Securitization for Sustainability
The new consensus in international development circles focuses on private finance as the solution to pressing sustainability issues. As Lord Stern, of the influential Eminent Persons Group, put it: “the challenge of achieving the Sustainable Development Goals (SDGs) is in large measure that challenge, of fostering the right kind of sustainable infrastructure,” for which, “you have to have good finance, the right kind of finance, at the right scale, at the right time” (Stern, 2018). The ambition, spelled out in the Billions to Trillions agenda, the World Bank’s new Maximizing Finance for Development (MFD) or the G20 Infrastructure as an Asset Class agenda, is to create investable opportunities in poor countries that can attract the trillions of global institutional investors (World Bank, 2018).
In turn, institutional investors find themselves at a critical juncture. Environmental, social and governance (ESG) issues are moving from the subfield of impact investment into mainstream investment practice, as climate risks in particular become increasingly apparent. The SDGs, it is often argued in the private investment space, could provide an overarching ESG framework for sustainable investments if and where investable opportunities are found.
The creation of investable opportunities requires derisking of development projects to better fit the preferred risk/return profiles of institutional investors. Securitization is envisaged to become one important de-risking instrument that would successfully crowd in private (institutional) investors and scale up sustainable assets. This is, for instance, the logic of the Asian Infrastructure Investment Bank’s (AIIB) recent Infrastructure Private Capital Mobilization Platform.
Thus, securitization is at the core of international efforts to encourage private finance to invest in SDGs and other sustainability-related activities. This paper maps three potential strategies that would guide the agenda of securitisation for sustainability:
- securitization of MDB portfolios;
- Multilateral Development Banks (MDBs) support for global banks and shadow banks’ securitization;
- country-level support for securitization.
The paper examines the claims that securitization would create winners at institutional, market, country and SDG level. It asks why securitization – a more complex financial instrument than standard fixed income securities like green bonds – has become central to SDG ambitions. It examines the mechanisms through which securitization may dilute sustainability commitments, asking whether securitization could better incorporate sustainability concerns (as for example captured through ESG ratings) than straightforward, simpler financial assets like green bonds? How, if at all, can securitization-based development interventions play to the strength of the instrument? What are the developmental implications of regulatory and market reforms that developing countries will be asked to make in order to accommodate the new investors under the World Bank’s MFD, or the G20 Infrastructure as an Asset Class?
It concludes that the new Wall Street Consensus - that re-imagines international development interventions as opportunities for global finance - will not deliver on its promises to deliver sustainability via securitization. The potential gains from organising development interventions around questions of “how to sell development finance to the market” are overstated, while the costs - in terms of structural changes in the financial sector, (de facto) privatization of public services via Public-private partnerships (PPPs) and the narrowing of policy space for a green developmental state - are downplayed.
At an institutional level, it is often argued that securitisation would help MDBs transform into catalysts for private finance. By de-risking development projects via securitisation of their loans, MDBs could help mobilise the trillions of global institutional investors for the SDGs.
MDBs’ business model would need to change if ambitions to scale up private finance from Billions to Trillions are to be realised. MDBs are more likely to prefer synthetic securitization instruments that allow them to retain loans on the balance sheet – as the African Development Bank did in the 2018 Room2Run deal (Chahed 2018) – to “true” securitisation that removes loans from MDB balance sheets. Yet institutional investors with long-term horizons require tailored conditions in order to enter synthetic securitization with MDBs. These investors may demand their own ESG criteria on MDB loans that would be securitized, or cherry-pick loans that are consistent with their ESG framework. The net socio-economic benefits (if any) and the developmental impact of MDBs de-risking for this class of investors needs to be fully transparent.
MDB support for securitization of (global) commercial and shadow bank portfolios would use development resources to subsidise systemic financial institutions, whose overall activities have a doubtful developmental impact. MDBs would have to clearly define the process for monitoring (shadow) banks for their business activities with significant adverse ESG/developmental risks. This would require strong institutional relationships with (global) banks and shadow banks, relationships that call into question the developmental mandate of the MDBs. As the AIIB’s recent Infrastructure Private Capital Mobilization Platform suggests, the pressure to leverage private capital will incentivise MDBs to replace their Environmental and Social frameworks with weaker, private-sector designed ESG criteria, without a clear framework for accountability.
The turn to securitization risks mission drift, as it would re-orient MDBs from concessional to commercial lending, and change the terms of the relationship between MDBs and private finance.
At market level, it is argued that securitization would accelerate international efforts to create local currency capital markets in developing and emerging countries (DECs). In tandem with the World Bank’s MFD agenda – that envisages a novel strategy for de-risking entitled 2 Daniela Gabor: Securitization for Sustainability the Cascade Approach - securitisation would increase the attractiveness of local capital markets for global investors, and thus reduce DECs’ reliance on foreign currency (dollar) debt, historically the source of balance of payment crisis.
The structural ambition of the securitization for sustainability agenda is to re-organise DEC financial systems from bank-based to capital-markets based models.
The structural transformation of financial systems towards securities market-based finance is necessary so that the trillions of institutional investors can find their way into sustainable projects. This is, for instance, the first objective of the AIIB’s Infrastructure Private Capital Mobilization Platform. This policy-engineered transformation does not resolve DECs’ vulnerability to global financial cycles, and volatile capital flows. It also threatens developmental policy space, by seeking a clean break from developmental models reliant on “policy-engineered industrialisation” that traditionally involved developmental banking guided by the priorities of industrial strategies and a closely controlled relationship with global finance (via capital controls and competitive exchange rate management).
The turn to private finance narrows the scope for a green developmental state, that is, a state that that designs and implements policies that substantively influence the allocation of resources to low-carbon economic activities. This reduces the prospect for a just transition to low-carbon economies, where the burden of structural change does not disproportionately fall on the poor. It may generate political instability.
At country level, it is argued that securitisation would pave the way for a more resilient financial system while allowing countries to re-direct scarce fiscal resources where most needed. Yet the financial stability benefits of organising domestic financial systems around securities markets are doubtful. Furthermore, the social and developmental impact of the turn to securitization is likely to be negative since it effectively encourages the (indirect) privatisation of public services, necessary to both generate and de-risk cash-flows that can be directed to the owners of securities.
This is explicit in the World Bank’s MFD initiative. It holds that developing countries can offer USD 12 trillion in market opportunities to global institutional investors. These opportunities include “transportation, infrastructure, health, welfare, education”. Everything can become an asset class, as the MFD agenda puts PPPs at the core of efforts to construct “sustainable” asset classes. Development is recast as an exercise in the privatization or commercialization of public services to generate returns for global finance, with state bureaucracies focused on how to sell development finance to the market rather than on how to design green developmental states.
At SDG level, it is often argued that sustainability is the big winner of the new push for MDBs to become catalysts for the trillions of institutional investors. These investors increasingly view SDGs as an overall framework to incorporate ESG criteria in their portfolios. Securitization is one key vehicle for aligning private finance with SDGs. In the optimistic scenario, the MDBs’ involvement would accelerate the realignment, as MDBs would draw on the Environmental and Social frameworks guiding their lending to set standards that can overcome the misincentives that underpin the use of private ESG ratings.
This optimism appears misguided.
The history of green bonds points to trade-offs between achieving scale and enforcing strict environmental/social safeguards. The same trade-offs characterise securitization. The imperative of selling development finance to the market, and scaling up “sustainable” assets, increases the chances of “sustainability” washing. Sustainability in securitization will be determined in part by the sustainability of underlying loans that are pooled together, and by the degree of societal impact from the basic structure (on financial stability, on financial system structure, on developmental model). Where MDBs are prepared to accommodate private ESG criteria to asses sustainability, as is the case for the AIIB’s Infrastructure Private Capital Mobilization Platform, loans/assets would be chosen through some green or ESG screen, none of which has any universality, and is applied inconsistently from issue to issuer of ESG ratings.
In turn, public ES(G) frameworks have been diluted (e.g. the World Bank’s new Environmental and Social Framework) or are politically negotiated with little attention paid to the particular context, or needs, of emerging and poor countries (as for instance the European Union’s Sustainable Finance initiative).
The MDBs’ turn to securitization may further dilute accountability, by increasing intermediation chains and reducing the (already weak) incentives for continuously enforcing ES(G) compliance. Private ESG criteria are likely to become the norm in sustainability-oriented securitization. The “ESG evangelism” at the core of the global policy agenda downplays the fickleness of this indicator, and the potential for SDG-washing inherent in the private and this far unregulated ESG provision.
MDBs should work with national authorities for a universal public ESG framework or sustainability taxonomy for private finance. Such a taxonomy should be enforced without prioritising the development of asset classes that meet the profitability requirements of institutional investors. A public ESG taxonomy, mapped onto the SDGs, and mandatory enforcement in sustainable securitization is necessary if the turn to securitization is to live up to its SDG promises.