Green Finance revisited
In December 2020 I wrote about multiple-dimension, programmable instruments in which I proposed using smart contracts to add further dimensions to the traditional corporate bond and account for the Social and Environmental impacts as well as demonstrating good governance.
I gave an example of a car manufacturer issuing a bond, pledging to generate electricity in the form of solar PV and wind turbines, and commit to selling electric powered cars to car sharing clubs and how a smart contract introduces transparency and a system of signing off the defined metrics and countersigned by an independent authority to issue the credits.
This was followed up in the next article by exploring how the idea of multiple dimensions could be applied to equities and create an instrument representing stakeholder value, by adding dimensions to the traditional equity which is a pure financial instrument and including other benchmarks and measurable outcomes.
The final article I wrote at the end of December 2020 was in the creation of portfolios of multiple-dimensional instruments adapting standard portfolio optimisation techniques to account for the further dimensions.
There was an unresolved issue around portfolio construction and transparency, namely if a portfolio was constructed in a smart contract with the constituent instruments and their weighting then this could be cloned or copied, or even traded against especially when rebalancing. The ability to use this information without contributing is a big disincentive to the publication of the data as it takes time and know how to research and optimise a portfolio. This is a theme I recently explorer with the balance of privacy and transparency and is not easy to resolve. The answer may be an off-chain subscription service where the composition and updates are sent as private, encrypted messages and the subscriber then goes to market to execute the strategy. It would be better if an automated solution could be found or as in the traditional markets the portfolios are packaged and sold as units.
Was there any progress since I first wrote about the multiple-dimensional programmable instruments?
The concepts were further developed into an idea where the instruments are listed on a new platform which has a high bar for the listing criteria to create a marketplace that issuers and investors could have the confidence that there were credible instruments based on measurable objectives.
One of the clear objectives of developing the instruments and marketplace is to change business behaviour by doing something radical.
To bring radical change we need to make capital cheaper for sustainable investments than traditional capital
What if organisations could raise capital cheaper for sustainable growth and were thus given a competitive edge over traditional businesses raising capital through the normal means?
There is a clear demand for sustainable investments, despite the politisation of ESG in baselessly calling it “woke capital” and the issues of greenwashing, driven by the millennials and Gen Z who don’t want their children to inherit a world beset with climate issues.
If this is a no brainer why did it not happen? There are a number of issue that need addressing.
There is a degree of regulatory uncertainty around the tokenisation of digital assets and the “same assets, same rules” approach is not helpful. We see this where the rules were designed to solve liquidity issues in a two day settlement cycle and in a DLT setting where instant settlement is done there is clearly a mismatch. Replicating the traditional markets processes and structures in a DLT setting negates the very essence of what a blockchain can do, adds an overhead of cost and processing that makes it unviable. There is more certainty since I wrote the articles with the Markets in Crypto Assets (MiCA) legislation in its final stages in the EU which goes a long way to bring more certainty, although digital assets that are securities remain under securities law and the EU member states implement the laws. ESMA has launched a DLT Pilot regime to work with the industry to achieve clarity around digital assets and how they work in the regulatory landscape. The regulatory uncertainty in USA is a drag with the courts trying to bring clarity and there are moves in Asia to bring more regulations into play and it will benefit the adoption of blockchain technologies, and thus help with the use of smart contracts in the ESG space.
The incumbents are not in a hurry to adopt new technology and innovate when there is an established market in Green Finance which works well for them. The barriers to entry are sufficiently high to deter even the most determined entrepreneurs and spook prospective investors.
Where are we now?
Much has changed in two years and yet it seems little has changed and we are no further in innovating in the Green Finance space using new technologies.
What has changed in the last two years?
- The EU green taxonomy initiative has made progress and good to see that standards are emerging, without which it is hard to make financial instruments.
- More regulatory clarity
- More focus on climate matters, a greater sense of urgency
Let’s say the fully automated multiple dimensional programable instrument running on a fully licenced blockchain platform is not attainable in the medium term. What else can be done?
There is nothing wrong with issuing a multiple dimensional programmable instrument (MDPI) with the automated processes in place using the predefined goals and benchmarks. It goes through the normal processes with attention being paid to the term sheet and the definitions of the instrument.
The MDPI is then traded on the normal market venues as a security, is settled as a normal security and forms a part of a customers portfolio. The reason why it is an MDPI is that it shows the key data on chain which is open and transparent.
There is a path for MDPI to become a dual issued asset, as a digital token and a normal (well, special) security and then evolve into a fully fledged digital asset trading on an automated exchange.
The asset class itself has much room to evolve into the number of dimensions and what the base product is. It would be an interesting structure to issue an instrument based on revenues and include social and environmental dimensions. This would enable companies to grow sustainably without taking on debt or constantly diluting equity.
A pragmatic adoption of the technology to solve hard green finance issues would be a good first step and bring the much needed transparency.
The longer term vision may still involve a fully digitised solution and it may take many turns in the path and may still not be fully realised.
We have to use what tools we have within the regulatory frameworks to achieve a clean and transparent green finance sector that offers an unfair advantage to sustainable focussed organisations.