Securitization Technology as a Bridge to Fund GHG Mitigating Projects in the Wake of a Financial Meltdown

The Kyoto Protocol’s project finance-based compliance mechanisms were devised to efficiently retool the global economy to be less greenhouse gas intensive and to facilitate sustainable development. By mitigating and reversing the accumulation of heat-trapping gasses in the atmosphere, these projects were to lower the frequency and severity of adverse climatic scenarios. While mitigating project finance activity has grown substantially since the Kyoto Protocol came into effect, it ultimately failed to reach the scale and environmental integrity needed to meet the recent precipitous increase in emissions of GHG. In response, there has been an urgent call for scaling-up investments in mitigating projects, while improving their environmental integrity. However, not only does structuring of mitigating projects involve traditional project financing risks, it is further limited by the uncertainties and hurdles of the newly created carbon markets and by dwindling financial resources in the wake of the financial crisis. Consequently, project sponsors and lenders could practically look only at the lowest hanging fruits, frustrating the urgent need to scale-up the investments in quality mitigating projects. However, while urgently needed projects are not being originated because they are too risky on a stand-alone basis, a significant portion of their risks is of idiosyncratic nature. Hence, a portfolio of weakly correlated mitigating projects could increase the spectrum of the financially feasible projects. Moreover, retaining only part of the financial exposure could increase that spectrum even further. Consequently, the aggregation and monetization advantages in securitization technology could potentially fund additional and better quality projects and contribute to the needed scaling-up of project origination. However, the viability and social desirability of securitization technology are highly questionable in the wake of the recent financial turmoil. While prior to the crisis securitization has been regarded as an agent of change, by facilitating major desired transformations, its contribution to the accumulation of toxic assets by “too big to fail” financial institutions evolved into unprecedented systemic risk and culminated in a financial debacle. This Article delves into this inherent tension between the need to employ the most powerful financial technologies to fund mitigating projects and the fear of fueling a “carbon bubble” and its associated systemic risks. It sheds light on the potential of securitization technology to bridge the needed investments in mitigating projects and the unrivalled deep pockets of the capital markets. It explores possible securitization structures to achieve this goal and discusses groundbreaking securitization transactions in this sphere. It then analyzes the viability of securitization technology in funding mitigating projects by assessing the applicability of key lessons from the recent financial meltdown. It suggests that evolving regulatory frameworks, both in the financial sector and in the carbon markets, could align the interests of structuring banks and investors and prevent reoccurrence of highly criticized practices and devolvement of their related risks. It concludes by arguing that although the private sector would ultimately structure and fund the bulk of the decarbonation process in the global economy, partnership with international financial institutions is of paramount importance, at least until the private sector recovers from the recent financial debacle and the carbon markets are more conducive for long term investments.