Treat loans for green projects like mortgages to help fund €470 billion annual investment in low-carbon in Europe

Posted on 27 Feb 2017 in Press releases

Green loans for small-scale low-carbon projects, such as energy efficiency upgrades on homes or the construction of rooftop solar power panels, should be treated like mortgages to provide the multi-billion Euro investments needed for the UK and Europe to make the transition to a low-carbon economy, according to a new policy paper published today (27 February) by the ESRC Centre for Climate Change Economics and Policy at the London School of Economics and Political Science, and the Climate Bonds Initiative.

The paper sets out how grouping small individual green loans into packages of debt and selling them on to big institutional investors, in the same way mortgage debts can be traded, could provide a new route for the massive investment in low-carbon technologies that is needed if Europe and the UK are to meet their climate change targets. The paper points out that there is already strong demand from investors for green investment opportunities, and that aggregating green loans into tradable packages will make them attractive to large institutional investors such as pension funds.

The paper also notes that European governments are well placed to kick-start trading of packages of green investments, and recommends five ways in which the public sector could support the growth of the market in Europe.

Europe needs to invest at least €470 billion every year until 2030 in improving infrastructure, such as transport networks, communications, energy supply, water and sewage systems. Current investment levels remain inadequate after being pushed down by the financial crisis and economic downturn which made it more difficult for banks to lend money for low-carbon projects. More investment is required and the proportion invested in low-carbon and climate-resilient projects, currently only 7-13% of total infrastructure investment globally, must be scaled up if the UK and other Member States are to meet their climate change commitments.

On their own, traditional sources of funding for new green technologies from banks, utilities and government are unable to fund the multi-billion Euro investments needed.

But grouping these investments into packages, known as ‘asset-backed securities’ (ABS) , means the debt can be sold on to much bigger investors who buy and sell securities on the multi-trillion Euro bond market. Selling the debts would clear balance sheets at banks and drive investment in new green projects, resulting in an overall increase in capital invested in low-carbon infrastructure.

The paper points out that in the EU, trading in bundles of green loans will play a major role in financing technologies such as renewable energy and low emissions vehicles. By 2020 €19 billion of annual investment in these technologies could come from asset-backed securities, and by 2035, €77 billion.

Sean Kidney, Chief Executive of Climate Bonds and co-author of the paper, said: “The key idea is to package together investments for small- to medium-sized green assets into bigger bundles, just like banks currently do with mortgages and student loans. This will enable packages of small-scale green investments to tap into the €100 trillion bond market and the institutional investors who provide the majority of the capital in this market, which is crucial for seeing investment in low-carbon assets reach the level and pace required to meet the climate policy goals that have been established in the EU and globally.”

The paper highlights that the public sector is well-placed to support the growth of the market for trading in these ‘asset-backed securities’, and there is now policy momentum to revitalise it, particularly in the EU.

Diletta Giuliani, Climate Bonds Policy Analyst and lead author on the paper, said: “What’s needed now is for the market in ABS for green assets to be accelerated in Europe. There’s a long history of the public sector facilitating the grouping of loans for other categories of these asset backed securities – like mortgages and student loans for example. National governments of EU member states could now help to grow trading in green asset-backed securities, and open a new financial stream outside banks’ and companies’ balance sheets. This will be most effective if government policies are clear and coherent and signal support for scaling up investment in green projects to the levels that are needed for the transition to a low-carbon economy.”

The paper identifies five ways the government could help to kick-start green asset backed securities trading:

1. Provide clear definitions of what qualifies as a ‘green’ loan

Some current investments, such as mortgages on energy efficient homes, could be reclassified as green and sold by banks into the bond market, freeing up investment capital for new loans. Guidance is needed from the public sector to tag investments that can be considered green.

2. Support the development of standard loan contracts for new green investments

Mortgages are regularly traded in bundles and have standard agreements but contracts for rooftop solar and loans for energy efficiency upgrades vary. An administrative burden is created by grouping these different loans. The public sector could encourage efforts to standardise contracts in these areas.

3. Play a role in securitising packages of loans originating from different credit institutions

Many lending institutions do not have sufficient green loans on their balance sheets to group them into a big enough tradable package. The public sector could facilitate the grouping of loans from different banks and investors into larger packages by setting up a financial warehouse through a public-private partnership or hosted in a development bank.

4. Guarantee groups of loans to support initial demand for high-quality securities

Asset-backed securities are typically structured in groups called ‘tranches’ with different levels of risk. The short credit history of the new assets and their limited availability make it difficult for the securities to achieve high-quality tranches that are attractive to institutional investors. In the early stages of the market the public sector could provide guarantees to the riskier tranches to make the deals more attractive to institutional investors.

5. Strengthen investor demand

Public investment in initial green securities deals would provide a signal to other investors. The public sector might also provide preferential regulatory treatment for green securities, though there may be unintended consequences which should be considered. 

Simon Dietz, Co-Director of the ESRC Centre for Climate Change Economics and Policy at the London School of Economics said: “This paper was supported by our Innovation Fund which aims to stimulate the flow of innovative ideas on climate policy. Greater investment is needed in low-carbon technologies and infrastructure in Europe and globally and new ideas about how to increase access to investment, such as the securitisation of green loans as discussed in this paper, have the potential to make a real contribution to the advancement of climate policy and to aid the transition to a low-carbon economy.”

For more information about this media release please contact
Victoria Druce, LSE, on +44 (0) 20 7107 5865 or v.druce@lse.ac.uk, or
Andrew Whiley, Climate Bonds Initiative, +44 (0) 7506 270 943 or andrew.whiley@climatebonds.net

NOTES FOR EDITORS

1. The Climate Bonds Initiative is an investor-focused non-profit, promoting large-scale investment in the low-carbon economy. It undertakes advocacy and outreach to inform and stimulate the market, provides policy models and government advice, market data and analysis, and administers the Standards & Certification Scheme. climatebonds.net
2. The ESRC Centre for Climate Change Economics and Policy (http://www.cccep.ac.uk/) is hosted by the University of Leeds and the London School of Economics and Political Science. It is funded by the UK Economic and Social Research Council (http://www.esrc.ac.uk/). The Centre’s mission is to advance public and private action on climate change through rigorous, innovative research.

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