• Marianne Haahr

New SDFA report on Digitization of Green Bonds

SDFA was honored to present our new report “Blockchain: Gateway for Sustainability linked Bonds”, in partnership with HSBC and in research collaboration with hiveonline, today at a special side event during the UN Secretary General’s Climate Summit in New York. The report describes the current state of the blockchain green-bond market, but most of its 46 pages describe next steps that banks can take to deploy technology to scale climate finance.

The answer is digitization of Green Bonds. “Blockchain: Gateway for Sustainability linked Bonds” is admittedly a little technical: its primary audiences are the financial and technology sectors, and we wanted to offer concrete guidance to help them digitize green-bond offerings. But the short—and happy—version of the story is that digitized green bonds can play a major role in financing the green transition. The key? Breakthroughs in blockchain, powered by simultaneous breakthroughs in artificial intelligence (AI) and the internet of Things (ioT), which drive lower costs, higher speed, and much better data from the real economy.

Among the highlights from Blockchain: Gateway to Sustainability linked Bonds:

'Digital green bonds can be the proof of concept for the entire bond market’s digitization'

Blockchain offers advantages to all types of bonds, but recent developments at the technological frontier present even greater opportunities for green bonds. Green bonds require an additional layer of “green performance” data. The issuers of green bonds must have meaningful data to report to the bond holders about how the underlying asset (e.g., wind turbine, solar panel, and so forth) is performing.

This makes green bonds more complex and demanding. After all, the holder of, say, a highway-construction bond can easily see the performance: the highway is getting built or it is not. The holder of a wind-farm green bond, on the other hand, will not only want to see that the turbines exist, he will want to know that the local carbon footprint has been reduced and that the wind farm is the reason why. That was the point of the investment. So Blockchain: Gateway for Sustainability linked Bonds dives into new developments. As it explains, blockchain is not developing in isolation but is converging with both IoT and AI. To stay with the example of the wind turbine, sensors can be installed into the hardware which not only monitor usage and measure the corresponding reduction in carbon usage, but then also upload that data directly to the blockchain. Once there, AI can interpret the data (which would be complex and time-consuming, and thus expensive, for human beings to interpret) before it reaches the investor. The example of the wind-farm turbines can of course be extrapolated to solar power, fleets of electric municipal buses, or countless other possibilities. The significance is that this “BiA Trinity"(blockchain, ioT, AI) points towards a future where one of the biggest constraints to the growth of the green-bond market—the difficulty and expense of reporting—is lifted. Exactly how the longer-term future scenarios will play out is uncertain. What is certain, however, is two things. First, the transformation of the green bond market structures is increasingly possible. Second, the green bond market is the tough case—as the song goes (since we’re in New York this week) “if you can make it there, you’ll make it anywhere.” The digitization of green bonds, thanks to the BiA Trinity, provides a potentially transformative model for the global bond market generally.

Current state of blockchain in the green bond market

As noted above, the original goal of this report was to map the blockchain-enabled green bond market, but we quickly discovered that there isn’t yet very much to map. The report therefore takes a broader perspective by including also none green blockchain bonds and debt products to offer an analysis of the current state of blockchain adoption in the bond market generally. The report finds that the opportunity presented by blockchain for green bonds falls into the three main areas: 1) Structuring, issuance and distribution; 2) Transfer of ownership, payment and settlement; and 3) Reporting (on Use of Proceeds and Proof of Impact). To date, blockchain technology for bonds has only been applied to the first two areas, and only partially in the second. The bottom line is that a fully digitized green bond is possible, and desirable, but remains in the future.

10X efficiency gains

Blockchain can step into the bond market to take over the role of trusted broker, making it easy to reduce the overall costs of bond issuance and impacting the minimum coupon size. On the blockchain, there will be no difference in costs between a 10-dollar bond and a 10 million dollar one. And if the bond issuer no longer has to worry about getting killed on transaction and servicing costs, then the green-bond market is open to everyone. Even very low-income citizens can purchase a stake in their countries’ green transition.

Blockchain: Gateway for Sustainability linked Bonds estimates the efficiency gains of blockchain at more than 10X the non-DLT bond process. The largest efficiency gains (measured in terms of money saved) would come via lowered costs for reporting, brokerage, and sales as well as structuring, price setting and risk rating.

‘Do It Yourself’ green bonds

Blockchain paves the way for “do it yourself” green bond platforms which allow issuers to create their own digital green bonds at low cost and offer them in some markets via security tokens, which is a digitized way of offering a bond to the market. This will enable smaller entities such as medium-sized businesses or even neighbourhoods to issue green bonds directly without the need for costly full-service intermediation by banks. Regulators and policy makers can pave the way for this DIY avenue to scale green bonds by unlocking savings. Only if regulation clarifies the regulatory status of crypto assets to make these regulated instruments for people to trust putting their savings into these platforms. These new forms of community green bond offerings could be just around the corner if regulators enable this market.

Countries stepping into a digital bond market future

The report points to the countries most prepared for blockchain-based green bonds, as an example and inspiration for others exploring the possibilities. Although of course dwarfed by the USD 100 billion global market for green bonds, as of Q3 2019, just over USD 1 billion has been raised via security token offerings on the blockchain. The market for the latter offerings has been driven mostly by the UK, USA, Switzerland, Germany, and Estonia. The common denominator for these countries is regulatory clarity of crypto assets.

Blockchain-enabled green bonds are, in other words, a small percentage of total green bonds. And green bonds in turn, are a small percentage—barely 2 percent—of the trillion-dollar global total for bonds. But even though blockchain is the upstart in the green bond world, it is a potentially revolutionary tool to re-think, as well as to speed up the growth, of money to build a green future.

We believe that the time is right for Blockchain: Gateway for Sustainability linked Bonds. The regulatory regime for crypto assets is starting to become clearer and more coherent, the necessary precondition to full digitization of green bonds. Meanwhile, the BiA Trinity technology advances every day. Most important of all: the iron law of supply and demand. Demand for green bonds outstrips currently supply, so bond market participants have powerful incentive to increase the volume. Blockchain: Gateway for Sustainability linked Bonds shows that blockchain can deliver the scaling to meet this demand, primarily by lowering costs and increasing speed, but also by powering use-case innovations.

HSBC and the Sustainable Digital Finance Alliance aim to help move the conversation from looking only at potentials of blockchain to transform the green-bond market to concrete proposals for next steps. We look forward to reporting progress.

Read the Report here: https://www.sustainabledigitalfinance.org/initiatives-publications

See the report video here: https://www.youtube.com/channel/UCYihGuyasWqs9C-IqMU5wtw

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