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Green Securitisations - Work Needed

12 April 2017
Richard Kemmish

t is natural that the country that invented covered bonds and that is so enthusiastic about environmental matters should sooner or later try to combine the two interests. So far we have seen a few, pioneering Gruener-Pfandbrief from issuers such as Berlin Hyp who are to be congratulated on successful bonds opening the debate.

But whilst safe-as-houses, full recourse covered bonds are one way to get money into the green sector they can only ever be part of the picture, German investors may have to reconsider their relationship with their less popular secured debt instrument – securitisations.

But what are those limits on green covered bonds?

The most obvious is also the most temporary. The green bond market has so far been driven by investors with an ethical aspect to their investment decision giving asset managers explicit ‘green’ mandates. That is, they are ‘real money’ investors who need yield. Unfortunately (for the investors, fortunately for the issuers) most pfandbrief nowadays have a negative yield which more or less rules out real money accounts and forces issuers to focus on technical investors such as bank treasuries. For investors who, for example, need liquidity assets or collateral, negative pfandbrief yields are still attractive relative to even more negative bund yields. I might be wrong but I am not aware of any collateral pledge agreements that require bonds to be green.

Of course one day this will change and yields will go positive again. Even then though the yields on covered bonds aren’t likely to be the sort of yields that get retail investors excited. Unless there are some regulatory reasons introduced for investors to prefer green bonds (such as a lower risk weighting?) the total demand will remain limited.

Part of the reason for the problem that green covered bonds face is the very strength of covered bonds: credit. By its nature a covered bond – green or otherwise - is a full recourse instrument of the issuing bank. The green and the regular pfandbrief must be pari passu with one another under German law, therefore green mortgages will be used to pay off non-green covered bonds and visa versa.

Green covered bonds need a complimentary product: green securitisations.

It seems to me that a green bond should ideally have an attractive enough yield to appeal to real money investors and, ideally, allow fund managers to argue that investing in the green bond is not in breach of their fiscal duty to optimise the risk-return pay-off. A green bond should also facilitate investments that would not otherwise occur and should properly align return and the risks.

How best to achieve this? Equities are the obvious instruments that meet those criteria. But they do run the risk of diluting the incentive for the instigator of the green project and, at least in countries and investor classes with traditional risk aversion they might be a step too far.

It seems to me that there is a huge ‘risk transfer’ role for green securitisations – no recourse to the ‘issuer’ but a risk based participation in the upside of the project – possibly in tandem with green covered bonds. By allowing investors to go down the credit spectrum they allow real equity investors to leverage capital more effectively.

Sadly, the ‘STS securitisation directive’ appears to be going in the opposite direction – Commission seems to think that securitisations should have less leverage (more risk retention) and are best suited to more standardised and granular products. I disagree.

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