The increasing number of reports, whitepapers and news articles discussing the use of Blockchain for Bonds, particularly Green Bonds, highlights the potential of this technology to help scale climate action.
The financial sector has been experimenting with Distributed Ledger Technology (DLT) for several years. For example, the well-known Corda (known as CorDapps) ecosystem started development in 2015 with a large number of financial institutions, completing its first live securities lending transaction on the platform between Credit Suisse and ING in March 2018. Later in the same year, the World Bank in partnership with Commonwealth Bank of Australia issued the first “Bond” using Blockchain. In February 2019, the first “Blockchain Green Bond” was issued by BBVA. Similar to the World Bank, BBVA used the technology primarily to simplify processes and streamline negotiation timeframes with investors.
The HSBC and Sustainable Digital Finance Alliance has released their report entitled “Blockchain: Gateway for sustainability-linked bonds”. It provides a comprehensive review of the state-of-the-art, coverings worldwide initiatives on this growing area of finance. One of the main contributions from the report is the objective comparison between “blockchain” vs “standard” bonds, which offers a glimpse of why these technologies should be adopted with more urgency in order to deliver clear climate actions. The report demonstrates that for the wider bond market, blockchain presents cost savings opportunities of more than 10x. The efficiency gains reported were calculated by companies studied and the analysis conducted within the report.
As the report explained, the application of DLT on Green Bonds can be split in three broad areas:
- Structuring, issuance and distribution
- Transfer of ownership, payment and settlement
- Benchmarking and reporting
The first two areas are applicable to all bond types. As demonstrated by the examples from the World Bank and BBVA, these areas represent the main areas explored, while the area of benchmarking and reporting opportunities are yet to be realised.
As shown in the extracted table below, the biggest gains (as money saved) come from “reporting”, “brokerage and sales” and “structuring, price setting, risk rating”. Although technology and proof of concepts are moving fast, regulatory aspects are still lacking behind. Countries like the UK, USA, Switzerland, Luxembourg, Germany, China, Japan and Singapore are among those more engaged in the readiness process that will help advance the use of blockchain across all areas of a bond.
Efficiency improvement comes as an important aspect of cost reduction. Blockchain can help reduce the number of actors involved in the bond process. Not only does it facilitate immediate distribution (e.g. smart contracts can handle complex rules for competitive bidding), it can also reduce reconciliation activities (e.g. cryptographic signatures remove the need for anti-fraud or error checks), and improved settlements (e.g. from 2-3 days settlement period to instant).
Source: Blockchain: Gateway for sustainability-linked bonds, HSBC and Sustainable Digital Finance Alliance 2019
Although cost reduction alone represents a great opportunity to adopt DLT, many other benefits offer even greater opportunities to the Green Bond market. For example, enhanced “credibility” can totally transform current practices as DLT is combined with other data technologies such as Internet of Things (IoT), which can allow investors to have direct and real-time access to the environmental impact of their investments (streamlining reporting and benchmarking activities).
The “trusted granular data” provided by these digital ecosystems offers the opportunity for fragmentation of green asset ownership; or the aggregation of many smaller assets into a bond. This type of innovation can potentially democratise the access to sustainable finance. This means that anyone could potentially become an investor or an investee of sustainable assets, projects or activities.
The report also provides a series of recommendations that can help accelerate the adoption of these technologies. For example, the concept of “Bonds as a Service” aims to increase accessibility to bond issuance via the use of automation and digitisation.
Although the HSBC and Sustainable Digital Finance Alliance report makes important contributions to this growing field, its scope was limited on multiple fronts. For example, figures provided on the above table are based on estimates (e.g. hidden costs of organisations, literature review of typical fees/processes, interviews with a wide range of practitioners, etc) and a varied range of assumption instead of hard proven figures. Another aspect that requires further work relates to the recommendations, for example the report recommends piloting all Green Bonds steps/areas into a DLT platform, but it provides limited “technical” and “legal/policy” details of how exactly such pilots could be achieved. These limitations demonstrate that there is still much work ahead. DLTs are fast-evolving while most of these platforms are not yet interoperable. There is a potential need for standardisation such that it becomes easier to scale adoption across different stakeholders of the bond process. More R&D is also required to ensure that any vulnerabilities are not exploited (for example code weaknesses have been exploited by bad actors) and deficiencies of existing DLTs are addressed.
As the report concludes, “markets are immature and technology is still evolving, however the time is right, and the need is urgent, to progress to the next stage”. More proof of concepts involving all the necessary stakeholders are required across all jurisdictions, something that the Blockchain & Climate Institute is actively working on. As demonstrated in all the early trials, huge opportunities are readily available and many more could become a reality within a short period of time.