Sustainable Securitisation – the next in filling sustainable finance gap in India

– Vinod Kothari and Payal Agarwal | corplaw@vinodkothari.com

A recent UNCTAD Report^[1] highlights the financing gap in sustainable development – citing the need for around $4 trillion additional investment annually for developing countries. India is no exception, in fact, various studies^[2] suggest the high sustainable finance gap in the country. As the need for sustainable finance continues to grow, so does the regulator’s vigilance towards providing a definite regulatory framework around the same. In this context, SEBI has released a Consultation Paper on expanding the scope of Sustainable Finance framework in the Indian securities market^[3].

The Consultation Paper proposes to expand the current regulatory framework around green debt securities^[4], by including other forms of sustainable or thematic bonds^[5]; to be covered by a broader expression “ESG Debt Securities”. The Paper also proposes to introduce a framework for Sustainable Securitised Debt Instruments (SDIs). In this write-up, we briefly discuss the concept of green and sustainable securitisation, and give our recommendations for the suggested framework for Green and Sustainable Securitisation in India.

Concept of Green Securitisation

There is not one universally acceptable definition of green securitisation, however, generally speaking, a green securitisation transaction takes either of the two forms, viz., (a) green collateral securitisation or (b) green capital securitisation^[6].

The first type (a) is a pure asset-backed transaction, where the assets backing the securitised notes are “green”, whereas the second type (b) is a “use-of-proceeds” bond, much similar to a green bond issuance, with the difference that the funds are being raised by issuing asset backed securities. Part A and Part B of the Graph below illustrate the two. We will call the two, respectively, Green Collateral Securitisation, and Green Capital Securitisation.

Part A – Green Collateral Securitisation

Part B – Green Capital Securitisation

Definition of green ABS in different jurisdictions

There have been efforts in defining green ABS in certain jurisdictions; reference may also be drawn from internationally recognized voluntary standards and practices. The following table captures the meaning of green ABS in different jurisdictions:

Country	Governing law	Nature of securitisation	Typical assets
United States	Not governed by any specific law,	As per available data, these are mostly backed by green collateral^[7]	● Green Residential Mortgage-backed Securities (RMBS)^[8], ● Property Assessed Clean Energy^[9] (PACE) securitised loans ● Solar, i.e., leases and loans funding solar energy projects^[10]
Europe	European Green Bonds Standard^[11] (EuGBS) – this is not yet effective	Both the conditions, viz., ● Green “use-of-proceeds” ● Backed by collateral other than restricted list^[12]	Since the EuGBS is not yet effective, the marketplace has been terming transactions are green based on collateral: ● Green RMBS ● Auto loans ● Solar ABS^[13]
China	Guidance from stock exchanges	● Backed by green collateral (70%), or ● Funding green projects (70%), or ● Originator’s business is green (i.e., (> 50% of total revenue derived from green business, or > 30% of total revenue and profits derived from green business and is higher than any other business lines)	● Renewable energy receivables ● Electric vehicle financing ● Green commercial mortgages^[14]
International Capital Markets Association	ICMA Green Bond Principles^[15]	Securitisation is covered by the larger term “Secured Green Bond” which includes securitisation, covered bonds, ABCP, secured notes and other secured structures. ● Backed by green collateral (Secured Green Collateral Bond), or ● Use of proceeds in green projects (Secured Green Standard Bond)	ICMA Principles-compliant issuances include asset categories such as energy-efficient buildings, renewable energy, etc.^[16]

Our Recommendations in Indian context

Significant questions to address are:

Is a framework for Green ABS important?
What should be the basis for classifying ABS as green – based on the underlying collateral, or the use of proceeds, or either/both?
Should there be any regulatory or other privilege/relaxation to be extended to green ABS?
Other than Green ABS, do we see a potential for any other form of Sustainable Securitisation?

We address each of these points below.

Need for a green ABS framework

Given the huge gap between the availability and supply of sustainable finance, any instrument that can help bridge the gap is appreciable; green ABS has a larger role to play, as discussed below. Green ABS can help in ensuring continuous flow of sustainable finance, by assisting the originators (lenders and leaseholders) in freeing up their capital invested in green assets, to generate further green assets out of such freed-up capital. With the regulatory steps being taken for the climate change actions and creation of green assets, green ABS can contribute significantly to the country for the following reasons:

Funding requirement: The sustainable financing gap of the country is huge (reported to be around USD 3.5 trillion in achieving the net zero by 2070^[17]). Green ABS may serve as a mode of raising green finance, filling the gaps in sustainable fund requirements.
Green assets created out of green deposits: RBI has released a framework for acceptance of green deposits^[18] by banks and other deposit-taking NBFCs/ HFCs. With the notification of the Green Deposit Framework, various financial sector entities have adopted the green deposits and financing frameworks and/ or launched green deposit schemes^[19]. The framework requires the regulated entities to restrict the use of proceeds of green deposits for the purpose of green assets only, as specified in the said framework. A framework around green ABS may help entities which have raised green deposits to invest in Green ABS and build requisite green assets..
Priority-sector lending (PSL): RBI has also laid down certain priority-sector lending targets^[20] that banks are required to adhere to. Amongst the eligible categories for PSL, loans pertaining to agriculture and some renewable energy projects may qualify to be “green assets”, whereas, the other categories may also be suitably considered to be “social assets” (see discussion on Social ABS below). These green and social assets may act as collateral for sustainable ABS, thereby, helping in meeting the regulatory requirements on one hand, and freeing-up capital for further asset creation on another. Alternatively, securitisation notes underlying green and social assets (depending on the category of assets) may also qualify w.r.t. meeting the PSL targets.

Lending to/for	Eligibility for sustainable SDI/ ABS
Agriculture	Green ABS
Micro, Small and Medium Enterprises	Social ABS
Export Credit	May depend on the nature of activity
Education	Social ABS
Housing	Social ABS Green ABS in case of green buildings
Social Infrastructure	Social ABS
Renewable energy	Green ABS
Others	May qualify as Social ABS

Freeing up capital locked in long -term green assets: Assets such as solar power assets are typically long term – having a payment cycle of 10 years or longer. Therefore any entity giving finding against such assets may end up locking up capital for a long term. However, every financial institution needs to take out its funding, so as to raise liquidity and redeploy the money. Here, green ABS may come in handy, and may free up both the liquidity as well as regulatory capital.
Addressing the risk of greenwashing: While there is a clear need for green ABS, in the absence of a clear mandate on what constitutes “green”, how is the “green” constituent identified and affirmed, what are the disclosures the originator may be required to make in the event of raising funds in the name of green ABS etc, there may be concerns around greenwashing. Therefore, building a regulatory framework around the same may help in addressing the concerns around greenwashing, which may, in turn, result in an increased investors’ confidence on such structured instruments.

Basis for classifying an ABS as green – “use of proceeds” or “collateral based” approach

There are varying practices around labelling ABS as “green”, as briefly discussed in the international context above. While ABS necessarily implies an “assets-backed” approach, hence, the focus should be on the underlying assets, the “use-of-proceeds” case is also popular in the context of green ABS, particularly on account of the need for creation of “green assets” coupled with a scarcity of existing green assets to be offered as collateral.

In the context of green ABS framework in India, however, we suggest that a collateral based approach be adopted, for the following reasons:

Securitisation, by nature, refers to a structured instrument where cash flows are generated from the underlying assets. An investor putting funds in the Green ABS will do so with the intent of funding a green asset; that is, the investor is buying the cashflows of a green asset. If it were a use-of-proceeds instrument, the investor does not get the credit of investing in a green asset; rather, it is the issuer of the ABS who invests in green assets. Therefore, we are of the view that green categorisation should be ensured at the level of the underlying assets.
Devising Green ABS s based on “use-of-proceeds” will give it a character similar to a green+ bond. In other words, green ABS will be indistinguisable from a green bond. .
Globally, there is evidence^[21] that in a “use-of-proceeds” form of securitisation, the originators are likely to structure the securitisation upon the “brown” assets, thereby, leveraging the “brown” assets to create “green” assets in their balance sheet.
For countries like Europe that prefer a “use-of-proceeds” approach, the rationale is the scarcity of sufficient “green” assets to be provided as collateral^[22]. In India, the concerns around insufficiency of green assets for collateralisation may not hold in view of the increasing use of green assets, coupled with ambitious targets of moving to 50 percent cumulative electric power installed by 2030 from renewables through 500 GW installed capacity.

The Consultation Paper also proposes to define sustainable SDIs in the following manner:

“instruments which have sustainable finance credit facilities as the underlying debt, and satisfies such international frameworks (as adapted or adjusted to suit Indian requirements) that are specified by SEBI from time to time.”

Thus, the proposed definition of sustainable SDIs require the “sustainable” condition to be fulfilled at the level of the “underlying exposures” and not by the “use of proceeds” freed by the originator through the SDIs.

Regulatory incentives supporting green ABS in India

The need for green finance is not merely a corporate commitment towards its stakeholders, but a subject of public policy. In this regard, some regulatory initiatives have been taken in the past, to support the green growth^[23].

Further, press reports^[24] reveal that banks have been demanding regulatory incentives w.r.t. growth of green financing, in terms of the following:

Relaxed norms on risk-weighted assets
Broadening the categories included under Priority Sector Lending (PSL) to cover more classes of green assets
Reduced Cash Reserve Ratio (CRR) requirements on green assets

Regulatory incentives only highlight the sensitisation and support from the regulators, but the fact is that much of the growth for ESG finance is currently because of investors’ preference.

Social ABS as a component of sustainable securitisation

While green securitisation is a popular term in the sustainable finance market, the scope of sustainable securitisation is not limited to green ABS, it also includes social ABS. Rule-making around social ABS is scarce, however, there are practical instances of social ABS. The ICMA Social Bond Principles^[25] also define social ABS in similar lines as that of green ABS.

The underlying exposures for the social ABS may include SME loans, consumer ABS (credit card receivables)^[26], social bonds, i.e., bonds aimed at financing social impact creation such as healthcare, gender bonds etc. Originators may specify their own conditions and eligibility criteria for referring a loan as suitable for social ABS^[27]. Alternatively, these may again be “use-of-proceeds” bonds^[28].

Motivations on sustainable SDI issuance – issuers and investors

Securitisation is a tool to free up the capital of the originator, and sustainable securitisation may lead to tapping a specific investor class – committed towards making investments in “green” or “sustainable” securities, such as impact investors, ESG mutual funds etc. Thus, it helps in diversification and expansion of the sources of funding for the issuer.

For the investors, especially corporates, the primary motivation may be to acquire green assets, thereby, showing their commitment towards making a positive contribution to the environment and the society.

See our other resources on Green Securitisation:

^[1] Financing for Sustainable Development Report 2024, UNCTAD – https://unctad.org/publication/financing-sustainable-development-report-2024

^[2] A February 2024 Report published by Climate Policy Initiative identifies that collective annual investment needs of six states alone in India amount to INR 444.7 billion (USD 5.5 billion) from 2021 to 2030 – https://www.climatepolicyinitiative.org/publication/financing-adaptation-in-india

A study published by CEEW in November 2021 suggests an investment gap of USD 3.5 trillion in achieving the net zero by 2070 – https://ceew.in/cef/publications/investment-sizing-india-s-2070-net-zero-target

^[3] https://www.sebi.gov.in/reports-and-statistics/reports/aug-2024/consultation-paper-on-expanding-the-scope-of-sustainable-finance-framework-in-the-indian-securities-market_85691.html

^[4] See an article on SEBI’s regulatory framework on green debt securities at – https://vinodkothari.com/2023/02/sebi-revises-framework-for-green-debt-securities/

^[5] See an article on different forms of ESG or thematic bonds at – https://vinodkothari.com/2023/01/sustainable-finance-and-gss-bonds/

^[6] https://www.simmons-simmons.com/en/publications/ck0bi7opto7ds0b36ujkz2wwz/300119-new-growth-in-the-green-securitisation-market

^[7] See for instance, Climate Bond Initiative’s Report titled North America State of the Market 202, giving details of various green ABS deals in the US – https://www.climatebonds.net/files/reports/north_america_sotm_final.pdf

^[8] Fannie Mae’s Single-Family Green Bond program is one of the most popular green RMBS programmes in the US, see details – https://singlefamily.fanniemae.com/single-family-green-mbs

^[9] See details about PACE – https://www.energy.gov/scep/slsc/property-assessed-clean-energy-programs

^[10] https://www.ca-cib.com/sites/default/files/2022-03/Project-Bond-Focus-Solar-ABS-2022.pdf

^[11] https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A02023R2631-20240109

^[12] Securitised exposures shall not comprise exposures financing the exploration, mining, extraction, production, processing, storage, refining or distribution, including transportation, and trade of fossil fuels. It may comprise of exposures financing electricity generation from fossil fuels, co-generation of heat/cool and power from fossil fuels, or production of heat/cool from fossil fuels, where the activity meets the criteria for ‘do no significant harm’ set out in the EU Green Taxonomy.

^[13] While the EuGBS currently focuses on “use-of-proceeds” over “underlying exposures”, the existing issuances also include issuances backed by green underlying assets. See some examples of green ABS deals originated in Europe in the annexure here – https://www.simmons-simmons.com/en/publications/cl3acryjv1n6p0a57trvx1sut/esg-securitisation-taking-stock

^[14] See a report on China Green Securitisation – State of the Market at – https://www.climatebonds.net/resources/reports/china-green-securitization-state-market-2020-report

^[15] https://www.icmagroup.org/assets/documents/Sustainable-finance/2022-updates/Green-Bond-Principles-June-2022-060623.pdf

^[16] Refer Sustainable Bond Market Data at – https://www.icmagroup.org/sustainable-finance/sustainable-bonds-database/

^[17] https://ceew.in/cef/publications/investment-sizing-india-s-2070-net-zero-target

^[18] https://vinodkothari.com/2023/04/rbi-framework-for-green-deposits/

^[19] See, for instance –

LIC Housing – https://www.lichousing.com/static-assets/pdf/Green%20Deposits%20Policy%20LICHFL.pdf?crafterSite=lichfl-corporate-website-cms&embedded=true

Bank of Baroda – https://www.bankofbaroda.in/-/media/project/bob/countrywebsites/india/shareholders-corner2/2024/24-02/bank-framework-for-green-deposits-and-associated-flow-of-credit-for-green-14-18.pdf

SBI – https://sbi.co.in/web/personal-banking/investments-deposits/deposits/sbi-green-rupee-term-deposit

Canara Bank – https://www.canarabank.com/pages/canara-green-deposit

Indian Overseas Bank – https://www.iob.in/IOB-Green-Deposit-Scheme

^[20] https://www.rbi.org.in/Scripts/BS_ViewMasDirections.aspx?id=11959