Investing In Green Blockchain Technologies

THE ADVENT of green bonds and other colours of ethical financial instrument has been perhaps the most important development in capital markets of the last decade. Digitalisation may be the most important development of the next one. It is no surprise, therefore, that the intersection of the two is generating a great deal of excitement.

The world is moving towards climate catastrophe and vast investments are needed in order to avert it. The green bond market hit $1tn cumulatively in 2020, according to the Climate Bonds Initiative but the same institution estimates that $5tn-$7tn of investment per year will be required to transition the world to a low carbon economy. At present, the green bond market is providing only around 10% of that.

Closing that gap will require a massive increase in scale. This will certainly require a huge increase in the resources working towards the goal — more staff at banks, investors and, of course, on the ground working on environmentally friendly projects and technologies. But technological improvements to make the market run more efficiently and lower the barrier to entry will also be a crucial part of the story.

Complexity of green data

The environmental, social and governance bond market has become a fiercely complicated place with a bewildering alphabet soup of taxonomies, principles and systems for certifying what is and is not green. Fundamentally though, the concept is simple: a bond is sold and the proceeds (or an equivalent amount) are spent on projects expected to bring about positive outcomes for the environment. The issuer is then responsible for reporting the impact these projects have.

The hope is that investors will pay more for these assets than for an issuer’s conventional bonds — the so-called ‘greenium’ — and thereby incentivise ethical, environmentally beneficial behaviour among borrowers.

Within this process, there are several different stages where new technologies like blockchain could meaningfully improve the instruments and add to their functionality.

The same advantages of digitalising conventional instruments also apply to green bonds, of course.

Nevertheless, it is important to acknowledge that efficiency savings in capital markets can have an important impact in stimulating more green finance activity. Many smaller issuers, particularly those in the SME sector, find it difficult to access capital markets because of the costs of setting up these programmes.

‘It’s important to lower the barrier to entry to capital markets for and small- and medium-sized enterprises,’ said Benjamin de Forton, bond origination and digital assets expert at BNP Paribas. ‘They play a key role to solve the climate challenge but if they’re not accessing the ESG bond market easily and in size, then we can’t use the market to incentivise more environmentally friendly behaviour in that sector.’

Those same techniques might also produce similar savings with green or ESG bonds. If digitalisation allows issuers to spend less time working on term sheets, that frees up resources to work on methods of efficiently gathering data they need for green bond issuance.

‘It’s labour intensive and costly for issuers to produce impact reporting for example,’ said de Forton. ‘The barrier to entry on a lot of green and social projects is partly due to the volume and quality of the data that’s required and the cost of gathering it.’

Standardising ESG reporting

One of the biggest challenges in the green bond market is the range and complexity of the methods issuers use to catalogue the impact of their green investments. The details of issuers’ green projects and the impact they’re supposed to have are typically contained in ESG framework documents, usually presented in pitch decks or PDFs.

Since each issuer produces their own framework documents, it is difficult for investors to compare assets to evaluate their greenness.

‘Because this is a fairly young market, there is no standardised way to report on impact,’ said Cecilia Repinski, chief executive officer and founder of Green Assets Wallet. ‘This makes it almost impossible for investors to compare, aggregate and evaluate their impact investments.’ Green Assets Wallet is attempting to address these challenges by giving investors a tool to standardise impact data across the issuers and securities in their portfolios and get a sense of their overall impact.

The key is to harmonise and structure the data provided in ESG frameworks and impact reports. At Origin Markets, founder Raja Palaniappan has been working towards this goal, creating a database of issuers’ funding needs and programmes. ‘10 years ago, that would have been their base prospectus,’ he said. ‘Now, many have set out ESG frameworks, which we’re adding as well.’

At first, these frameworks were, in Palaniappan’s words, ‘fairly loose’ but he says that gradually, more structure is creeping in.

‘With the arrival of the European Union taxonomy, issuers are increasingly using structured data that can be categorised in a database,’ said Palaniappan. ‘Issuers can select and tag the standards and principles that they adhere to.’ These might include the International Capital Market Association’s green bond principles or the EU’s green bond taxonomy. ‘The UN’s sustainable development goals are particularly useful because there’s a broad range, so you can map your project to the SDGs it supports.’

This allows a dealer to search through the database for issuers that meet particular specifications, like nationality, the class of issuer they represent or the area in which their proceeds will be invested.

At present, this service is available to bankers on Origin’s platform, helping dealers and salespeople source assets for investors, but Origin may make it available for investors directly.

The hope is that, by making it easier for investors to track and assess the impact of their portfolio, more will be encouraged to invest in ethical instruments.

Challenges with data

Developing shared standards for ESG reporting is a key stage in digitalisation. It won’t be easy — it has taken many years to develop even the ICMA’s green bond principles, which are basic pillars that lay out issuers’ reporting obligations. Drawing up the EU’s taxonomy of what is and is not green was an even more contentious process and many are still far from satisfied with the result.

Even the term sheet — one of the most ubiquitous pieces of documentation in the conventional bond market — still does not have a standard format, and ESG data is far more complex and varied.

Heike Reichelt, head of investor relations and sustainable finance and at the World Bank warned that: ‘It will be a while before we can fully benefit from technology as part of ESG analysis. The problem in much of the ESG market is: how do you aggregate impact data? You have to harmonise and standardise the metrics, so that when it gets to the impact reports, it’s easier for investors to compare and interpret the data. But the context is always critical for the correct interpretation.’

The World Bank and other international finance institutions, now as part of an impact report working group, have been working together to agree on an expanding set of harmonised metrics for reporting since 2015, when the first impact reports were published for green bonds. This work built on joint efforts on climate reporting agreed by multilateral development banks to track climate finance. Progress has been made since the early days, with Reichelt saying that: ‘It took months to agree on the first template that was published.’ Even with harmonised metrics, it’s difficult to compare assets without context, although this is becoming easier with progress in areas like greenhouse gas accounting.

The problems are not all technical. Green bond investors can have philosophical differences on the purpose of a green bond. ‘Some investors want to own assets that are making the biggest impact on trajectory of climate change, while others want to hold something that’s very green but doesn’t necessarily solve the problem,’ Reichelt said.

A green bond financing project in North Africa, for example, may have a much bigger, positive impact than one in a country in Europe because the baselines for each are so different. ‘Technology might be less developed in an emerging market,’ said Reichelt. ‘So, on a marginal basis, investment there has a huge impact versus more sophisticated technologies in developed markets. Both are important, but it’s difficult to compare on a like-for-like basis.’

Reichelt also highlighted that it is not just about collecting data. It depends on how appropriate the data is as an input to the decision-making and how it is interpreted. ‘Having the right metrics and understanding the context and how to interpret them is even more important. Those analysing green bond impact data should not simply take data gathered at face value, but try to understand what’s behind the data,’ she said.

Issues like this mean that even if issuers agree to present their reports in a uniform manner and technologists develop a means of efficiently scraping impact data from green bond reports and presenting them for investors to compare, it will still be a complicated task for investors to assess the impact of each individual instrument.