The International Capital Market Association has provided fresh guidance on green securitisations, covered bonds and other secured structures in the appendices to its Green and Social Bond Principles, a move that may help to foster growth in a lagging area of the sustainable capital markets by providing greater clarity.
The new version of the widely respected guide distinguishes between “standard green use-of-proceeds” bonds, where the cash raised by selling unsecured green debt is ring-fenced for climate-friendly projects, and “secured green bonds”, which includes asset-backed securities, covered bonds or asset-backed commercial paper. The language is mirrored for social bonds in the Social Bond Principles.
The guidance provides some clarity in particular for potential issuers and structurers of green and social securitisations, which have been slower to catch on than other sustainable capital markets instruments. Securitisation bankers have put this down in part to a lack of suitable green collateral, so the ability to label a bond as green, even if the collateral it is secured on is not, may help spur more green ABS issuance.
The guidance opens the door to a two-track green and social ABS market in which bonds can be labelled either because they are secured on eligible projects and therefore qualify as “secured green collateral bonds”, or because the proceeds will be exclusively used to finance or refinance green projects that are not part of the collateral of the bonds themselves. ICMA categorises the latter as “secured green standard bonds”.
What's on the tin
In order to comply with the updated Green and Social Bond Principles, issuers of green secured debt should specify in their marketing materials which type of green bond is being issued.
"One of the things that has been made very clear is that at the time of announcing a transaction, issuers need to say which method they’re using, so that investors will immediately know what’s on the tin, so they know how to focus their attention," said John Millward, head of EMEA ABS at HSBC, who was involved in producing the new definitions as co-chair of the ICMA task force on sustainable securitisation.
But ICMA left some questions for investors to answer themselves. A bond labelled green because of how its proceeds are used, for example, could be secured on environmentally questionable assets. In practice, this is already the case for green first mortgage bonds issued by several utility companies in the US. First mortgage bonds, a popular secured funding option for US utilities, are typically secured on all of the company's assets, which in many cases include coal-fired power plants.
A similar approach in RMBS or CMBS might involve using mortgages on buildings with poor environmental attributes as collateral for a green bond whose proceeds are used to finance or refinance buildings with better sustainability scores.
In such cases, ICMA said investors "should form their own views" whether such a bond would be "in line with their investment mandate".
"It may be that some investors don’t want to buy trades unless the collateral pool itself is 100% green or social," said Millward. "Many others will be comfortable where the eligible projects are outside the pool but they may still want to ensure that the pool itself does not contravene their investment criteria. We’ve addressed that by saying that issuers need to provide enough information for investors to make an informed decision as to what is suitable for them."
Double counting
The new language of the Principles also reinforces the rule banning “double counting” of green projects, for instance by using them as collateral for a green secured bond when they have already been allocated proceeds from another type of green bond issuance, while clarifying what this means for various secured financing structures.
"At any point in time, a green or social project may only be counted towards one GSS bond," ICMA explained in a document accompanying the new version. "This does not preclude refinancing however as once a GSS bond is repaid the green or social project may be used as collateral for a further GSS bond."
The self-regulatory body specifically addressed ABCP and other structures involving back-to-back financing arrangements. In such a transaction, ICMA said, "there could be various back-to-back financings between the transaction originator, the ABCP conduit sponsor and the ABCP issuer, however only the ABCP is the capital markets instrument so only the ABCP can claim the GSS bond label".
ICMA also left the door open to green synthetic securitisation, while noting that consideration must be given in such cases to the full impact of the transaction on the issuer, including any capital released and risk-weighted asset benefits, when calculating the amount of capital that must be deployed in green projects.
“We were conscious to ensure that there was no type of structure falling between the gaps,” said Millward.
Additional clarity
Last year, Kensington Mortgage Company brought to the market a social UK RMBS, Gemgarto 2021, and a green UK RMBS, Finsbury Square 2021-Green, transactions that ignited a lively debate over the direction of ESG securitisation, with industry figures such as Hugo Davies, head of capital markets at LendInvest, calling for greater standardisation.
Kensington structured its social and green RMBS deals to comply with the Green and Social Bond Principles as they were formulated at the time and hired ISS ESG to provide a second-party opinion on their alignment with the Principles.
The rewriting of the Principles is not expected to result in a reassessment of the validity of the approaches that have been taken so far by issuers like Kensington. A spokesperson for ISS ESG declined to comment on whether the company would review its second-party opinions in light of the new language. Rather, the new guide is intended to help shape best practice when marketing green secured bonds in future.
“Considering existing transactions in the market, I don’t think any of the approaches that have been taken would be incompatible with what’s proposed," said Millward. "But what has been proposed may have benefited those transactions by providing additional clarity.”
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