Transition finance: accelerating the EV transition
Nov 10, 2022
‘Transition finance’ has a critical role to play in channelling the estimated $35trn of investment needed over the next decade to areas of the economy where transformation is required to reach net-zero emissions. Rather than allocating capital to activities that already meet green standards, it focuses on supporting firms in emissions-intensive and hard-to-abate sectors to pivot to net zero.
Transition Finance & Electric Vehicles
As one of the largest emitters of GHG emissions in the UK, road transport needs to pivot away from the internal combustion engine (ICE). In 2020, the UK government committed to end the sale of new petrol and diesel vehicles by 2030 and the transition to electric vehicles (EVs) is well underway. Despite this, as modern petrol and diesel cars sold today can be expected to be on the road for more than 12-15 years, so transformation of the entire UK vehicle parc will be a gradual process. Transition finance has a critical role to play in unlocking the liquidity currently held in ICE vehicles and redirecting it towards those which produce zero emissions, thereby contributing to the net-zero transition.
Potential Accusations of Greenwashing
Transition finance often involves investing in firms with higher emissions, which means it can be more vulnerable to claims of ‘green washing’ than direct investment into companies or assets already considered green. This is because of the need to provide convincing evidence that the funds will and are being used to help the higher-emitting firm reduce its emissions.
In the automotive sector, for example, transition finance could be used to redeploy capital from ‘brown’ ICE vehicles into EVs through a ‘use-of-proceeds’ bond. To ensure this is what is truly happening and avoid accusations of greenwashing, investors need bond issuers to provide them with data to verify where the proceeds are being applied. Currently, however, there is no standard set of data points identified by investors. Consensus and standardisation around the data requirements of issuers would therefore assist the development of transition finance.
For securitisation, this challenge is further compounded by the fact that EV loan providers are one step further removed from investors than in the case of ordinary bonds; there is no direct contract between the two parties which the investor can rely upon in the case of non-compliance around the use of proceeds. For some investors, this lack of immediate control can exacerbate pre-existing anxiety surrounding greenwashing allegations.
Securitisation & Transition Finance
The transition finance movement has a significant role to play in unlocking the potential of securitisation to accelerate EV uptake. Currently, there is no official framework for sustainable securitisation, with market debate centring around whether both the collateral and the use of proceeds need to be ‘green’ for a deal to qualify for a green label – i.e. do the securitised loans and leases need to be for EVs, as well as the divested proceeds of the bonds. Taking this approach limits the role securitisation can play until we reach a critical mass of EVs in the market. In the meantime, therefore, the question is whether a green ’use of proceeds’ on its own is sufficient to justify ‘green’ status – and if not, then whether a ‘transition’ label might be more appropriate.
Some argue a ‘use of proceeds’ approach alone is sufficient to justify green status, as is the case with green bonds. The ‘International Capital Markets Association’, which developed an internationally recognised green bond framework, recently made an announcement which supports this view, with new and updated definitions for securitisation; they distinguish between a pure green collateral bond (‘secured green collateral bond’) and a use-of-proceeds approach (‘secured green standard bond’).
Within the EU, the European Banking Authority has been advocating for a wording change to the EU Green Bond Standard to allow its definition of a green ‘use-of-proceeds’ bond to be extended to cover securitisation. Conceptually a ‘use-of-proceeds’ approach ought to justify some level of green status, even if it is a lighter shade of green than a securitisation that also draws cashflows from sustainable assets (i.e. even if it is considered less environmentally friendly). However, until the market reaches consensus on this view, many investors and originators will continue to be unwilling to take on the risk of calling this type of deal ‘green’. Labelling these as transition deals can help to mitigate the risk of greenwashing.
GFI’s Demonstrator Solution
The Green Finance Institute is working with members of its Coalition for the Decarbonisation of Road Transport to unlock the barriers to green and transition securitisation. In the absence of sufficient green collateral in the short term, transition securitisation can enable market participants to mobilise capital to help fund the transition by ring fencing the proceeds of debt issuance to finance further EV loans. Not only would this create a new ‘green’ asset class for securitisation investors, but it has potential through a ”greenium” to lower the cost of finance for lenders and thereby the cost to the consumer – helping to address the price premium of EVs when compared with ICE vehicles, and accelerating EV adoption.
If you’re interested in finding out more about transition finance to accelerate the EV transition, or how you can support the GFI, please contact CDRT@gfi.green
