Abstract
Recently, a number of structured funds have emerged as public-private partnerships with the intent of promoting investment in renewable energy in emerging markets. These funds seek to attract institutional investors by tranching the asset pool and issuing senior notes with a high credit quality. Financing of renewable energy (RE) projects is achieved via two channels: small RE projects are financed indirectly through local banks that draw loans from the fund’s assets, whereas large RE projects are directly financed from the fund. In a bottom-up Gaussian copula framework, we examine the diversification properties and RE exposure of the senior tranche. To this end, we introduce the LH++ model, which combines a homogeneous infinitely granular loan portfolio with a finite number of large loans. Using expected tranche percentage notional (which takes a similar role as the default probability of a loan), tranche prices and tranche sensitivities in RE loans, we analyse the risk profile of the senior tranche. We show how the mix of indirect and direct RE investments in the asset pool affects the sensitivity of the senior tranche to RE investments and how to balance a desired sensitivity with a target credit quality and target tranche size.
Highlights
We consider the problem of valuing and optimally designing structured finance instruments when the underlying asset pool is inhomogeneous
In “collateralized debt obligations (CDOs) sensitivities” we introduce CDO tranche sensitivities with respect to the Renewable Energy (RE) sector, solve for the optimal asset pool structure and senior tranche size and give examples based on publicly available data on existing structured funds
We study public-private partnerships that have a CDO-like investment structure
Summary
We consider the problem of valuing and optimally designing structured finance instruments when the underlying asset pool is inhomogeneous. In 2018, 91% of the fund’s asset pool consisted of indirect financing of RE projects through financial institutions, while 9% were direct investments in RE (a significant increase from 1.2% in Q1/2014).4 In such a fund, the equity tranche bears the first losses that occur in the asset pool. While it is ensured that all capital invested into the structured fund is channeled into RE projects, the large proportion of indirect financing creates exposure mainly to regional banks in developing and emerging countries, and to RE projects only to a lesser extent. This may be unsatisfactory for an institutional investor seeking exposure to the RE sector to diversify their existing portfolio. If the asset pool consisted only of (large) direct exposures to RE projects, diversification could be too low to provide a reasonably-sized senior tranche
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