As world leaders gathered in Dubai for the COP28 summit last month, the battle against climate change has returned to the top of the public, political and business agendas. But whatever commitments were made by governments and corporations alike (e.g., around reducing carbon emissions), what will really matter is that the delivery against these commitments is both credible and provable.
The underlying question from a financial services perspective is therefore how to prove that sustainability-related investments are delivering against their “green” promise in a clear and reliable way? And that is not only because financial regulators across the world are getting much more serious about this question, looking to implement regulatory regimes that prevent unsubstantiated claims of products being “green” or “sustainable”.
The challenge of proving green credentials
This growing scrutiny also presents questions for green bonds. As the name suggests, these are fixed-income financial instruments issued specifically to fund projects that generate positive environmental and/or climate benefits. The first green bond was issued by the World Bank in November 2008 and since then, they’ve become a well-established feature of the global financial landscape.
However, every green bond faces the fundamental challenge described above: proving it’s actually green. Investor appetite for such investments is rapidly increasing, as banks, asset managers and large corporates all seek ways to invest in sustainability. But they’ll only invest if they have proof about where the money is going. And it’s not just investors who want this proof. As mentioned above, market authorities are also more and more seeking auditable evidence that green bonds are delivering the claimed environmental benefits.
The way forward: embedding trusted data…
To prove a bond really is green, what’s needed is the ability to reconcile and trace back—in a trustworthy, verifiable and efficient way—what the funds are really being used for. The relevant data needs to be collected, assured, and distributed across the base of investors (and regulators) on a regular basis. Today, this usually involves message-based reconciliation across the multiple parties—a process that’s rather slow, expensive, and largely inefficient.
The good news? A solution is already in hand—in the form of distributed ledger technology (DLT), more widely known as blockchain. The key lies in DLT’s ability to incorporate trusted, assured information into the financial instrument itself through a technology known as “tokenization”, which could turn green bonds into a form of a digital asset.
While this may sound complex overall, it’s actually a straightforward concept. When a bond is issued as a token on DLT, it represents an asset—in this case an investment in a green bond—immutably securing the buyer’s ownership. And data attributes proving the achievement of sustainable goals can then be embedded within the token, allowing irrefutable validation of the provenance and the purpose of how the funds are being used.
…and harnessing the power of smart contracts
What’s more, the rules governing the bond’s deployment, payment schedule and coupon rate can be coded into smart contracts and enforced programmatically. All of this makes the process of issuing the bonds far cheaper and more repeatable: research by HSBC and the Sustainable Digital Finance Alliance suggests that full blockchain automation could cut the costs of green bond issuance by almost 10 times.¹
Also, since DLT is a “shared state” model, authorized parties can access the embedded data directly. This would remove the burden of traditional reconciliation, hence reducing friction and costs. And the resulting savings could be fed back into higher returns and/or more investment in sustainability—not just by institutions, but also by private investors worldwide.
Rising maturity heralds a bright future
All of this underlines a unique alignment between DLT and what’s needed for cost-effective green bond issuance, investment and trading. And, I believe, a DLT-enabled future for green bonds is getting closer all the time, thanks to rising maturity across two dimensions: The first is around digital assets increasingly joining the investment mainstream. The second is in the data attributes to be included in a DLT-enabled green bond as the development towards internationally recognized ESG reporting frameworks continues—with COP28 providing further evidence.
While issuing green bonds on DLT may not be the only way, it is at present probably one of the most promising and practical mechanisms to drive capital towards green initiatives. I will share more details—especially about the practicality point and the view of market participants on it—in a future blog based on the findings from a recent Accenture research on the future of capital raising.
But at its root, what’s needed is a way to make trusted data visible and accessible in a controlled and cost-effective manner. By doing so, DLT is likely to catalyze the emergence of a whole new generation of sustainable finance and other financial instruments. It’s an exciting prospect that I look forward to research together with my colleagues and industry participants. If you want to join me on this journey, please feel free to leave a comment under this blog or reach out to me directly.
¹ HSBC / Sustainable Digital Finance Alliance: Blockchain – Gateway for sustainability linked bonds, 2019