Digital Transition Finance - The Case of Japan
Japan just hosted the FINSUM, a large fintech event bringing together policymakers, regulators, fintechs, and financial service institutions to discuss the future of finance. Flip through the conference program and you get a good sense of Japan’s current priorities for fintech: blockchain, crypto assets, and a notable emphasis on elderly finance for the country’s rapidly greying population. But the timing of last week’s conference also happened to come just a few months after the Japanese government issued its long-term strategy for Japan to deliver on the Paris agreement on climate change. That strategy does not explicitly carve out a role for fintech, but it could have: a number of the objectives outlined in the Japanese strategy document are already being advanced in other countries via fintech practices. The Alliance was invited to deliver a keynote at FINSUM, and we explored how Japan can use fintech to deliver better green metrics and green capital markets, and how it can help create new incentives for a carbon-light lifestyle for citizens.
Expanding on all the conversations in Japan, I will focus this article on transition finance and the role of digital, as it fits even better the change path upon which Japan is embarking as it pursues its new strategy towards Paris.
Impact data wallets
The Japanese government wants to use data visualization strategically to accelerate decarbonization. Part of this strategy involves positioning Japan as a model country for climate-related financial disclosure, and here visualization is going to play an important role. The Japanese government has developed the world’s first platform to enable side-by-side comparison of different companies’ climate-related information. This visualization is intended to provide investors with the information they increasingly value and thus to attract more foreign capital to Japanese companies.
This is a different approach than the European Union’s taxonomy for sustainable investing which provides the investor with a sort of check list of sustainability metrics against which the investor himself evaluates potential investment-target companies. The Japanese and the European approaches each have downsides. The Japanese platform displays the data powerfully, but the underlying data is self-reported. The EU taxonomy tells the investor what’s important to measure and how to do it, but the actual gathering and analysis of the data can be cost-prohibitive.
The bottom line is that both approaches require new, cheaper, and easier ways to capture and analyze data. Data software analytics tools powered by artificial intelligence and Big Data are the most mature of the fintech innovation space applicable to green finance. There are software solutions that can define long-term climate scenario planning on individual companies, and software that automatically review and analyse all available information about a company. There are satellites measuring carbon emissions from space and the integration of fintech with IoT is going to be the big game-changer.
A question that Japan can think through is the most relevant digital infrastructure to support these efforts to visualize sustainability and green metrics. What data infrastructure best supports the purpose? Which can facilitate the highest quality data and ensure that it is maintained over time?
Is the infrastructure a databaseas mentioned in the strategy? Or might the optimal infrastructure be a digital impact data wallet,owned by each company, pointing to the need for a blockchain-distributed database. That would allow each company to build a transition history as it starts increasingly to deploy clean technology and to share this history with investors. Even if stored on a distributed blockchain platform, each company owns its digital impact data wallet which makes it more practical (and provides the incentive) to keep the information updated.
Digital Transition bonds
Japan’s commitment to green bonds has made it the second largest (after China) Asian Pacific issuer and the 10thlargest in the world. The Japanese Ministry for Environment subsidizes expenses including external reviews, the establishment of green-bond frameworks, and other upfront costs for companies or local municipalities that require support; last year alone the total cumulative bond issuance was USD 9.7 bn.
At the moment green bonds finance green start-up projects, such as roll-out of renewable energy. But along with financing “good new” green businesses, Japan also needs financial instruments to help decarbonize “brown” existing businesses, supporting their transition to clean technologies and more sustainable business models. This is where transition bondscome in. They are a financing tool to enable not-so green businesses to, for instance, capture and store carbon emissions or gradually move away from brown energy. Carbon capture and storage is contemplated under Japan’s long-term Paris strategy as one of the primary transition tactics, so a transition bond market in support of capture-and-storage should be a logical financing priority.
What makes a transition bond different from a green bond is the funding of behaviors rather than fixed assets. However, there is no consensus yet about the commitments a company must make to qualify for a transition bond or about meaningful and transparent progress reporting protocols. Japan can use the impact metrics platform for companies to report in a transparent way. A transition bond experiment could start with a pilot in a sector where IoT is sufficiently advanced to automatically capture metrics about the behaviors of the company.
There are already practices of issuing sustainability performance-based lending and leveraging AI and Big Data to track performance. Japan can look at the particular way that digital is deployed in these models. In 2017, the Dutch ING bank issued the world’s first sustainability-linked loan. It knocks of a percentage of the cost of capital if a borrower reduces its impact on the environment, hence the interest on the loan is linked to the ESG rating on the company. In Holland ING Bank has developed a digital tool to help their commercial real-estate borrowers identify energy improvement measures for their buildings that provides the most attractive returns and greatest carbon reductions. The tool is an app, offered to all Dutch clients. The client enters data about the building, such as age and location and the app automatically offers 10 measures per building to reduce costs and to reduce CO2 emissions. Loans are then be linked to how well the borrower performs. In Asia DBS bank issued the first sustainability-linked loan to an IT company in Asia.
Japan’s long-term strategy to deliver on the Paris agreement opens a number of opportunities to move fintech into serving as a tool to deliver green and transition finance. These were just two examples. There are many more to be explored and to be developed through innovation.