Corporates and policymakers embrace sustainability themes
Securitization comprised only a sliver of the US$1.7 trillion global sustainable debt market in 2020 but is seen to play a bigger role in the future given the sector finances a range of collateral that apply ESG objectives. Momentum is being driven by stronger commitments from corporates and policymakers towards sustainability goals, and as investors take more interest in climate change, human rights and social development.
“What is critical is just how high on the agenda it is for corporates to really spend time on developing their ESG policies,” said Jennifer Hellerud, RBC Capital Markets Head of Securitization, Australia.
“Investors are really starting to ask these questions around ESG policies and there may come a time where investors will not buy bonds from issuers if they don't at least have appropriate corporate ESG policies in place.”
A vast majority of securitization market participants (86%) had ESG programs at the enterprise level by the end of 2020, while nearly half (47%) had one at the structured finance level, according to the Structured Finance Association’s ESG Industry Engagement Survey (2020).[1] While only 13% of respondents had sponsored an ESG-focused securitization program, nearly half (43%) indicated they were developing one.
The growing interest has spurred a flurry of ESG securitizations over the last two years across a wide spectrum of sustainability concerns.
One of the stand-outs was Toyota Financial Services’ US$1.6 billion Asset-Backed Green Bond issued mid-2021 to finance the sale of hybrid, fully electric (EVs) and late-model vehicles that meet emissions standards. The proceeds will go towards future hybrid and EV originations that meet “green” eligibility criteria.[2] Other securitization transactions focused on the social component of ESG, including the £280m CMBS issue by social housing group Sage Housing in October 2020, with proceeds to be on-lent to fund the acquisition or refinancing of affordable housing in the UK.[3]
Private sector pushing Australia forward amid challenges
While the northern hemisphere has led the market for ESG securitization, Australia is also moving forward despite notable challenges of scale and relatively few incentives from policymakers. Non-bank lender and payments company Humm group, formerly known as FlexiGroup, became the first Australian company to issue a “green” asset-backed security in 2016 to fund its solar panel installation financing.
There have been a slew of landmark deals since, including non-bank lender Firstmac’s A$750 million residential mortgage-backed security (RMBS) issue in June, Australia’s first RMBS to comprise exclusively green tranches. The deal provides finance for homes that meet efficiency criteria in the Nationwide House Energy Rating Scheme.
Australia has yet to catch up with Europe in terms of policy and tax incentives to drive capital into ESG investments. Scale also remains a hurdle for certain assets. While the country leads the world with the highest solar photovoltaic capacity per capita, electric vehicle uptake remains low compared to developed world peers due to a lack of incentives, infrastructure and limited availability of models. Low levels of EV collateral in warehouse facilities is still an obstacle to ESG-focused auto ABS securitization but the landscape is expected to shift rapidly over coming years as EV sales eclipse internal combustion engine (ICE) vehicle sales.
“As we see supply become available and the entry price drop for EVs, we expect to see a marked increase in finance applications,” said Hellerud.
“Government initiatives should drive consumer uptake even higher. We are in the last decade where ICE cars outsell EVs, and every manufacturer is looking at EV options.”
While industry and tax incentives are the missing piece in Australia, the private sector continues to power ahead.
“Corporates have this ESG consciousness that they're seeking to formally incorporate. Similarly, investors are wanting to make sure that they're investing in in companies and securities that have a base level of ESG accountability,” added Hellerud.
Placing a premium on social equity and diversity
While ESG securitization has largely focused on environmental and sustainability criteria, there is growing interest and activity on the social component. The COVID-19 pandemic has concentrated minds among policymakers, regulators and investors on the importance of diversity, equity and inclusion in investment decisions. RBC has been recently active in social-focused securitization as sole structurer, joint book runner and Diversity and Inclusion Coordinator for Verizon’s US$1.7 billion ABS issue in May. RBC and Verizon developed a syndication structure which provided diverse-owned firms with enhanced transaction economics and equality of opportunity to place ABS securities with investors.
“The issue underlined how corporates are trying to incorporate more social equity into their capital market transactions,” said Hellerud.
“It also provides means for them to expand their investor base through the investor relationships that these diverse-owned dealer-brokers have.”
Clearer standards to boost investor confidence
While interest in ESG securitization is growing, a lack of clear and unified standards remains a challenge for the sector. The market continues to debate how to define “green” and “social”, what metrics should be used to measure performance and how to penalise non-compliance. The opacity has left corporates setting their own definitions and benchmarks, raising concerns about green-washing. Some jurisdictions are moving faster than others in producing policy frameworks to guide market participants. The European Union (EU) in particular has made strides in formulating a detailed classification system through its Taxonomy Regulation which will help provide clarity as to what economic activities can be classed as sustainable. The EU’s Green Bonds Standard is also offering a unified standard for the green bonds market.
With Australia trailing the EU in setting standards, there is still considerable nuance in the classification of ESG transactions. To date, the most common approach involves issuer adherence to the principles from the International Capital Market Association (ICMA). This includes, for instance, Green Bond Principles, which outline best practices when issuing Green Bonds and ultimately help promote transparency and disclosure. In the absence of mandatory classification systems, the voluntary approach counts as best-practice, said Hellerud.
“A common global approach to defining sustainable transactions would make life a lot easier for everyone and would certainly assist with mitigating problems like green-washing,” she added.
There is also more work to be done to produce agreed frameworks for measuring and reporting impact of investments. As a minimum, participants must be able to demonstrate they have the ability to capture and report the data underpinning ESG metrics. This can be straightforward for certain assets but complex for others. With portfolios of vehicles, for example, capturing tailpipe emissions and other energy efficiency indicators is common. RMBS issues for housing may be anchored by national energy benchmarks and ratings systems. However, verifying long-term impacts of investments, whether through decarbonization or improved social equity, will inevitably require more sophistication. Industry will need to collaborate to agree on reasonable and robust standards that can be applied broadly and regulated effectively.
“I think investors will certainly play a part in this as well. They will be in a position where they'll be able to dictate what it is that they need in order to classify a transaction as ESG,” said Hellerud.
Pricing ‘greeniums’ into sustainable issues
Ultimately, corporates will be assessed, and in some cases, penalised by investors and consumers on their level of commitment to ESG in their investments and operations. Issuers that can demonstrate clear ESG commitments and a track record of positive performance in pursuit of them will naturally be viewed as reliable long-term capital managers. In corporate ESG issuance, investors are seeing “greeniums” - premiums for green transactions - of about five basis points for ESG-compliant deals versus non-compliant ones. ESG securitizations are likely to see a similar greenium emerge over time. “There's not quite enough volume of transactions in the space yet to determine whether that greenium exists but I think ultimately it will emerge with volume,” said Hellerud.
Industry has rarely failed to innovate when presented with opportunity, and the securitization sector will be no different as it meets growing demand from investors and consumers for products that deliver a sustainability dividend. Industry participants who commit early to ESG will be well-positioned as new policy incentives come online and standards become clearer.
RBC is committed to mobilizing C$500 billion (US$394 billion) in sustainable finance by 2025, and to achieving net-zero emissions in lending by 2050. RBC Capital Markets’ dedicated Sustainable Finance Group works in collaboration with clients on their sustainability journey, partnering across the capital markets platform to deliver advice and solutions that also aim to have a positive impact on the world.
“The investment community is a lot more socially and environmentally conscious now,” said Hellerud. “It’s important not to be left behind. Corporates have got to be on board in terms of their policies and how they will achieve their ESG objectives.”
[1] Structured Finance Association, November 2020, ESG Engagement Survey 2020
[2] Toyota, June 2021, Toyota Financial Services issues new asset-backed green bond
[3] Sage Housing, September 2020, Sage Social Housing Securitisation
Article published in the Australian Securitisation Journal, Issue 21. View journal here.
