Securitization involves the pooling of financial assets into one group to form a new, sellable financial product. The financial assets that are pooled are usually loans or other debt, with regular cash flows being generated by the financial assets. These loans and debt must be fungible or interchangeable—that is, they have similar risk and return characteristics. The issuer pools loans into one group and usually transfers them into a newly created special-purpose vehicle, typically an asset-based security (ABS), and then sells these repackaged assets to investors. The shares of these securities can be sold in secondary markets. This enables companies and lenders to sell off existing financial assets, which increases their liquidity.
The instrument is defined as “green” when the underlying cash flows are derived from financial assets (i.e., loans) to fund low-carbon assets or when proceeds from the deal are earmarked to invest in low-carbon assets. Renewable energy, energy efficiency, and transport projects lend themselves to securitization due to their stable income profile and low operational risks. Incorporating physical climate risk considerations into the design of these projects could support climate adaptation efforts.
Current or potential adaptation-relevant sector applications:
- water supply (infrastructure) – water management;
- energy infrastructure – energy generation (including renewables);
- transport infrastructure; and
- other built environment and infrastructure – urban development.
Additional insights:
- This is an emerging instrument for adaptation action in the water sector.
- It is a mature instrument for other purposes, with the majority of green ABS issuance to 2021 taking place in the United States. There is increasing use in China, and a limited number of sustainable securitizations in Europe.
Considerations for using securitizing assets:
- This instrument requires multiple revenue-generating projects.
- Securitization requires legal expertise and the definition of strict terms and conditions.
- This tool is typically promoted with the active support of the government.
Adapted from the following sources:
Chen, J. (2023, September 29). Securitization. Investopedia. https://www.investopedia.com/terms/s/securitization.asp
European Banking Authority. (2022). EBA report: Developing a framework for sustainable securitisation. https://www.eba.europa.eu/sites/default/documents/files/document_library/Publications/Reports/2022/1027593/EBA%20report%20on%20sustainable%20securitisation.pdf
Harwood, A. (2021). Accelerating securitization in Africa to finance the SDGs: Future flow securitizations. Milken Institute. https://milkeninstitute.org/sites/default/files/reports-pdf/Accelerating%20Securitization%20in%20Africa.pdf
Rado, G. (2018, August 17). Green securitisation: Unlocking finance for small-scale low carbon projects. Climate Bonds Initiative. https://www.climatebonds.net/resources/reports/green-securitisation-unlocking-finance-small-scale-low-carbon-projects#:~:text=A%20securitisation%20can%20be%20defined,invest%20in%20low%2Dcarbon%20assets