Perceived risks related to financing of green assets in developing countries is one of the principle obstacles standing in the way of unlocking finance into communities. Another is the lack of pipeline of bankable projects and assets in these countries. Taking the current developments digitization of bonds and applying them to design community-based bonds in developing markets can help redesign both risk and pipeline.
First Digital Baby Steps in the Bond Market
Key elements from the digitization of capital market instruments with distributed ledger technology currently unfolding can be used as building blocks to reshape risk and how pipeline is developed in developing markets.
This year and last distributed ledger technology left the lab and entered capital markets. The most cited example is when the World Bank launched a blockchain operated new debt instrument, the bond i last year, as the world’s first bond to be created, allocated, transferred and managed through its life cycle using distributed ledger technology. Now the Commonwealth Bank (CBA) has enabled secondary market trading recorded on blockchain for bond-i. A sharia compliant bond was issued immediately after the bond i and recently the Spanish bank BBVA issued the first green bond on the blockchain.
Distributed ledger in capital markets is taking off. It is possible to predict a number of areas of added value of issuing bonds on the blockchain with relevance to these markets. These include reduced time to market, increased transparence, faster transferability and settlement. Not to mention cost reduction.
I addition it opens up the opportunity of issuing significantly smaller bonds in a cost-efficient manner. Something I’ll get back to later, as that suddenly allows us to look at the pipeline problem from a new perspective. But let’s first look at the risk question first.
De-risking through Automation
On the investor risk perception of assets in developing markets, the emergence of convergence of IoT, AI and blockchain in the context of bonds hold promise to change risks and risk perceptions. Data to document the use of proceeds can be stored securely and communicated in real-time on distributed ledger technology. Data can for some green assets be harvested in an automated manner from intelligent chips embedded in the assets, which lowers the costs of data harvesting and increase the credibility of the data and of the investment.
Or put differently, with technology green assets become intelligent. They can communicate to investors without all the paper work and logistical processes involved. Hence, they can potentially lower a number of risks associated with investments into green projects and assets in these countries.
The Pipeline Paradox
Shifting from the perceived and real risks associated with investing into developing markets to the barrier of missing pipelines. Micro finance offers an interesting point of departure for this discussion because it is a type of investment product, which was build from the ground up to evolve into a standard element of any investor project pipeline. Micro finance started off as an NGO game. Today banks in developing markets buy micro-finance institutions to fast-track access to a customer with very low default rates and interesting returns. In 2002 the first institution, the Compartamos in Mexico, undertook a $68 million local-currency microfinance bond issue in 2002. The first international microfinance security, a $40 million securitization of cross-border loans to nine MFIs in Latin America, Eastern Europe and Southeast. Today micro-finance investments are part of any investors developing market portfolio. It has unlocked deployment of capital into local communities and offered access to capital market instruments for capital to scale. Micro-finance was built on an unleveraged asset in communities, people and their ability to save and repay.
It essentially raises the question of whether is it really the pipeline that is the problem? Or whether it is the way financial instruments are designed that blinds them from seeing assets?
Micro or Community Bonds on Blockchain
Many communities have other assets that can be made investible just as micro finance did. It is assets such as cereal banks, livestock and a lot of sun just waiting to be harvested by pay-as-you go solar panels to unlock renewable energy to enable homework in the evening, or to start an online business.
Unlike in the early days of micro finance today we have technology that can give these community assets visibility through sharing data onto distributed ledgers. We also have the first blockchain based bonds to inform new ways of connecting these assets with investors directly and how to issue bonds at low cost. A community bond essentially crowd fund finance for community projects such as roll-out of smart grids and solar panels in one place. Ticket sizes can be low because the costs of issuance and management of digital bonds are low.
It can both improve community infrastructure and offer new ways to save and invest open to local ordinary people. However, it is it not a quick fix but an idea that needs testing, adjusting and team work. It is news ways to structure investments that really require systemic change and adjustments to existing practices and legislation.
Regulation – the missing ingredient
We have the mix of technology that is needed to re-shape what pipeline is and to de-risk investments in developing markets by structuring digital bonds using distributed ledgers and adjacent technologies. Regulation is the missing ingredient. Africa is taking a ‘wait and see’ approach to blockchain regulation. In Europe more and more countries are formulating blockchain regulation and Asia appears to be a rising champion for blockchain implementation, as it brings together regulatory activism, a vibrant technological/fintech ecosystem, supportive governments, collaboration of industry and entrepreneurial players, and sustained access to venture capital.
A green digital finance test zone could be a way to go about it. In a zone a collaboration between actors such as a central bank, technology providers, MFIs, infrastructure providers such as solar companies, a financial service institution and a community to explore could test out different ways to structure the bond. Investors could be local communities and people living in the urban areas as a means to connect to populations in rural communities and invest in the development of the country.
A test can yield information about the required regulation of crowd funding, of the technologies used (DLF, IoT etc.). It can inform about the appetite of locals to become investors in local assets, about the most cost-efficient way to structure a community digital bond, about how to structure the automated data collection from the project and much more. Emerging markets are well positioned to take the lead in testing out digital community bonds because the need is greatest here and no legacy structures and interests that a test would have to manage. It can unlock capital, make local populations investors in the rural development of their country and hence unlock new sources of green and sustainable finance.