Although covered bond supply this year is down by over 50% compared to the same time last year, ESG bond activity has remained strong. Early last week Berlin Hyp issued its third green Pfandbrief and on Thursday OP Mortgage Bank followed with its inaugural green mortgage covered bond.
The week before, Crédit Agricole Italia issued the first Italian covered bond secured on green mortgages only days after Hypo Tirol Bank issued the first Austrian deal secured on social housing.
In all cases, the ESG bonds were issued from the same cover pools used for conventional covered bonds. And, more often than not, the funding was for eligible loans that have yet to be originated. This can create transparency issues for investors who typically like to see a verifiable audit trail linking assets with liabilities.
As such, one of the most important challenges that covered bond issuers face is how to flag up the ESG assets within their cover pools and show green investors that this where the funding they are providing is actually going.
In other words, asset tagging must be done in a way that creates a verifiable audit trail, which enhances transparency and helps prevent the perception of greenwashing — where green bonds give a false impression of how environmentally-friendly the use of proceeds is.
Tagging in a cost-effective, automated process that also keeps ahead of regulations is typically a challenging task. For example in Finland, when OP Mortgage Bank was in the process of setting up its green covered bond programme, considerable effort was involved setting up systems.
"There was also lots of coding work involved in building a system that would automatically tag green loans at the point of origination," said Sanna Eriksson, head of investor relations and chief executive officer of OP Mortgage Bank. But this was considered a worthwhile exercise because OP intends to become a regular issuer of green covered bonds.
But the concern is that not all banks follow this route. In the absence of a system that automatically tags specific assets to the appropriate liabilities this would have probably have to be done manually.
“Banks may not necessarily have the IT systems that [automatically] tag assets with liabilities,” said Arjan Verbeek, chief executive officer of Perenna, a start-up mortgage lender.
Verbeek, who previously worked at BNP Paribas and Barclays as a senior originator and structurer, said that an associated problem with this process is "it’s not always clear how proceeds are linked with assets". Because of that “there’s a gnawing concern about the potential for greenwashing,” he said.
Perenna is expected to start originating mortgage loans later this year when it gets UK regulatory approval. At that point it plans to issue deals under the Danish covered bond model where it is necessary to directly match loans and bonds.
This means the moment it has an appropriate asset, it can automatically be tagged to a liability. “If we’re going to issue a green or social covered bond, we can automatically link those to the appropriate mortgage loans and create a verifiable audit trail,” said Verbeek.
Perenna is undertaking this work in conjunction with a Toronto-based fintech firm, Tao Solutions. Tao's managing director, Jim Metaxas, believes the majority of the banking industry relies heavily on legacy systems and manual processing.
He believes banks see few alternatives that are more efficient, reduce risks and meet regulatory requirements. “Finding a flexible solution that can address an ever-changing regulatory landscape is considered critical for issuers and market participants alike,” he said.
Tao’s technology supports the automatic tracking and selection of eligible assets. Metaxas believes Tao can introduce its platform at a pricing point that can displace internally built bank systems.
Working with Canada’s major mortgage lenders, Tao Solutions was recently able to rapidly implement and roll out functionality that enabled its clients to participate in and conform to newly introduced liquidity programmes set out by the Bank of Canada and Canadian and the Office of the Superintendent of Financial Institutions — at no extra cost.
Tao Solutions' mandates include working with banks to replace their ABCP conduit administration systems, along with mandates in covered bonds, RMBS, as well as auto and equipment finance.
These asset classes have been multi-jurisdictional and multi-currency. Tao has also worked with trustee and trust management firms on their reporting.
Metaxas is confident the firm’s propriety systems can meet reporting requirements set out by the European Securities and Markets Authority, the Financial Conduct Authority and, for the securitization market, compliance with the Simple, Transparent and Standardised standard.
"We are in the process of implementing a generic regulatory reporting framework that will be available late this year," he said. "We can also handle STS transactions with our system having the ability to manage all underlying collateral data and enforce standardisation of reporting as required".
In relation to the European Commission's sustainable activities taxonomy, Metaxis said issuer's servicing platforms would provide asset-level tagging "that we would handle and use in the process of selection and reporting as required".