A Carbon Offset CLO

Abstract

A primary purpose of typical bank balance sheet collateralized loan obligation vehicles (CLOs) is to facilitate bank regulatory capital management on a specific portfolio of existing loans. But could a CLO perform other loan portfolio management functions as well? This article describes the addition of a carbon offset feature to a standard synthetic carbon CLO for project and infrastructure loans. The objective is to facilitate the management of the level of indirect carbon emissions associated with banks' project loan portfolios. The fundamental concept is that a bank and a multilateral development bank MDB, by working together within their normal institutional parameters but utilizing the CLO and Basel II framework, can achieve significant carbon dioxide equivalent amount (CO2e) mitigation of a project loan portfolio. A CO2e emissions, or carbon, trading market is rapidly developing in the corporate sector. It is also expected to develop among project lenders, which are becoming increasingly concerned about—and may some day incur out-of-pocket costs related to—the overall carbon-emission footprints of their project loan portfolios. A possible carbon offset CLO structure described in the article highlights how structured finance techniques can be used to mitigate banks' indirect emissions. The carbon offset CLO really performs three functions: 1) providing transparency for assessment and reporting, 2) utilizing an existing structural and regulatory framework for precise policy implementation, and 3) establishing a mechanism to connect loan terms to carbon market prices.

TOPICS: Project finance, CLOs, CDOs, and other structured credit, legal and regulatory issues for structured finance