(Bloomberg) -- The European Bank for Reconstruction and Development is working on its first-ever deal designed to offload balance sheet risk to institutional investors.
EBRD plans to transfer part of the risk tied to roughly $1 billion of private-sector loans to a group of pension funds and asset managers, the London-based lender told Bloomberg. The deal, which the bank expects to wrap up within a year, would free up money for further lending for social and environmental projects, it said.
“The pressure will always be on to have a higher impact,” Burkhard Kübel-Sorger, vice president and chief financial officer at EBRD, said in an interview. The goal is “quality over quantity,” he said.
Banks that use synthetic risk transfers, or SRTs, can claim they’ve reduced their credit risk, which in turn reduces their capital burdens and opens the door to more lending. The institutional investors that take on the portfolio risk often do so at returns that can exceed 10%, underpinning their appeal.
SRTs remain rare in the world of public finance, but a growing number of multilateral lenders is now turning to the products as they look for ways to achieve scale. If its SRT succeeds, EBRD will become the third major multilateral lender to have struck such a deal. The African Development Bank concluded an SRT in 2018, while the Inter-American Development Bank finalized a transaction earlier this year.
Alternative asset managers buying such risk transfers say they expect to see significant growth in the market. There’s a “real sea change” underway as multilateral lenders increasingly turn to SRTs, Molly Whitehouse, managing director at Newmarket Capital, told Bloomberg in October. The investment firm led transactions for both ADB and IDB.
Multilateral lenders globally are under pressure to stretch their balance sheets and scale up their operations as developing nations, already weighed down by unmanageable debt burdens, suffer some of the worst effects of climate change. An agreement secured last month at the COP29 summit in Azerbaijan to triple annual climate finance by 2035 hinges to a large degree on the capacity of multilateral lenders to mobilize private finance.
The market for risk transfers, meanwhile, has seen record growth this year, as commercial banks turn to the instruments to achieve capital relief. And clearer guidance from ratings agencies has reassured multilateral lenders that using SRTs can reduce their capital burdens without affecting their prized AAA ratings.
EBRD is working on “capacity creation” by tapping new types of investors, said Christian Kleboth, head of debt mobilization at the lender. “We work with commercial banks and the private insurance sector, but we hope that pension funds or asset managers would buy into an SRT structure, which would be a new type of investor pocket for us.”
The bank is still finalizing the contents of the loan portfolio that will underpin the risk transfer and expects to mandate an investment bank to structure the deal early next year, Kleboth said.
The transaction also needs to go through a number of internal approvals, he said.
An SRT is “quite a costly thing to do,” Kleboth said. “You don’t spend this kind of money easily.”
--With assistance from Esteban Duarte.
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