The World Bank and other multilateral development banks should harness securitisation to increase their lending power by up to 10 times, according to striking new proposals that appear to fit with the new World Bank president's plans.
Deals could be structured using conduits in which MDBs would place their developing country loans, with private capital taking up as much as 90% of deals issued by such vehicles to leverage commitments to fund climate transition in the developing world.
Until now MDBs have barely engaged with securitisation and not at all with conduits. The African Development Bank’s US$1bn “Room2Run” deal in 2018 was a notable exception, but even that was a synthetic securitisation through which it retained the underlying loans. AfDB, the Asian Development Bank and the World Bank have also conducted portfolio risk transfers, though almost entirely with donor governments.
However, the conduit proposal seems in line with the thinking of the new regime at the World Bank. Speaking at the COP28 climate meeting in Dubai, World Bank president Ajay Banga said a key goal would be “figuring out a model of originating to distribute, of creating a securitisable asset class … where large pension funds [and] large players like BlackRock would find that to be an attractive place to put billions to work”.
The World Bank's private sector affiliate, the International Finance Corp, is developing its “Warehouse Enabled Securitization Platform” that will “pioneer an originate-to-distribute model for participating MDBs and other development finance institutions”, according to a World Bank Group development committee report in October.
Also this month, 10 bodies representing major financial institutions – including the Institutional Investors Group on Climate Change and the UN-convened Net-Zero Asset Owner Alliance and Net-Zero Banking Alliance – issued a “call to action to scale private capital mobilisation”. This urged MDBs to “move from an originate-and-hold to an originate-and-distribute model, creating structures that are familiar to institutional investors”.
Global conduit
Against this background, bankers have begun making the case for securitisation to facilitate a massive ramp-up of MDB lending. This would avoid institutions taking on additional leverage, which could jeopardise their top credit ratings, and sidestep the political challenges of bringing in additional equity from their diverse sovereign shareholders to lend against.
“Instead of mobilising US$100bn a year lending to developing countries, you could be thinking about originating 10 times that at US$1trn – without sacrificing your rating or changing your charter, all while continuing to retain the host country relationships. [If we keep] the US$100bn annual lending amount on the MDBs' balance sheet and pass on the rest to a global conduit where the private sector can participate ... we can help tranche the risk and scale up capital deployment,” said Karen Fang, global head of sustainable finance at Bank of America.
In this model, the US$900bn of loans passed to the conduit for refinancing via private creditors would rank pari passu with MDBs' retained loans.
“We can help MDBs increase lending capacity by crowding in private-sector capital to accelerate capital deployment because the host countries of the global south clearly need more,” Fang said.
A diversified currency hedging pool would also be needed to bridge the gap between borrowers’ preference for local funding and US dollar and euro-based international private capital.
Fang described the conduit model as “the right counterparties coming into the right part of the capital structure, based on their risk/return constraints”, citing banks, insurance companies and possibly pension funds as potential senior debt investors, infrastructure or private equity funds as mezzanine buyers, and philanthropic foundations and other concessionary investors (such as the new loss and damage fund or government grants) as takers of first-loss risk.
Stratospheric performance
Since most MDBs raise and on-lend very cheap funds, pricing on senior conduit tranches could be an obstacle to investor participation. However, their likely low yields would also reflect the likelihood of minimal loan losses.
The expected public release next year of the Global Emerging Markets Risk database of MDB loan performance could be a factor. “If the data show that the loan performance is stratospheric compared to other lenders, the private sector may have a stronger reason to participate in the [conduit] schemes and to do it for cheaper cost,” said Arnaud Louis, global head of supranationals at Fitch, which is reviewing its MBD rating criteria.
Viktor Szabo, investment director at fund manager abrdn, cautioned that similar structures like debt-for-nature swap bonds have fallen between investor requirements: “too low yield for EM investors given the credit enhancement, and too spicy for DM investors, even with a high enough rating for the bond – and illiquid for both,” he said.
He sees scope for standardisation to alleviate the pricing issue, and possibly liquidity too.
Not just banks
However, Chris Humphrey, a senior research associate at thinktank ODI and a member of the G20 expert panel on MDB capital adequacy, “disagrees fundamentally” with the idea that sovereign lending MDBs should take a conduit/securitisation route. “These are not just banks. These are international cooperatives, created by governments for public policy purposes. Trying to turn them into dealmakers for investors at scale would be a mistake.”
In particular, “shipping loans off to some hedge fund or insurance company” could weaken sovereign lending MDBs’ legitimacy with their borrowers, which are also members and owners of the institutions, and, in turn, undermine preferred creditor status.
Humphrey also made a key distinction between MDBs that lend to sovereign and quasi-sovereign borrowers and those that serve the private sector in developing countries.
“There's no reason why the IFC or IDB Invest or the DFIs cannot be massively increasing their originate-and-distribute approaches,” he said, in the same way that the original Room2Run referenced AfDB’s higher-yielding non-sovereign loans.
Preserving PCS
Any conduit would require “very careful design” to preserve preferred creditor status, Louis said. MDBs would have to “at least retain some skin in each loan transferred away”.
Despite its many recommendations for reform, including hybrid capital, the G20 panel did not see a fundamental shift of the sovereign lending MDB sector to an "originate-to-distribute" model as appropriate.
Humphrey argued that MDBs could “unlock” far greater volumes of private sector investment in developing countries in a different way. They should design multi-year rollouts of sustainable infrastructure with regulators, governments and investors.
MDBs could co-finance these programmes as part of blended packages, though other development goals such as primary education and maternal health are less amenable to co-financing.
Corrected story: Corrects wording in 10th paragraph