As we see rapidly increasing costs for energy, especially for fossil fuels and electricity, across Europe, alongside the strongest increase of the inflation rate for decades, we are reminded that renewable energy is not a thing of the distant future, but much needed at the present day. A key factor in limiting carbon emissions and make a contribution towards a Europe that is independent from energy supply coming from countries outside of Europe, is the development and significant increase of renewable energies is key. A prominent part in this development is to be played by solar energy. The European Solar Strategy, that was re-announced in early 2022, calls for 20 Gigawatts of annual production capacity coming from solar energy by 2025 and 600 Gigawatts by 2030. A large portion of that renewable energy is going to come from solar panels installed on rooftops, many of them installed on residential houses. However, this potential is – as of today – not adequately represented by means of financing the acquisition of such solar panels.

What's happening across the pond? Experience with solar ABS and renewable energy financing in the United States

To get an idea of future developments in Europe, one has to take a look at the United States.

Since the first solar loan transaction in 2013 the market has grown rapidly. Starting with a $50 million transaction in 2013, the market has grown to a size of $15 billion. This development was also driven by legal and regulatory reasons. During the last couple of years, solar panels were eligible to investment tax which enabled households to reduce income tax liabilities. Moreover, California adopted a law, that required all new build residential homes to have solar panels. As of today, this growing market for residential facilities in the United States is highly concentrated in the hand of a small number of very large and powerful originators that solely focus on the installation and related financing of solar panels. This results in much concentrated portfolios that are of a size where a portfolio-based approach to the financing makes a lot of sense and adds structural protection to investors.

With the much higher volume of these assets comes a need and a potential for commercial scale solar financing, and as a result, we are likely to see more and more commercial scale solar financing alongside consumer solar financing.

European Solar ABS

In Europe we see a growing market for renewable energy and solar panels. Some countries already require new buildings to be equipped with solar panels, which will drive the market for assistance for private households to finance the equipment. The European Union adopted a directive that allows Member States to lower the VAT on solar panels on and adjacent to private dwelling and housing. Additionally, in some countries, as for example in Germany, subsidy-schemes were introduced to facilitate the instalment of solar panels and guaranteed tariffs for long periods of time for private households that sell energy from their panel to the grid.

However, the situation is very different from the United States. While there is a strong concentration of the market share in the hand of only a few originators in the United States, the situation in Europe is much more diversified: Here we see a much more fragmented market. One reason being the variety of jurisdictions. While the difference between a consumer loan in California and such loan in Florida is not considerable, the differences in such loans across European states are much larger. This results in smaller portfolios and therefore make securitisation much harder. Therefore, it is much more likely, that we will see the development of "national champions" within each European region. These national champions are dedicated originators whose sole focus is solar installation and related financing. The more market-share these originators take from commercial banks, which are the alternative in terms of lending, the more we are likely to reach a critical mass that is needed for securitisation.

Challenges to the adoption of solar ABS

Against this background, there are a number of challenges to the securitisation of solar loans in Europe:

• Fragmentation: A large portion of the European market is covered by small installers with little standardisation of approaches and data between themselves, which makes it difficult to get a standardised set of data across a number of installers that are needed for ABS.

• Changing the consumer approach: In many European countries, upfront payment for the installation of solar panels on residential rooftops has been widespread. A key challenge for new originators will be to bring the long term nature of a solar loan or lease product to the end-consumer and show the potential for savings for the consumer, especially in the context of rising energy prices and high inflation rates.

• Legal uncertainty: Although the specifics of the legal and regulatory requirements vary from jurisdiction to jurisdiction in Europe, typical questions that come up in that regard are: Does the solar panel become part of the real estate – and as such will be covered by the mortgage as security – or can it be financed separately? Can you take separate security over the solar panels? Can the investor remotely deactivate the panel if there Is a default in a portfolio? Can you reallocate the sale of electricity and recover the proceeds from the sale? Can the investor intervene, if the real estate is sold? Many of these questions are not yet finally determined which creates legal uncertainty for consumers as well as for financing parties.

• Long periods of financing: In difference to other asset classes, solar panels require a longer financing period, typically 15 to 20 years financing. That is much longer than other asset classes and require specific skills and an investor base, which is just evolving. In a small portfolio environment, the financing of such long dated assets is especially challenging in multi-currency scenarios, as in a pool of assets that are distributed across various European countries.

• Adequate regulatory support: The development of a market for private financing will also depend on governmental approach to subsidisation of solar panel installations. We have seen some extensive subsidy schemes in Europe, where consumers could get back the entire costs incurred with the installation of solar panels upfront, if they renovated their homes in a specific way. Such extensive governmental support minimises the need for private financing and the potential for ABS.

What's next?

Driven by rising energy costs and high inflation rates, the demand for cleaner and cheaper renewable energy that is generated on the top of your own roof is growing across Europe. This is emphasised by the European Solar Strategy, aiming to meet the European Green Deal's climate and energy targets.

Simultaneously, we already today see an increased demand for sustainable and ESG compliant financing and a growing appetite from the investor side to create ESG compliant ABS. The EU Commission has issued a proposal for European Green Bond Standards, which is currently in the legislative process. Although there is no final EU Directive on European Green Bond Standards yet, solar loans will certainly fall into that category, which creates potential for future securitisations.

The key question, however, is going to be which originator will have the portfolio large enough for securitisation. In Germany for example, there is on one hand the state owned bank KfW, that is very active in solar lending, but will not securitise its portfolio, and on the other hand a number of local savings banks that only have small portfolios. Against this background we believe that the driver for securitisations will come from solar installation companies that generate large enough portfolios for securitisation. One of the mitigants for the fragmentation might be a European regulation that could help to get the data standardised which is a necessary step for ABS. The United Kingdom could lead in that regard: there, all solar panels are to be certified under the Microgeneration Certification Scheme, which could help to get a standardised set of data across a number of installers.

We believe that we are likely to see private securitisations in the not too distant future, which lead the way for public securitisation transactions further down the line.

After all, we could be on the edge of a golden era for solar energy in Europe: For consumers, the wedge between opportunity costs and the capacity to generate cleaner, cheaper energy on their rooftops is growing quicker than in other markets at the moment. Growing demand for renewable energy against the background of climate change and rapidly rising costs for fossil fuels and energy could accelerate the transition to a green economy. While the benefits for the consumer are obvious, securitisation could play a key role in accelerating this transformation.

Hogan Lovells' Structured Finance and Securitisation practice has deep experience advising on the financing of a wide range of classic and innovative asset types, as public and private stand-alone issues, master trusts, programmes, through conduit structures, and on portfolio sales, forward flow and financings of these transactions. We have built the practice across the globe with lawyers in the major jurisdictions of  Europe (including UK), the United States and Asia, providing an integrated service to our clients on their most complex transactions. We are known as experienced and pragmatic counsel who advise arrangers, lenders, originators, investors, trustees and investors. We are regularly commended by independent market guides, particularly for our ability to advise on new and innovative transactions. We run one of the few practices able to offer dedicated and knowledgeable advice to capital markets trustees.

We would be delighted to discuss any of these issues with you further. Please do not hesitate to  call one of us or your usual contact.

Authored by Dietmar Helms and Felix Ackermann.