The Association for Financial Markets in Europe (AFME) published a paper that discusses the potential role of securitization, including the Asset Backed Commercial Paper (ABCP) programs, in developing sustainable finance, particularly in a post-pandemic economic recovery. The paper discusses the regulatory status of the disclosures and due diligence requirements for securitization in EU and identifies the environmental, social, and governance (ESG) factors that are important in the context of securitization, especially given the absence of the Social Taxonomy in EU. Finally, the paper makes recommendations to ensure consistency in the ESG disclosures and due diligence of market participants, with respect to the securitization transactions.
The paper notes that, although the market for ESG securitization is still relatively small, strong investor demand exists in addition to a growing supply of ESG securitization bonds. To flourish, this market requires availability of a sufficiently large pool of assets for ESG securitization and a common ESG standard for disclosure and due diligence. As originators transition to more sustainable business models, pools of suitable assets will increase naturally over time. As for ESG disclosures and due diligence, the already very high standards required under EU Securitization Regulation provide a strong starting base from which to develop, where necessary, further relevant ESG data. The EU Securitization Regulation is expected to undergo a review by January 01, 2022, which is likely to introduce further ESG related disclosures into the framework. The paper also notes that a future sustainable securitization framework is, therefore, expected to draw on the EU Taxonomy and the EU Sustainable Finance Disclosure Regulation, which in the EU policy context, together provide a framework for defining legally sustainable activities and establishing sustainability-related disclosures in financial services. The EU Taxonomy will be particularly important in providing a standardized approach to the measurement of the environmental impact of the economic activity supported by the investment being sought. However, its criteria are difficult to satisfy today, narrowing down the potential pool of assets compliant with the EU Taxonomy which can be securitized.
The paper also highlights that there is general agreement among most standard-setters that the pillars of sustainability are environmental objectives, social objectives, and good governance. However, while the EU Taxonomy Regulation provides a definition for what “environmentally sustainable” means for certain economic activities, there is to date no single universal definition of those three factors. The paper identifies and outlines examples of ESG factors that are common across various definitions and practices for financial and non-financial firms include climate change factors in the area of environment (including greenhouse gas emissions, biodiversity, and water use and consumption); human rights, labor, and workforce considerations in the area of social; and rights and responsibilities of senior staff members and remuneration in the area of governance. When assessing ESG factors for securitizations investors typically consider both the securitization portfolio (for example, green mortgages, SME loans to energy-efficient projects) and the key transaction counterparties (particularly the originator and servicer). It is, therefore, how the performance of the assets aligns to environmental and/or social objectives and how these are underpinned by good governance, that is most relevant for consideration when evaluating a securitization transaction. To ensure consistency of ESG disclosure and due diligence, AFME encourages parties to consider the following recommendations (on an “if available” basis) and ensure that:
- references to the ESG aspects of the securitization are clear and understandable and that relevant ESG factors are addressed in the prospectus/offering documentation.
- any material ESG-related risks that have impact on credit performance of the assets underlying the securitization transaction are reflected in the risk factors section.
- any relevant definitions (for example, for "Eligible Green Projects") are provided and that information on how the issuer identifies and selects appropriate ESG assets or projects is available.
- details of any third-party opinion obtained to verify the securitization complies with ESG factors is provided and that any details on parties providing verification for any post-issuance reporting are included, where applicable.
- all the information related to how performance of the underlying assets aligns to environmental and/or social objectives and how these are underpinned by good governance is provided.
- there is a reporting standard for originators across an asset class, for example via investor reports, to ensure a level of homogeneity in ongoing disclosure provided to investors and to lessen the reporting burden on originators.
- information relevant to transitioning assets is provided, if applicable.
Keywords: Europe, EU, Banking, Securities, Securitization, Sustainable Finance, ESG, Securitization Regulation, Disclosures, Taxonomy Regulation, SFDR Regulation, Climate Change Risk, AFME
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Dr. Denton provides industry leadership in the quantification of sustainability issues, climate risk, trade credit and emerging lending risks. His deep foundations in market and credit risk provide critical perspectives on how climate/sustainability risks can be measured, communicated and used to drive commercial opportunities, policy, strategy, and compliance. He supports corporate clients and financial institutions in leveraging Moody’s tools and capabilities to improve decision-making and compliance capabilities, with particular focus on the energy, agriculture and physical commodities industries.
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