The Intersection of Securitization and Sustainability in Global Finance

In today’s global finance landscape, the convergence of securitization and sustainability has become a critical focus. The financial industry is increasingly addressing the challenges of environmental, social, and governance (ESG) considerations, highlighting the intricate relationship between securitization structures and sustainable practices. This dynamic interplay, particularly between synthetic and true sale securitization methods, significantly influences sustainable finance.

Understanding Securitization in Sustainable Finance

Securitization transforms illiquid assets into marketable securities, aiding capital allocation and risk management. The contrast between synthetic and true sale securitization methods adds depth to sustainability discussions. Synthetic securitization uses derivatives to transfer risk without transferring assets, whereas true sale securitization involves an actual transfer of assets. This distinction raises important questions about each method’s alignment with sustainable finance goals.

Examining Environmental and Social Implications

This article explores the relationship between securitization and sustainability, analyzing the environmental and social impacts of each approach. As financial markets increasingly integrate ESG factors into decision-making, understanding how securitization structures affect sustainability is crucial for investors and financial institutions.

EU Taxonomy Regulation and Sustainable Securitization

Despite the EU Taxonomy Regulation’s lack of a strict definition of “environmentally sustainable” for specific economic activities, three key factors typically evaluate a securitization transaction’s sustainability:

Positive impact of collaterals on ESG aspects.
Commitment of transaction proceeds to ESG-related assets.
Achievement of ESG-related KPIs by transaction counterparties.

These factors help map the EU sustainable securitization market’s size and composition. In 2021, sustainable securitization accounted for only 6% of total EU securitization issuance, smaller than the American and Chinese markets. The European Banking Authority (EBA) identified the lack of a uniform sustainable securitization definition and a scarcity of sustainable assets as major market impediments.

Advancing the Sustainable Securitization Market

Overcoming these obstacles could foster a liquid market for sustainable securitization in Europe, benefiting investors, corporations, and financial intermediaries. This market would increase funds and investment in sustainable projects and boost the volume of sustainable loans. The EBA emphasizes the need for an applicable framework for sustainable securitization. While it’s premature to establish dedicated frameworks for true sale and synthetic securitizations, the EBA plans to extend the EU Green Bond Standard to true sale transactions and is cautious about regulating synthetic processes until further market trends are reviewed.

Case Study: Sun King and Citi’s Sustainable Securitization

In May 2023, Sun King and Citi closed a $130 million sustainable securitization deal to enhance off-grid solar finance in Kenya. This transaction, arranged by Citi with Standard Bank Group as the co-placement agent, supports Sun King’s off-grid solar energy sector over four years. The securitization pools future payments from over a million Sun King customers, allowing investors to finance solar purchases and connect unbanked or underbanked customers with affordable solar energy.

Sun King’s pay-as-you-go service, facilitated through “Easy Buy” financing, enables affordable installment payments, addressing the issue of three out of ten Kenyans lacking electricity access. The initiative involves participation from commercial and development finance institutions, including Citi, Absa Bank Kenya PLC, and British International Investment. Sun King’s Sustainable Financing Framework aligns with the United Nations’ Sustainable Development Goals and received a Very Good Sustainable Quality Score from Moody’s.

Conclusion: A Pivotal Juncture for Sustainable Finance

The intersection of securitization and sustainability represents a pivotal point in finance, where profit aligns with environmental and social responsibility. The global shift towards sustainable practices compels financial institutions to reassess investment strategies, with securitization emerging as a key tool for fostering a responsible financial ecosystem.

Integration of ESG Factors into Credit Ratings

Since the inception of ESG ratings in 2006, initially driven by activist investors, these ratings have evolved from voluntary firm adaptations to essential components of financial success. Climate change and social responsibility are now critical issues, necessitating that credit ratings account for sustainability.

Challenges in the Green Bond Market

Despite noble intentions, green bonds and sustainable investments still face maturity challenges. The lack of standardized criteria and transparency in defining “green” can lead to “greenwashing,” where bonds are marketed as sustainable without rigorous adherence to environmental standards. This issue complicates investors’ ability to assess the actual impact of green bonds on climate goals. Furthermore, the green bond market’s relatively small size limits its capacity to fund substantial climate initiatives. Addressing these challenges is crucial to ensure green bonds effectively promote meaningful environmental impact while maintaining investor confidence in their sustainability credentials.

Authors: Tommaso Pasqualucci, Elisabetta Filippini, Leonardo Breedveld, Carlo Del Vescovo.