ESG securitisation disclosure – a moveable feast

Background

Securitisation transactions frequently involve underlying assets that could have an impact on environmental, social and governance (“ESG”) risks and easily lend themselves to sustainable securitisation as we have seen in the market with recent solar transactions, electric vehicles and social securitisations.  Investors increasingly need more information about sustainable credentials of these products, whether labelled as sustainable or not, to be able to meet their own applicable reporting requirements, manage risks and assess alignment with purpose objectives, including their own net zero goals.

“Greenwashing” or “ESG-washing” remains a huge concern for the market.  Industry initiatives, such as the ICMA Green, Social, Sustainability and Sustainability-linked Bond Principles (the “ICMA Principles”) have been helpful in terms of establishing standards and promoting transparency.  However, there are many perceived gaps and a lack of clarity for investors trying to measure real world impact based on the product information available to them.  Legislatures and regulators are increasingly focused, however, on ensuring that sustainable investment products are accurately described and their sustainability claims are substantiated. 

While there is an increasing focus on disclosure requirements throughout the transaction chain generally, regulations relating specifically to ESG aspects of securitisation have been limited to date. However, there are a number of ESG initiatives in the pipeline which are likely to impact the securitisation market, whether directly or indirectly.  Investor due diligence and external verifiers also have a role to play and we discuss these further below.

What are the current regulations impacting securitisation investors?

We have seen a number of developments in the EU that impact in-scope banks, large corporates and asset managers by imposing disclosures of sustainability risks, including in some cases social and governance considerations.  These in turn drive the type of information investors (including asset managers) might need from originators.  Some prominent regulations include Regulation (EU) 2019/2088 (the "Sustainable Finance Disclosure Regulation” or "SFDR"), and Directive (EU) 2022/2464 (the “Corporate Sustainability Reporting Directive” or “CSRD”, which amends and extends the existing Non-Financial Reporting Directive).  Complementary to these is Regulation (EU) 2020/852 (the “EU Taxonomy Regulation”) which, together with Commission Delegated Regulation (EU) 2021/2178 (the “Delegated Act supplementing Article 8 of the Taxonomy Regulation”) and the Commission Delegated Regulation (EU) 2021/2139 (the “Taxonomy Climate Delegated Act”) and Commission Delegated Regulation (EU) 2022/1214 (the “Taxonomy Complementary Delegated Act”), combines with these regulations to provide a framework for what is considered “green” (the “EU Taxonomy”).  There are also some quantitative and qualitative disclosures and a green allocation ratio under Article 449a Capital Requirements Regulations, as amended.  These regulations can impact securitisations from a bottom up perspective as securitisation investors have obligations to report under their relevant regimes and therefore securitisation documentation needs to evolve to enable compliance with these requirements. 

The UK has a clear commitment to follow a similar trajectory including, for example, the FCA's proposed Sustainability Disclosure Requirements and investment labels (CP 22/20) (“SDR”), which is the UK’s answer to the SFDR.  On 17 January 2022, the UK became the first G20 country to mandate climate-related financial disclosures, impacting over 1,300 of the UK’s largest companies and financial institutions.  On 30 March 2023, the UK Government published an updated Green Finance Strategy which sets out plans for creating a “Net Zero-aligned Financial Centre” with a framework for green and sustainable finance policies.  The Green Finance Strategy also highlighted the UK Government’s commitment to adopting a UK green taxonomy and commitment to implementing the SDR.  Other jurisdictions are also following suit in this area, increasing obligations for disclosure and reporting on investors and other stakeholders, which in turn passes down through the market impacting products and documentation.  For more information on these EU and UK regulations please see our other Engage articles on these topics¹.

What are the current and proposed ESG disclosure requirements for originators and issuers?

There are very few ESG disclosure requirements directly impacting securitisation at the moment.  However,  measures are being considered in the EU and UK, and indeed worldwide, which may go some way to enhancing ESG transparency requirements in the securitisation market.  These aim to ensure that more ESG-related transaction data is available for relevant stakeholders and align requirements for securitisation with other existing regulations impacting investors to create a level playing field for securitisation with other products (such as covered bonds) and to allow investors sufficient information to compare financial products.

Securitisation Regulation and regulatory technical standards

The only regulatory reporting requirement for securitisation transaction ESG data is in Regulation (EU) 2017/2402 (the "EU Securitisation Regulation") which currently requires the provision of limited environmental performance metrics (where available) in respect of residential and auto portfolios for simple, transparent and standardised (“STS”) securitisation transactions.²

The Joint Committee of the ESAs published, on 25 May 2022, a Final Report on draft Regulatory Technical Standards on STS securitisations-related sustainability disclosures (“Final RTS”).  The Final RTS closely aligns disclosures under the EU Securitisation Regulation’s STS regime with the SFDR.  The ESAs seek to create efficiencies in reporting (at least for residential loans and automotive loan and leases, though other asset classes may be considered).  This might be a welcome initiative, given problems around lack of clarity as to methodologies and characterisation of principal adverse impacts ("PAI") indicators.  Whilst this is a move forward for increased transparency, key points to note:

• The Final RTS applies only to STS traditional securitisations and on-balance sheet-securitisations (and not asset-backed commercial paper (“ABCP”)) where the underlying exposures are residential loans, auto loans and leases.  The initial consultation had requested feedback as to whether these categories should be expanded.  This potentially leaves gaps in relation to other asset classes such as commercial real estate, corporate debt (including trade receivables), small and medium-sized enterprises consumer loans and credit cards.
• The Final RTS are entirely voluntary.  It will remain possible for originators in STS traditional securitisations and on-balance-sheet securitisations to comply only with the initial disclosure requirements relating to environmental performance set out in first sentence of Article 22(4) and Article 26d(4) of the EU Securitisation Regulation.  By allowing originators the option not to comply with the Final RTS, investors in securitisations might not have the ESG information they need to fulfil their reporting requirements.
• A securitisation does not constitute a “financial product” under Article 2 of SFDR and therefore SFDR does not apply directly to securitisation products; however securitisations are indirectly subject to SFDR through the entity level disclosure requirements, as PAI indicators under the SFDR cover all investment decisions, including investments into securitisations. 

Alignment of the Final RTS with SFDR may be helpful for SFDR-compliant investors, such as asset managers as they seek to harmonise their investment criteria.  However investors and/or originators not otherwise subject to the SFDR are potentially in a difficult position – they may not want to make or receive SFDR-compliant disclosure and may not have systems in place to track this but may nevertheless feel compelled by market practice to disclose in accordance with the voluntary requirements of the Final RTS.

• The voluntary disclosures under the Final RTS may continue to be limited by the availability of consistent data.  Disclosure could be hampered by jurisdictional variations in disclosure requirements, availability of information and lack of effective systems and controls to monitor data.  DBRS Morningstar notes that the “absence of widely recognised energy standards and energy-efficiency data poses a difficulty for issuers in creating marketable green securitisation products” and further that “data availability and quality can be a challenge, as climate data can be complex and incomplete or unreliable at the regional or local level”³.
• The Final RTS propose a form of SFDR-aligned template that is contemplated as a stand-alone document for now, separate from the current templates, as required by Article 7 of the EU Securitisation Regulation, but this will be reviewed as part of ESMA’s ongoing template review (as discussed further below).
• The fact that the Final RTS will not apply in the UK, unless the UK adopts similar standards, is a potential area of divergence.  The UK on-shored the EU Securitisation Regulation with effect from 1 January 2021 with minimum changes (the "UK Securitisation Regulation" and together with the EU Securitisation Regulation, the "Securitisation Regulations").  As such, currently the same requirements apply as in the EU through the UK Securitisation Regulation.  Any subsequent amendments or technical standards do not form part of this onshoring and the UK Securitisation Regulation does not currently provide for the drafting of any sustainability technical standards.  However, in its Review of the Securitisation Regulation: Report and call for evidence response HM Treasury said that further consideration will be given as to whether it is appropriate to extend the UK Securitisation Regulation’s environmental information disclosure requirements and that it is likely that any additional information required would be subject to availability, as is currently the case.  It seems inevitable that, in order for UK companies to comply with their reporting requirements under the SDR in due course, this will necessitate more disclosure from the securitisation industry, consistent with investor needs.

It is unclear to what extent originators will comply with the voluntary disclosures of the Final RTS once they are finalised.  It appears that there has not been a material uptake in the market for completion of the current environmental fields provided by the EU Securitisation Regulation so it seems possible currently that the additional voluntary disclosures will not be widely adopted, in the near term at least.  DBRS Morningstar commented that, according “to the European Datawarehouse (EUDW), energy performance certificate (“EPC”) information was reported in loan-level data for only 48 European RMBS transactions out of a possible 143.  Moreover, not all 48 deals have complete loan-level information about the EPCs”⁴.   

The impetus needs to come from elsewhere, which is why advancing standards in the loan and bonds markets and in investor reporting all need to combine  to generate engagement and impact.

For more information please see Engage article - Step forward for green securitisations with standardised STS-related environmental disclosures.

European Green Bond Standard

In May, 2023, the EU Parliament and the EU Council published the final compromise text on the European Green Bonds (“EuGB”) and optional disclosures for bonds marketed as environmentally sustainable and sustainability-linked bonds (the “EuGB Regulation”).  This introduced a voluntary standard and all bonds labelled as "EuGB" or “European green bond” will need to be aligned with the provisions under the EU Taxonomy Regulation, comply with prescribed disclosure and reporting requirements and be subject to oversight by ESMA.  The EuGB Regulation is unlikely to apply until the end of 2024 and there are quite a few level 2 measures that the European Commission and ESMA need to publish and which will provide further clarity as to some of the finer details.  Please see Engage article EU Green Bond Standard – a panacea for securitisation?

Whilst only the final compromise text has been published, and is subject to change, securitisation market participants will be pleased to see that proposed modifications to the EuGB Regulation will permit a “use of proceeds” framework applicable to an originator, as opposed to the issuer, in securitisations.  This would mean that, rather than being limited to including green collateral at the issuer level, a securitisation may now benefit from looking at the originator’s role in sourcing green assets in allowing transactions to adopt the EuGB label.

In addition to complying with any ESG-related disclosure requirements under the EU Securitisation Regulation, securitisation bonds using the EuGB label will be subject to reporting templates in addition to any prospectus disclosure requirements.  The securitisation market is already very familiar with disclosure requirements and the EuGB Regulation proposes another layer to these rules, necessitating new disclosure templates, a “European green bond factsheet” and “European green bond allocation report”.  Securitisation bonds are expressly contemplated in the Annexes of the EuGB Regulation.  There will also be new voluntary templates for bonds marketed as environmentally sustainable and sustainability-linked for which the European Commission will publish guidelines within 12 months so there remains some work to be done in this area.  We do not know yet to what extent, if at all, the EuGB Regulation disclosure will impact or interact with reporting under Article 7 of the EU Securitisation Regulation, which is currently under review by ESMA.

As with existing securitisation reporting requirements, voluntarily-disclosed climate-related data for securitisations under the EuGB Regulation should be available through securitisation repositories, as has been proposed by the ESAs and the ECB in the Joint Statement in relation to loan-level data (as discussed further below) and via websites.  There are also proposals to make data publicly available via the European Single Access Point, which aims to provide a central point for information about EU companies and products.

To a certain extent the EuGB Regulation could be viewed as being a big step forward for ESG securitisation in the EU, though it will be limited to use of proceeds that align with the EU Taxonomy.  Given that not all use of proceeds securitisations will be able to align with the EU Taxonomy a large portion of securitisation transactions will not fall outside the scope of the EuGB Regulation, such as social securitisations and synthetic transactions (though inclusion of some social metrics is included in the European green bond impact report contemplated by the EuGB Regulation).  Complying with the “Do No Significant Harm” principle has proved problematic for some interpreting the SFDR and is likely to be a challenge in EuGB Regulation compliant securitisation transactions that will also  need to meet this standard.  We expect therefore that securitisation bonds not within scope of the EuGB Regulation will continue to develop ESG credentials via alternative routes, including continued reliance on industry standards, such as the ICMA Principles.

The UK has not yet set forth proposals as to any changes to the prospectus requirements for any green or other ESG bond standard.  However, the FCA has indicated that it might consider a framework for ESG securities in due course as part of its review of prospectus requirements and its overall UK regulatory framework review⁵.  Meanwhile, the FCA has encouraged issuers of ESG-labelled “use of proceeds” securities to consider voluntarily applying relevant industry standards, such as the ICMA Principles and related guidelines.

ESAs and ECB joint statement – voluntary climate-related disclosure

We can see that the EU Securitisation Regulation, related Final RTS and the EuGB Regulation go some way to addressing data provision in relation to environmental risks, but this will apply in relation to only a limited number of scenarios.

As securitisations often include underlying assets that could impact climate, the European Supervisory Authorities (the “ESAs”) and the European Central Bank (“ECB”) want to enhance disclosure standardisation for securitised assets and have, in a joint statement on disclosure on climate change for structured finance products (the “Joint Statement”) called on originators, sponsors and issuers to be proactive and collect data at the time of loan origination that investors need to assess ESG risks and fill in the voluntary climate-related fields in the existing securitisation disclosure templates.  The voluntarily disclosed climate-related data should be available through securitisation repositories.  This data may be of interest to other stakeholders, such as rating agencies, financial institutions and the general public and is of increasing relevance to regulators.  This may also be relevant to covered bonds.  It is also worth highlighting that this request only relates to climate-related data and so, similar to the EuGB Regulation, focuses on the “E” of ESG.

Loan-level disclosure templates review

Following on from the European Commission report on the functioning of the Securitisation Regulation (“Article 46 Report”), ESMA is in the process of reviewing the securitisation loan-level disclosure templates under Article 7 of the EU Securitisation Regulation, with a view to producing a dedicated, simplified template for private securitisations.  Consideration is being given to the inclusion of additional climate-related metrics in the templates.  However, we do not yet know to what extent any climate-related disclosure will be required in these templates and to what extent it will take into account the call from the ESAs for originators to provide additional loan-level data reporting.  Many investors have struggled with the XML format for current reporting; the benefit of the templates could continue to be limited if the XML format were to be mandatory also for the revised templates.

As discussed above, the Final RTS provide voluntary templates for some limited reporting for PAIs for residential loans, auto loans and leases. It is currently envisaged that this will be a stand-alone SFDR-aligned template, separate to the existing Article 7 templates.

Where securitisation templates for reporting are desired by investors, but not available or may not cover social and governance-related data, other templates could be adapted for use on a voluntary basis for bespoke investor disclosure purposes.  For example the RTS under Delegated Regulation (EU) 2022/1288 (the “SFDR RTS”)⁶ provides templates for PAIs which could be adapted for use.  The Task Force on Climate-related Financial Disclosures (“TCFD”), the Taskforce on Nature-related Financial Disclosures (“TNFD”), the forthcoming European sustainability reporting templates for CSRD compliance, as well as the ICMA templates and guidance may also be of use⁷.  In addition, the disclosure reporting templates under the EuGB Regulation might also prove helpful, even for transactions that are not within its scope.  Proliferation of forms and templates with potentially similar requirements but slightly different data requirements, is also a concern as the burden this creates on market participants from a reporting perspective needs to be contained.  Whilst it is clear that we are unlikely to be able to converge on a “one size fits all” approach, government regulators and the industry need to bear in mind that efficiencies will be gained by avoiding “battle of the forms” and ensuring centralised information repositories and inter-operable data sets and templates are developed during the formative period.

Prospectus requirements, marketing materials and frameworks

In December 2022, the European Commission proposed some changes to the EU Prospectus Regulation as part of the Listing Act package of reforms.  The proposals include power for the European Commission to adopt delegated acts setting out standardised annexes specifying the ESG-related information that should be included in a prospectus which is advertised as taking into account ESG factors or pursuing ESG objectives.  Similar to the proliferation of forms concerns raised above, it will be important to ensure that these new annexes are consistent with the templates for the voluntary standards for bonds marketed as environmentally sustainable or sustainability linked bonds under the EuGB Regulation.

Different jurisdictions or regulations may impose additional disclosure requirements.  Most recently, in May 2023 , the UK FCA published an engagement paper⁸ in relation to new rule making powers under the public offers and admissions to trading regime which anticipates strengthening, and providing for more consistency of, ESG disclosure requirements for green, social or sustainably labelled debt instruments.

The UK proposes that issuers, and parties with responsibility for the prospectus, should ensure that there is clear disclosure of ESG risks in order to provide transparent information for investors and mitigate risks or green-washing or misleading investors.  Areas to consider include:

• Disclosure

  • All relevant ESG risks should be disclosed and disclosure of relevant ESG information should be accurate and not misleading.  Requirements of applicable law and regulation must be complied with.

  • Avoid ESG-washing, taking into account regulatory and investor demands.  For example it should be noted that there is currently no consensus as to what constitutes, or what the relevant attributes are of, a “green” or "social" or other “sustainable” bond and claims as to meeting particular ESG goals should not be overstated or misleading.  Transactions have tended to focus on relevant industry standards, such as the ICMA Principles and related guidelines Particular care should be taken when making forward-looking statements in the context of a “use of proceeds” securitisation.

  • Care should also be taken that the prospectus aligns with the relevant marketing materials. Although the prospectus is subject to regulation as to its prescribed form and content, any misstatement in other marketing materials could potentially result in regulatory sanction and possibly a claim by investors if it can be shown that they relied on this to their detriment (and liability is not otherwise excluded).

  • Many transactions involving ESG securitisations adopt ESG frameworks which contain details as to the ESG features of a securitisation: these should not conflict with the prospectus or marketing materials.  ICMA provides pre-issuance checklists that help in the development of ESG frameworks and ESG securitisations have generally utilised verification agents to check their compliance with the relevant industry standards.  These ESG frameworks may be modified from time to time.  Importantly, they are not usually incorporated by reference into the prospectus.  However, care should still be taken where any reference is made to frameworks (which should not be incorporated by reference, but may otherwise be referred to) in case these are deemed to be advertisements and fall within any regulatory ambit, as the FCA has discussed in Primary Bulletin 41.

• Disclaimers

  • This may include, for example, language confirming that there is no assurance that the bond will meet the investor’s ESG expectations.  Disclaimers are notoriously difficult to draft and care should be taken to ensure that they are clear and cover all relevant areas where parties might want to try to limit liability.

  • The reports of external verifiers and reviewers are not incorporated by reference, disclosure should include whether any regulatory or supervisory regime applies in relation to such verification or reviewer report and statements should also be included as to non-reliance on these reviews.   As is usual in the context of the relationship between issuers and professional investors, it should be stated (and understood between the parties) that investors should make their own determinations and, where relevant, that third parties have no liability to noteholders or trustees or other relevant persons.

Currently, the scope of representations and covenants in transaction documents for ESG transactions varies significantly between transactions, though we expect to see increased standardisation going forward, driven by both regulation and continued use of industry-led principles.

Markets in Financial Instruments Directive

It is worth noting that on 3 April 2023 ESMA published Guidelines on certain aspects of the suitability requirements of Directive (EU) 2014/65 (“MiFID II”) which apply six months from the date of publication on ESMA’s website in all EU languages ("MiFID II Guidelines"). The previous ESMA guidelines issued under MiFID II on 23 September 2022 will cease to apply on the same date. The aim of the MiFID II Guidelines is to clarify the application of certain aspects of the MiFID II suitability requirements and to integrate sustainability risks in the investment decision or advisory processes of manufacturers and distributors as part of their duties towards investors and/or clients.  The MiFID II Guidelines also reflect recent developments including sustainability-related amendments to the MiFID II Delegated Directive  which integrated sustainability factors into the product governance requirements and applied from 22 November 2022.  Any manufacturer or distributor, as part of its product governance requirements, and acting in clients' best interests, should consider to what extent sustainability considerations for investors in securitisations are incorporated within any relevant suitability assessments and product governance obligations, including within internal systems and controls and as part of the target market assessment.

Supply chain due diligence regulations

The proposal for directive on corporate sustainability and due diligence (“Corporate Sustainability Due Diligence Directive” or “CSDDD”) envisages that in-scope companies, including financial services companies, will carry out due diligence on their supply chains, including outside Europe, to identify adverse impacts of their operations and how to improve them.  The aim of this Directive is “to foster sustainable and responsible corporate behaviour and to anchor human rights and environmental considerations in companies’ operations and corporate governance”.  Once the CSRD is approved and published in the Official Journal of the EU, EU Member States will have 18 months to transpose the directive into national law. Entities will therefore need to check how particular EU Member States transpose the CSRD as there may be differences in transposition which will affect how the directive applies in different EU Member States.  There are also other relevant jurisdiction-specific laws on supply chain due diligence that parties may need to take into account, such as the German Supply Chain Law, Uyghur Forced Labor Prevention Act, Norwegian Supply Chain Transparency Act9, and the UK Modern Slavery Act 2015.  We can therefore expect an increased need for information, not just about the underlying assets in a securitisation, but also concerning the supply chain lying behind those assets, given that some originators may be within scope of the CSDDD themselves and will also have investors who will require information in order to comply with their CSDDD obligations.  Originators may need to consider to what extent their systems and controls can support this, as well as the format of disclosure (there are currently no standardised templates, and the templates that are evolving in relation to the climate and green aspects of securitisations and their underlying do not currently contemplate these features).  Many investors in securitisations will be in scope and may start to pay closer attention to supply chain risks of their investment products.

The role of due diligence in investor protection

The role of due diligence in securitisation

Due diligence of ESG risks in securitisation may include reviewing data templates provided and also raising additional questions.  The integrity and availability of ESG data is essential for investors to make a robust assessment of ESG risks and real world impact.  From a climate change perspective, investors need to determine to what extent a product meets their net zero ambitions and be able to benchmark products against others. 

Investors are also increasingly required to comply with and report under various regulations, such as the SFDR and this will only increase with regulations such as the CSRD and CSDDD.  These also have an effect on investor’s investment strategies and consequently as to the due diligence they carry out, to obtain the information needed on investments as they align their business to sustainability driven regulations, as discussed above.

No one size fits all at the moment

At present, practice varies a great deal in this area with the depth and complexity of questions varying from transaction to transaction; there may be market and jurisdictional variance, as with all due diligence, depending on nature and type of underlying asset and location of the target market.  For example in the US there are new potential SEC climate-related disclosure requirements for ESG¹⁰.  Questions may be guided by internal reporting requirements of PAIs under regulations such as SFDR (as discussed below), however overall the proliferation issue remains a challenge here too and, although some industry due diligence questions, like those used by the Alternative Investment Management Association are helpful guidelines, many bespoke requirements remain.

What impact does ESG due diligence have on investors?

Investors need to be satisfied that a product meets its ESG-credentials.  They also need the information for their own funding credit and market risk assessments and results of due diligence may inform the size and type of credit given and the type of products investors are willing to purchase.  Due diligence is also needed as part of an investor’s overall systems and controls.

The role of external verifiers and reviewers and ESG rating agencies

Role of external verifiers or reviewers

We mentioned external verifiers above in relation to appropriate prospectus disclosure concerning use of such reviewers and reliance on reports.  Use of external verifiers is already common as issuers engage their services to to validate green credentials.  These verifiers and their reports will be of increasing relevance under the EuGB Regulation.  As well as providing investors with reports and certifications on particular transactions,  they offer tools to compare different types of ESG transactions in the market.  Comparability is very important to investors, including to be able to weigh the alignment characteristics of one transaction against their own goals, with another.  This can guide investment decisions and help investors pursuing net zero transition pathways, as well as other ESG goals.

ESG rating agencies

Some rating agencies provide specific ESG ratings, as well as “indicators” or “scores” which indicate how ESG factors affect credit ratings or may simply include an analysis of ESG in their ratings reports¹¹.  Investors often rely on such ratings when they have no capacity to collect the data (or access to it) or perform the analysis themselves.  Unlike credit rating agencies, ESG rating agencies, and other reviewers, are unregulated in the ESG space.  Regulators and market participants have identified areas of concern, such as lack of transparency in methodologies used, difficulties in interpreting ESG rating as well as issues relating to conflicts of interest, bias and governance. No doubt keen to avoid a repeat of previous failings, as evidenced in the 2008 financial crisis, regulators in various jurisdictions are reviewing the provision of ESG ratings and it is likely that regulation in this area is coming down the track.¹²

What to consider when engaging with external reviewers, verifiers or rating agencies

Parties should consider appropriate terms of engagement that can provide some comfort as to the parties’ expectations, including as to a reviewer’s expertise and agreeing the extent of reliance on any ratings or reports.  The FCA  in its Primary Market Bulletin 41 also suggests that issuers engage with opinion providers to ensure that they adhere to appropriate standards of conduct.

What does the future hold for securitisation ESG disclosure?

As we have seen, there are a number of proposals in the works that could be beneficial to the data and disclosure requirements of the securitisation market.  There is still some work to be done however to manage gaps between investors’ obligations and requirements, including for example under legislation such as the SFDR or as part of their internal systems and controls,  and the current securitisation framework.

• Bespoke framework for securitisation. 

Alignment with the EU Taxonomy, and therefore adoption of an EuGB label, will not be possible for some securitisation asset classes, which will not sit neatly within the framework; and of course it is not available for synthetic securitisations.  The Final RTS will apply to STS non-ABCP traditional securitisations and are limited as to asset classes covered.  This may leave a large portion of ESG securitisation transactions outside the scope of regulatory proposals, although these could nevertheless choose to adopt similar standards on a voluntary basis.  Industry standards, such as the ICMA Principles will continue to have a significant part to play.  The possibility of a bespoke framework, or a formal ESG-securitisation label like the “STS” label, remains an option in the future; inevitably a significant concern would be that holding securitisation to a higher standard compared to other financial products, such as covered bonds, could be harmful but it can’t be ruled out that a bespoke framework may be required in order to propel securitisation further in this area.  The EBA and HM Treasury in the UK have each concluded that no dedicated green securitisation framework is expected for the time being, though this could be reconsidered as the market evolves.  The EuGB Regulation also contemplates future reviews for the securitisation framework.¹³ Please see Engage article EU Green Bond Standard – a panacea for securitisation?

• Template and disclosure developments

The review of the current Article 7 templates and proposed introduction of the EUGB label under the EuGB Regulation could be beneficial for market participants but a gap for products not within their scope could remain an issue; originators may need to continue to use other market driven templates or adapt templates that are not specifically crafted for securitisations.  Securitisation products can expect demands for increased disclosure from a multitude of sources as referenced above including supply chain and corporate sustainability due diligence drivers, as well as the “green” and “social” product regulations and standards as they evolve.  The ESAs and ECB have stated that, from 2026, only assets from companies within scope of CSRD will be accepted as collateral for its Eurosystem collateral operations, though requirements relating to securitisations, which are not within scope of the CSRD, have not been clarified yet. 

• Voluntary versus mandatory requirements

ESG disclosure and data reporting proposals at the moment are almost entirely based on voluntary compliance.  However DBRS observes significant under-reporting under the EU Securitisation Regulation and that as “only 19% of securitised residential loans and 21% of securitised auto loans in Europe have reported their EPC information (as reported in the EUDW database), achieving this goal of reporting without mandating certain disclosures might continue to be difficult”¹⁴.  Overly prescriptive and/or mandatory requirements are unlikely to be a welcome addition to the market at this stage, which is already subject to significant reporting requirements and could in fact have the opposite effect of hampering the market in its drive to contribute to net zero.  It is not inconceivable that voluntary reporting could become mandatory over time however, particularly if reporting remains inconsistent and as the market becomes more standardised. 

• Greater focus on the “S” and “G” of ESG

As we have discussed, much of the current focus for securitisation is on climate-related data with other environmental factors (such as biodiversity) with social and governance factors not being subject to as much scrutiny.  Other regulations impacting investors, such as the SFDR, CSRD and CSDDD impose increased reporting obligations with respect to social and governance factors and this may be a future area of focus for securitisation.

• Jurisdictional divergence

There is a risk of increased divergence in this area that will need to be considered on transactions.  It is unknown to what extent the UK will adopt a similar or consistent approach with the EU and there is a risk of divergence with other jurisdictions which can provide more complications for parties having to comply with conflicting requirements and risk of arbitrage.

• Blockchain

Developments in blockchain technology may be looked at by the market with interest as a possible solution to data monitoring, reporting and verification, as well as supply chain due diligence, and is an area to watch.  Information transfer could be automated, direct and near instantaneous, becoming more transparent and simplified as well as possibly more cost effective due to lack of intermediaries.  Real time data reporting would help with investor due diligence and also would be useful for assessment of credit and market risk for purposes of secondary market trading.  ESG rating agencies, verifiers and auditors could access source information directly and on an as needed basis which would help credibility of ratings, reports and audit avoiding opportunities for data errors and manipulation. 

Conclusion

Given the continuing drive from investors and governments in pursuit of ESG goals, including crucially, the need to alleviate the climate crisis and achieve Net Zero by 2050, there will be an increasing need for green and wider sustainability orientated products.  We also expect demands for improvements on ESG data quality, accessibility and transparency overall.  Specifically in securitisation, for STS securitisations, which already are subject to heavy reporting obligations, increased disclosure requirements might be seen as yet another administrative burden with associated costs.  However, it may be that non-STS securitisations effectively begin to “catch-up” here , given that on sustainability factors, clear and proportionate data analysis is of increasing relevance to all parties in the chain in order to contribute to the continuing battle against ESG-washing and bolster confidence.

As things stand, market driven efforts have produced some relevant ESG information but not in sufficient quantity and initiatives to date also suffer from a proliferation of bespoke requirements and many inefficiencies.  Regulations are coming which should be of assistance in this respect.  The devil, as always, will be in the detail of the rules, but market participants will be hopeful, as ever, that the regulators will strike the right balance between a useful centralised approach that is not  unduly prescriptive and that a level-playing field with other green and sustainable financial products can be reached.  Overly burdensome reporting requirements can prevent the market from driving forward and so vigilance is needed to  promote investor confidence and greater supervisory oversight, whilst helping to give a much-needed boost to the market.

Authored by Sven Brandt, David Palmer, Bryony Widdup, Sebastian Oebels, Jane Griffits, and Deborah Giurgola.

References

1 Relevant Hogan Lovell Engage articles:

EU Green Bond Standard – a panacea for securitisation?

Talking about a revolution: making ESG securitisations mainstream

EU Corporate Sustainability reporting - impact on non-EU entities

UK: FCA update on SDR and investment labels consultation

UK: Updated Green Finance Strategy 2023

2 Article 22(4) and Article 26d(4) of the EU Securitisation Regulation

3 https://www.dbrsmorningstar.com/research/413031/esg-data-in-structured-finance-the-more-the-merrier

4 https://www.dbrsmorningstar.com/research/413031/esg-data-in-structured-finance-the-more-the-merrier

5 FS22/4: ESG integration in UK capital markets | FCA

6 The EC adopted a Delegated Act amending and correcting SFDR RTS relating the content and presentation of information in pre-contractual documents and reports for financial produces in ESG.

7 ICMA pre-issuance checklist for Green Bonds/Green Bond Programmes

8 Paper 4:  Non-equity securities

9 This is an unofficial translation of the Norwegian version of the Act and is provided for information purposes only. Legal authenticity remains with the Norwegian version as published in Norsk Lovtidend. In the event of any inconsistency, the Norwegian version shall prevail.

10 To allow underwriters to (i) establish a due diligence defense under Sections 11 and 12(a)(2) of the Securities Act of 1933 (as amended) (the Securities Act) and (ii) negate the inference of fraud under Rule 10b-5 under the Securities Exchange Act of 1934 (as amended).

11 https://www.unpri.org/credit-risk-and-ratings/esg-in-credit-ratings-and-esg-ratings/11071.article

12 The EU has been contemplating ratings practices relating to ESG since 2018 and to what extent ESG ratings affect credit ratings. No amendments to  Regulation (EU) 462/2013 (the “CRA Regulation”) were recommended but ESMA issued advice, followed on 18^th July 2019 by its Guidelines on Disclosure Requirements Applicable to Credit Ratings.  The International Organization of Securities Commissions (“IOSCO”) also published recommendations in 2021, including as to publicly disclosed data sources, defined methodologies, management of conflicts of interest, high levels of transparency, and handling confidential information. 

On 3 February 2022, ESMA launched a call for evidence on market characteristics for ESG rating providers in the EU

On 4^th April 2022, the European Commission published a consultation on the functioning of ESG ratings market in the EU and on the consideration of ESG factors credit ratings.  AFME and ISDA joint responded jointly.

In the UK, on 30 March 2023, HM Treasury published a consultation paper on the future regulatory regime for ESG ratings providers seeking views on whether ESG ratings providers should be brought within the regulatory perimeter and if so, how this should be done. 

13 HM Treasury’s Review of the Securitisation Regulation: Report and call for evidence response and the EU Commission’s Article 46 Report each concluded that no green securitisation framework is expected to be established in the immediate future.  In its Report on developing a framework for sustainable securitisation (the “EBA Report”), assessing how to integrate sustainability-related transparency into the EU Securitisation Regulation, the EBA concluded that it is not appropriate to establish a dedicated framework at this time but could be more relevant as the ESG market evolves, though it did suggest safeguards to be considered should a proposal for a green securitisation framework be proposed. 

14 https://www.dbrsmorningstar.com/research/413031/esg-data-in-structured-finance-the-more-the-merrier