised criteria are required to allow the proper assessment and categorising of ‘green’ investment products and avoid companies giving a false impression of an investment’s green credentials – greenwashing. Time is also needed for the development of the green economy in order to generate sufficient volumes of green assets which can then form the basis of green securitisations.”
There is an opportunity for Ireland, however. “Over the last 30 years Ireland has become a leading jurisdiction for securitisation and other structured finance transactions,” says McLaughlin. “Given Ireland’s established infrastructure and regulatory regime together with its highly developed international financial service industry means Ireland is well-placed to build on its strong track record in the securitisation market and become a core jurisdiction for the future growth of the sector.”