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Will synthetic securitisations become a key impact investment tool?

A look at one of the world’s biggest ever impact deals, and what it means for the market

One of the largest-ever impact investment deals was announced last month – an innovative, $1bn synthetic securitisation. 
Those involved in the transaction see it as a way to really scale impact investing, although these types of instruments still evoke mistrust from many corners, following their role in the 2008 financial crisis.
The deal sees the African Development Bank (AfDB) buy credit protection on a $1bn portfolio of loans from a group of investors led by New York-based credit fund Mariner Investment Group.
The investors do not acquire the assets – approximately 50 senior loans split between infrastructure and African finance institutions – but take on some $152m of default risk on the $1bn portfolio, in exchange for returns.
Dr. Andrew Hohns, Lead Portfolio Manager and Head of the Mariner Infrastructure Investment Management Team, explains that the capital structure has four tranches: the bank which is retaining a junior tranche of $20m which is 0-2%; the investor tranche which represents the next 15.25%, and a 10% tranche from 17.25 to 27.25% which is an unfunded guarantee from the European Commission through the European Fund for Sustainable Development.
The loans remain on the AfDB’s balance sheet, but the transaction allows it to hedge credit risk. Most importantly for the AfDB, it retains the most senior tranche with a lower risk weight attributed to it.
Hohns says the lower risk weight allows the AfDB to free up capital to do new lending in Africa under rating agency capitalisation standards, in this case more than $600m of new lending to renewable energy projects.
But for many, securitisation has a dark side. It was deeply implicated in the 2007-08 financial crisis when the housing bubble burst and investors suffered significant losses. Since then, stringent regulatory measures have been implemented – though now European policymakers are eager to relax these to revive the market and spur lending in the real economy. The European Commission has named restarting high-quality securitisation as one of the main objectives of its Capital Markets Union project. 
Broadly, pure securitisation is the transfer of pools of loan exposures to the capital markets. While ‘synthetic’ securitisation is where credit risk is transferred through bundled loans via credit derivatives or guarantees to the capital markets. 
In a paper published last year, Deustche Bank Research said synthetic securitisation was making a quiet comeback after the financial crash, with growth from €20bn in 2013 to €94bn in 2016 – with five large deals alone amounting to roughly €20bn. 
And Dutch asset manager PGGM sees “simple synthetic securitisation” as a useful way to meet its responsible investment commitments. 
PFZW, the pension fund owner of PGGM, has given it an exclusive mandate to invest up to 2.5% of their assets in securitisations, with a focus on synthetic structures. PGGM has done these since 2006, and PFZW has allocated €4.79bn euro to synthetic securitisations far. Two years ago, PGGM completed a €2.3bn trade to insure loans of Spanish bank Santander.
“By engaging in risk sharing transactions, PGGM and PFZW help the banking sector to manage their credit risks exposures, leading to less systemic risk and a more sustainable financial system – one of the pillars of PGGM’s responsible investment philosophy,” says PGGM
To counter some of the risks associated with synthetic securitisation deals – such as opaqueness – PGGM says it takes measures like pricing credit risks as a simple fee, separate from the interest rate on the underlying loan.
It also strives to establish long-term partnerships with those involved in the deal and a deep understanding of the underlying credit risk. 
This latest deal, called Room2Run, uses the synthetic securitisation structure to create what it describes as the largest impact investment deal ever. Tim Turner, Group Chief Risk Officer at the AfDB admits the deal was initially met with suspicion from staff.
“A lot of people had impressions from the financial crisis that this was a dangerous instrument.  We tried to learn lessons from the financial crisis – what are the types of structures we need to avoid? What do we really need to ensure? And resist? In this structure, the AfDB takes the first 2% of losses of the underlying portfolio, which was something that the investors very much appreciated.”
There is precedent in the US for impact-focused funds using securitisation as a tool to scale investments and attract institutional investors. Impact Community Capital aggregates small mortgages of up to £1m for affordable housing. CEO Jeff Brenner says it has made around $2bn of impact investments over its 20-year history. 
For those involved in the Room2Run deal, similar principles apply. 
Juan Carlos Martorell, Co-Head of Structured Solutions at Mizuho International, which structured the deal, says: “The AfDB deal is not purely about capital relief. Yes, it is principally about creating head room – hence the name Room2Run – but the multilateral part of the mandate is about catalysing private financing, and this instrument is creating important pathways into institutional investors that have capital to put to work in the developing markets.”
‘This is why development banks issue $5-10bn worth of bonds in the capital markets each year and they are gobbled up by pension funds. But a very different set of investors are participating in this transaction that actually have direct, project-level risk. That’s something we felt very strongly about as a key feature of the deal, enabling investors in the developing world to take on project risk and as a result you are getting a very nice return in the low double digits.”
Investors alongside Mariner include Africa 50, a pan-African infrastructure investment platform owned by 27 African countries, the AfDB and two African central banks.
For the AfDB, the deal is also an important part of it meeting a call from the G20 for multilateral development banks (MDBs) to share more risk with private investors through structured financed, mezzanine financing, credit guarantee programmes, and hedging structures. 
Mariner’s Hohns explains: “The G20 began to advocate in 2013 and especially in 2015 during Canada’s presidency for something called the ‘MDB balance sheet optimisation action.’ It was essentially the shareholders of all these MDBs through the G20 saying we are less able to provide the capital resources we have been providing for many, many years, so we urge you to adopt some techniques from the private sector to strengthen your existing resources and make them go further.
“One of the specific techniques which they called out was securitisation.”
A recent report from S&P Global Ratings on multilateral organisations mobilising private sector capital found that in 2017 they attracted $162.6bn in private sector co-investments. Though risk-sharing structures like securitisation are scarce, the report says the approach is likely to become more frequent. 
And what of the impact? Turner from the AfDB says the released funds will be redeployed into renewable energy projects around Africa. The AfDB measures the impact of all its investments: “For each of our projects there are pre-set development indicators that are being monitored by the portfolio team and then that data is integrated into a results framework. This year, we were rated as the fourth most transparent financial institution in the world in terms of being able to present these types of results”.