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ABSTRACT
We observe that the actual system of support to agriculture in Europe neglects many of the existing and potential interactions in the financing chain and, for this reason, remains scarcely participated in by institutional investors. In an attempt to overcome this issue, this paper provides a theoretical framework for a market-oriented financing of agriculture in the EU, with particular emphasis on environmentally friendly practices. In more detail, the paper identifies the conditions for implementing a comprehensive originate-and-distribute securitisation mechanism for environmental loans backed by a general public guarantee. The discussion provided allows the identification of the main gaps between the target financing infrastructure and the instruments currently available in the market. In this respect, two elements would deserve a specific implementation. First, an integrated policy programme able to leverage the public spending though a balance of grants (which should support only unprofitable environmentally friendly practices) and external credit enhancer in the securitisation mechanism. Second, a specialised data set able to provide reliable environmental and financial performance indicators on different environmentally friendly investments to farmers, intermediaries and institutional investors.
Disclosure statement
No potential conflict of interest was reported by the authors.
Notes
*This study has been realised in the framework of the Chair Finagri of the University Paris 1 Panthéon-Sorbonne. The works of the Chair have benefitted of the joint participation of the IAE (Institut d’administration des entreprises) of the University Paris 1 Panthéon-Sorbonne and of the INRA (Institut national de la recherche agronomique) as well as of the participation of professionals from the financial industry. We thank all the participants to the works of the Chair for their precious contribution to the improvement of this paper.
1. As of today, EU agricultural producers are highly dependent on direct public support. In the period 2010–2013, the average share of direct payments to the agricultural factor income amounted on average to 28%. In the same period, taking into account all subsidies, total public support in agricultural factor income reached on average 40%. Agricultural factor income represents income generated by farming which is used to remunerate borrowed/rented factors of production (capital, wages and land rents), and own production factors (own labour, capital and land). (EC Citation2015b).
2. Sustained by a positive view, the securitisation market experienced exponential growth in the years before the financial crisis. Later, it has been blamed for having contributed to the explosion of the sub-prime mortgage crisis in the US and ignited the financial contagion worldwide. In particular, the negative view was due to the observation that securitisation had probably incentivised lax credit policies and poor asset quality standards (e.g. Dell’Ariccia, Igan, and Laeven Citation2008; Keys et al. Citation2010). For these reasons, in the aftermath of the financial crisis, securitisation operations have registered historically low levels of issuance both in Europe and the US. Policy makers and international organisations have recently reacted by proposing amendments to existing regulations in an attempt to contrast the misalignments observed in the securitisation chain and give new impulsion to the market (e.g. BCBS Citation2014). In Europe, the ongoing reform aims, in particular, to identify criteria for simple, transparent and standardised securitisation (EC Citation2015a).
In the figure above, European securitisation includes asset-backed securities (ABS), collateralized debt obligations, mortgage-backed securities, SMEs securitisations, public finance initiatives, and wholesale business securitisation. U.S. securitisation includes ABS, commercial mortgage-backed securities and residential mortgage-backed securities. Figures for 2014 are annualized based on data to September (IMF Citation2015).
3. In this regard, excess spread (the practice of issuing notes with an overall yield lower than that of the underlying assets) and overcollateralisation (the practice of issuing an amount of notes lower than the available underlying assets) are also used as sources of internal credit enhancement and to cover transaction costs linked to the securitisation operation.
4. In a true sale securitisation, the ownership of the underlying exposures is transferred or effectively assigned to a securitisation special purpose entity. In contrast, in a synthetic securitisation, the underlying exposures are not transferred, but the related credit risk is transferred by means of a guarantee or derivative contracts.
5. Nevertheless, such a phenomenon is somehow ambiguous. Albertazzi et al. (Citation2014), on the basis of a sample of more than 1 million mortgages issued by 50 Italian banks in the period 1995–2006, found that for given observable characteristics, securitised mortgages have a lower default probability than non-securitized ones. This shows that banks may care about their reputation for not selling lemons.
6. The SMEs segment represents 58% of the value added creation and 67% of the employment in the non-financial sector in Europe. Data refers to 2014 (EC Citation2015c).
7. Conventionally, cooperative banks and savings institutions are considered as practising relationship lending.
8. Another factor that can induce small banks to focus on SMEs is the borrowers’ concentration problem that they could suffer by lending to large enterprises.
9. Financial statement lending, asset-based lending, credit scoring, and factoring are some of the most widely used transaction lending technologies.
10. The share of the CAP within the total EU budget has decreased sharply over the past 30 years despite the successive EU enlargements (from 73% in 1985 to 39% in 2013). Such a trend has been induced by a series of successive reforms, which have mainly had the objective of incentivising a progressive transition towards a more market-oriented system. Nonetheless, in the actual multiannual financial framework (2014–2020), the CAP funds amount to over € 55 billion per year (EC Citation2015b).
11. Depending of the country, direct payments (hence excluding other forms of subsidy) may range from 15% or less (Cyprus, Lithuania, Malta, the Netherlands and Romania) to more than 40% (Ireland, Luxembourg, Slovakia and Sweden). Source of data: EC (Citation2015b).
12. In this paragraph, the citations in italics refer directly to the vocabulary used in the CAP provisions. To be eligible for mandatory greening payments, farmers have to comply with a number of practices considered beneficial for the environment. In particular, this refers to the maintaining of permanent grassland, crop diversification and the presence of an ecological focus area.
13. Agri-environment and climate payments are considered within the Rural Development policy. These payments are co-financed by the European budget and national or regional authorities, which have a large autonomy in designing their own multi-annual programmes on the basis of the menu of measures available at the European level. The provider-gets principle states that farmers who sign up for environmental commitments beyond the reference level of mandatory requirements shall receive funds to cover the costs incurred and income forgone.
14. These authors have, in particular, observed that specialised arable farms on highly productive land and intensive dairy farms are most likely to opt out of greening and renounce their entitlements.
15. Cross-compliance is a mechanism that links payments to compliance by farmers with basic environmental and other standards. In the 2014–2020 multiannual financial framework, Pillar I and many Pillar II payments may be reduced in the case of non-compliance.
16. In more detail, the tendency that can be observed can be explained by (i) problems with the access to debt for small farmers and (ii) debt in charge to the farmer and not to the agricultural firm.
17. File cost includes information collection, credit worthiness evaluation and other administrative expenses linked to the origination and to the monitoring of the loan.
18. This reasoning holds in the case where the originator keeps a sufficient level of skin in the game. In such a case, there would not be incentive to reduce screening and monitoring costs. To shed some additional light on these aspects, we specify the predictable behavioural relations for lenders and borrowers in an originate-and-distribute mechanism. First, the intermediary’s profitability condition at a single-transaction level is respected if:(1) where ∂ is the average portion of the risk which remains in the intermediary’s balance sheet after the asset sale, iA and iF are respectively the interest rate charged to the borrower and the cost of funding linked to the transaction, RC is the cost of risk directly chargeable to the loan, L represents the loan amount, M is the intermediation fee received in the case that the deal is concluded and FC represents the file cost necessary to carry on the transaction. Similarly, the borrower would enter the deal if the expected value added of the investment were positive. That is, if:
(2) where E(rECO) is the expected net return rate of the environmental investment (not including financing costs). For the model to work, both (1) and (2) must hold. As ∂ is expected to be relatively small, the final remuneration of the financial intermediary would be mostly dependent on its capacity to maximise M-FC. It can be argued that the money value of these quantities may not be proportional to the size of the loan. In fact, file-related costs, such as information collection, credit worthiness evaluation and other administrative expenses, may not vary proportionally to the amount financed. In addition, those costs are typically at the basis of mark-up mechanisms to calculate the intermediation fee. In the graphs below, the grey area represents the space of a potential deal, in which both conditions (1) and (2) are respected.
19. See for example the seminal work of Bernanke and Lown (Citation1991) and the subsequent literature on the possible supply-side causes of a credit crunch.
20. To this extent, also note that positive externalities linked to environmentally friendly practices are typically not considered in the farmer’s individual investment choice pattern.
21. In such a case, the relation (2) would be transformed to:(3) where CPECO represents the conditioned payment. Even if relation (3) does not represent a free-market condition, it may have two advantages. On the one hand, it allows private funds to finance environmentally friendly practices; on the other hand, it may reduce the role of public intervention to the entity of market failure.
22. In our reasoning, it is not necessary that environmentally friendly practices coincide with or are restricted to the standards specified in the CAP provisions concerning greening, agri-environment or climate payments.
23. This is typically the case when environmentally friendly practices respect the parameters for eligibility defined in the CAP schemes.
24. In principle, specialised market players could also cover the role of external enhancers.
25. In this respect, a contemporary use of subsidies within the CAP framework and other supporting instruments at the EU level (such as a guarantee scheme or securitisation managed by the European Investment Bank or the European Investment Fund) is not forbidden, but is regulated (see, in particular, Regulation No 1303/2013 of the European Parliament and the Council of 17 December 2013). The notion of financial instrument we refer to is the one contained in this Regulation.
26. Another element that could direct the demand would probably be the compliance with the green bonds principles (ICMA Citation2015).
27. In this respect, it is important to underline the main peculiarities of the cooperative paradigm. Primarily, it is reflected in a unique ownership structure. Cooperatives cannot exclude new members unless motivating the reasons and, most importantly, the one-head-one-vote rule is in use in the decision making processes. Furthermore, cooperatives have a very limited profit-seeking nature. In fact, most of them face constraints in terms of profit distribution. Finally, the link with the territory and the mutualism principle mainly steers the cooperative activity. Normally, it has to be focused first of all towards their members and in the territory where they mainly operate.
28. See Bijman and Iliopoulos (Citation2014).
29. In some cases, cooperative banks have experienced exceptional growth. As a consequence, those financial institutions have been transformed into universal banks (e.g. Crédit Agricole in France or Rabobank in the Netherlands).
30. The notion of a repository of the soft information we refer to is the one discussed by Berger and Udell (Citation2002).
31. As a matter of fact, this is the typical case of captive financial institutions operating within larger industrial or commercial groups and that might be replicated in the largest agricultural cooperatives or federations of agricultural cooperatives.