Author: Luis Hernández Aramburo, professor at EGADE Business School of Tecnológico de Monterrey.
More than USD 6.5 trillion must be mobilized each year to achieve global decarbonization goals. Capital markets, and in particular green bond issues, have been presented as one of the solutions to mobilize these resources. Although green bonds have been the most dynamic type of asset in fixed income markets, resources are insufficient and a series of questions have recently been raised about the reliability of these instruments to appropriately channel resources. Hence, certain technological advances such as artificial intelligence or distributed ledger systems (DLT) have been sought as a solution to mitigate these limitations.
DLT technology allows two objectives to be achieved simultaneously. On the one hand, establish property and use rights in a digital environment, and on the other, not require a centralizing entity. This is achieved through an ingenious combination of cryptographic elements and incentives to participants. The most well-known application of DLT is the Bitcoin blockchain case. However, a DLT instrument allows the securitization of a wide variety of projects backed by the financial flows of real assets.
This latter activity is known as real asset tokenization. For example, Apollo, BlackRock, Blackstone, BNY Mellon, Carlyle, KKR, Morgan Stanley, State Street, UBS and WestCap have formed a consortium that plans to use blockchain technology in the alternative assets sector. Reports from various agencies place the tokenization potential of real assets in the trillions. Citigroup estimates for 2020 a growth in real tokenized assets of 80x and a market value of USD 4 trillion (USD units).
Some of the first issues of digital instruments that have been carried out on the DLT platform are precisely green bonds. Among the bond issues through blockchain, the following stand out:
-Vesteda (corporate): issued EUR 5 million green bond with support from ABN AMRO;
-European Investment Bank (EIB): issues SEK 1 trillion (USD 93 million) green bond with the support of SEB and Credit Agricole (June 2023);
-European Investment Bank (EIB): issues £50 million ($59.8 million) using HSBC Orion (January 2023);
-Hong Kong: issues HK 800 million (USD 100 million) using the Goldman Sachs platform (February 2023);
-KfW: issues EUR 20 million (USD 21 million) blockchain bond using Deutsche Borse platform (December 2022);
-MAPFRE: issues first green bond of EUR 35 million (USD 36.7 million) through BBVA (February 2019).
What are the advantages of issuing a digital bond?:
1.- Operational efficiencies. A bond issued in digital format allows you to significantly reduce costs by making processes efficient and eliminating intermediaries. According to an HSBC study, the issuance costs of a green bond in the amount of USD 100 million could be reduced from USD 6,449,000 to USD 692,000, a reduction of 90%.
2.- Democratization. High issuance costs have limited access to the bond market for both issuers and investors. Digitalization, by reducing costs, facilitates access for medium-sized companies and retail investors. Additionally, digitalization allows high-value and illiquid assets to be fractionalized.
3.- Data analysis. The greatest advantage of bonds that use blockchain is being able to obtain data that is reliable and traceable to sources. This credibility in the data obtained through IOT (Internet of Things) and analyzed using artificial intelligence allows us to greatly mitigate the problems associated with greenwashing. It is this issue that arguably represents the greatest threat to the development of a green bond market. The combined use of DLT, IOT and AI technology finally allows us to offer truly programmable financial instruments.
What is needed for digital green bonds to reach critical mass? The first step is to have a clear regulatory framework. In its early stages, the issuance of cryptocurrencies as a source of capital raising resulted in bad practices and lack of supervision. Fortunately, several countries have begun to publish guidelines for this type of digital assets. These include Canada, the European Union, Switzerland, the United Kingdom, Singapore, Hong Kong and the United Arab Emirates, among others. A second aspect is to facilitate interoperability between platforms. It is not possible for a single platform to meet all scalability and security requirements. Facilitating this interaction will give greater liquidity to the bonds.
Originally published in Las Empresas Verdes.