Begum Gursoy, global technical head, debt capital markets and sustainable finance commercials at Sustainalytics, answers SCI's questions

Q: Sustainalytics supports investors develop and implement responsible investment strategies, including by providing second-party opinions (SPOs) on whether a green, social or sustainability bond framework is aligned to market expectations. Could you outline the steps involved in assigning an SPO to an ESG securitisation?
A: The overarching function of an SPO provider is to have a holistic view of the market standards and communicate that view clearly and transparently. The key pillars of an SPO centre on an issuer’s investments, how the projects are selected, how the proceeds are managed and reporting. It should also provide investors with the full picture of how an investment fits with the issuer’s sustainability goals and how the financing will provide a positive impact.

With ESG securitisation SPOs, Sustainalytics tries to gain a robust understanding of whether the instrument is aligned with investors’ expectations and the relevant external standard, such as ICMA’s Principles. Each transaction is different, so it’s important to identify which type of securitisation it is, whether the underlying assets are credible and impactful, and which other parties are involved. A key goal is to understand the mechanisms to avoid double-counting, thereby ensuring that the green or social label is assigned to a single party and that the labeled transaction does not purchase another labeled instrument.

The next step is to analyse the alignment of the instrument against the relevant standard - such as ICMA’s - component by component, in terms of governance and undertaking reporting.

One piece that isn’t so obvious about providing SPOs is that part of our role is understanding the considerations that investors may take into account, which aren’t necessarily limited to making a call about what’s ‘green’ or ‘social’. Investors consider many different factors, including that the parties involved have sufficient entity-wide sustainability practices in place, that the originator is credible and that the instruments and its investments contribute to parties’ sustainability journey. In that sense, we want to make sure SPOs are one-stop communication tools to enable investors to make informed decisions.

Q: Are there any securitisation-specific challenges that need to be overcome when providing an SPO?
A: ESG securitisation is a relatively new market that continues to evolve. As such, official definitions and guidance are still developing - which could be challenging because we’re still expected to opine on the alignment of instruments against evolving market standards. Such an environment also allows for ambiguity of interpretation, which can result in issuers testing different structures.

Overall, there is still work to be done on creating or uniting ESG standards for securitisation on a product level. We observe that relying on the ICMA principles, for example, sometimes limits access for issuers in certain jurisdictions, given the challenges around looking at the transaction from an originator’s point of view.

The European Commission recently published new measures to strengthen the EU sustainable finance framework that stipulate the use of proceeds is applicable to the originator, rather than the issuer. This means that instead of relying on eligible assets being included in an ESG investment, an investor can analyse the role of the originator, which would be committing the proceeds to generate new green assets.

It is a different approach and has the potential to open up the ESG securitisation market if it’s implemented in a credible and diligent manner. However, while the measures might result in more deals being eligible, they don’t address the lack of supply for ESG assets to securitise, because the assets need to be aligned with the EU Taxonomy.

Q: Sustainalytics provides annual reviews of ESG bond frameworks. What happens when a securitisation is no longer aligned with the commitments set out in its bond framework?
A: Annual reviews gauge whether an issuer has allocated proceeds and reported on the impact of the investments in the way that was proposed in the Framework. Sometimes there is a different outcome – for instance, the issuer needed to change strategy – and the transaction is no longer aligned to the framework. Our job is to be transparent about the divergence in alignment; it’s up to the issuer and investors to take any further action, where necessary.

Q: A lack of clarity seems to persist within the securitisation industry around what constitutes a ‘social’ bond. Does this impact the provision of SPOs?
A: With respect to ‘green’ activities, an issuer is expected to meet a widely recognised and science-based criteria in order for a securitisation to be ESG-aligned. However, there is no agreed-upon definition in terms of the positive impact of ‘social’ activities and a lack of knowledge about their additionality. Every context is unique and the outcomes are different, depending on whether the issuer is domiciled in the Nordics, the US or Asia, for example.

For us, the key is to understand the social challenge, as well as who faces that challenge within a given jurisdiction. Consequently, a social investment should ensure that the investment is addressing the challenge without creating additional struggles.

Q: In your view, is the ESG securitisation market on the right track?
A: Yes, I believe that the ESG securitisation market is moving in the right direction. Investor demand for ESG securitisation remains strong and sponsors continue to integrate ESG considerations into their businesses.

However, diversification is an important topic right now. The majority of the securitisation market is focused on green assets, whether that be energy efficient buildings or renewable energy assets. But the market also needs to move beyond the core sectors of green securitisation – and there is potential to expand into other sectors, such as affordable housing and education, and therefore attract a broader range of investors.

Another pressing issue is incorporating transition financing elements into the ESG securitisation framework. There isn’t a widely recognised official definition of what constitutes a ‘transition’ securitisation yet, but there is an understanding that such financings could target industries, activities or assets that are crucial to overall decarbonisation efforts, without creating a ‘lock-in’ effect in the case of technologies or business models that may be greener. In order to help industries meet the climate targets, it is important to embrace the principle of ‘enablement’ and look at assets from this point of view.

Corinne Smith