The European Green Deal - how does securitization help?

02.02.2024, by iconicchain

The European Green Deal is a package of policy initiatives, which aims to set the EU on the path to a green transition, with the ultimate goal of reaching climate neutrality by 2050. It supports the transformation of the EU into a fair and prosperous society, promotes sustainability, and fosters a green economy.

While securitization is not a direct component of the European Green Deal, it can play a role in supporting some of the financing aspects and goals associated with the initiative. Securitization allows financial institutions, such as banks, to combine similar financial assets (such as loans and mortgages) into pools and sell them to investors in the form of securities or transfer the associated risk to third parties. This process helps banks secure new capital or free up capital that can be used for new lending, including for green projects.

Funding and Capital Release

The concept of green/responsible securitization involves designing financial instruments in a way that aligns with environmental, social, and governance (ESG) criteria. Concerning the Green Deal, this means using securitization to support sustainable and climate-focused projects.

Traditional (True Sale) securitization secures new sources of funding that can be directed towards climate-relevant projects. Counterparties buying the assets may put conditions on the use of the funds, e.g. towards financing new, climate-focused projects.

On the other hand, risk transfer transactions reduce capital reserve requirements, freeing up existing capital for various new initiatives. Many protection providers – such as the European Investment Fund – require protection buyers to use the freed-up capital to finance specific projects.

Overall, securitizing existing assets can secure – or free up – the capital required to finance the large-scale projects outlined in the Green Deal. Governments or regulatory bodies can encourage responsible securitization by setting guidelines and standards for the types of assets that can be securitized. Requiring the proceeds from securitization to be used for financing the green transition ensures that the released capital directly contributes to environmentally friendly initiatives. Responsible securitization not only frees up capital for banks but also helps direct that capital toward environmentally sustainable initiatives. This double impact aligns with the goals of the Green Deal, as it not only supports the financial system but also ensures that the released funds contribute to the transition to a greener and more sustainable economy.

Encouraging Financing for High-Risk Climate Projects

The Green Deal involves financing projects that may be considered higher risk due to their innovative nature or the uncertainties associated with transitioning to a green economy.

Securitization, when aligned with the principles of the European Green Deal, can facilitate the flow of financing into high-risk climate projects by addressing risk concerns, attracting diverse investors, and supporting the overall transition to a sustainable and climate-friendly economy through shared risk taking.

In summary, securitization can be a key instrument in financing the European Green Deal by promoting the release of capital from banks, supporting responsible and climate-focused projects, and encouraging investment in higher-risk initiatives that contribute to the overall environmental objectives of the plan.