How distributed ledger technology (DLT) can provide authenticity to the green finance revolution

Anchored in the broader context of environmental, social, and governance (ESG) developments, sustainable finance is gaining increasing prominence. This momentum is driven by factors such as rising consumer demand, environmental considerations and the allure of potential long-term returns, especially within the realm of asset management and pension funds.

Simultaneously, there's mounting pressure from diverse stakeholders, ranging from shareholders and employees to governments, pushing companies towards more sustainable practices. However, a significant challenge in this evolution is "greenwashing", where some financial offerings misrepresent their environmental credentials, undermining genuine sustainable investments.

Quick take:

• Sustainable finance is on the rise, propelled by consumer demand, environmental urgency and the potential for long-term gains.
• Greenwashing, a misleading portrayal of financial products as eco-friendly, threatens the essence of genuine sustainable investments.
• Distributed ledger technology (DLT) offers a transparent, tamper-proof method to bolster sustainable finance, though challenges like interoperability and data privacy persist.
• Collaboration and proactive adoption of technologies like DLT are essential for the future of genuine green finance.

Crackdown on greenwashing and the push for authenticity

The tectonic shift towards genuine green finance represents an evolution in global business ethics and a pragmatic response to a rapidly changing financial ecosystem. With greenwashing under the microscope, the financial sector is witnessing an era where mere claims of environmental responsibility are insufficient. In today's context, the emphasis is on demonstrable action and this transformation stems from multiple driving factors.

Regulations are undeniably at the forefront, steering the direction of the industry. As they grow more stringent, businesses are prompted to reconsider their strategies, aligning them with both the letter and spirit of the law. Yet, beyond mere compliance, there's an intrinsic value in genuine green commitments. In an increasingly aware global marketplace, the consequences of greenwashing are manifold. A tarnished reputation can lead to loss of consumer trust, a decline in shareholder value and potential legal ramifications. For businesses, this is a trifecta of risks too significant to ignore.

The European Union’s Sustainable Finance Disclosure Regulation (SFDR) exemplifies this new age of rigorous oversight. By raising the bar, the EU is helping make sure organizations are transparent in their claims and is fundamentally altering how businesses conceptualize sustainability. With the recent push for evidence-backed environmental claims, there’s an unmistakable message being sent: green finance can't be a mere marketing gimmick. Instead, it needs to be woven into the very fabric of business operations.

This increasingly intense focus on authenticity in green finance is more than just a regulatory or reputational mandate; it's a reflection of a global sentiment. Investors, consumers and stakeholders are increasingly discerning, seeking verifiable proof over superficial promises.

DLT as the lubricant of sustainable finance

Blockchain, a type of DLT, has emerged as a potentially transformative force in the realm of sustainable finance (for more on how DLT could enhance development finance, see Potential of distributed ledger technology to revolutionize development finance ). Its strengths lie in offering a transparent, tamper-proof record, enabling stakeholders to track funds with pinpoint accuracy, making sure they are directed to legitimate sustainable ventures. Leveraging DLT's inherent features, the investment world can gain more insight into the deployment of funds, streamlining auditing and amplifying investor confidence.

DLT can help:

• Track funds with precision: DLT can create a transparent and tamper-proof record of transactions. This can be used to track the origin of funds, so they are genuinely being invested in sustainable projects. DLT allows for real-time tracking of how funds from financial instruments – e.g., sustainability-linked bonds or loans – are disbursed and used. This is especially critical given the funds from these instruments are intended for specific green or sustainable projects.
• Enforce terms with smart contracts: These are self-executing contracts with terms of the agreement between parties directly written into lines of code. They can be used to automatically enforce sustainability criteria, so investments meet predetermined green or other criteria before they're executed. Smart contracts on DLT platforms can automate and enforce conditions set for bonds or loans. For instance, if a bond is issued with the stipulation that funds be used solely for renewable energy projects, the smart contract can be coded so funds are only disbursed when specific renewable project criteria are met.
• Provide real-time reporting and verification: Investors can see in real time how their funds are being used, reducing the delay often seen in traditional reporting structures. Independent verification nodes can be integrated into the DLT system.[1] These nodes can validate funds are being used as intended, offering an extra layer of surety for investors.
• Reduce fraud and misappropriation: The decentralized nature of DLT means that no single entity has control over the entire ledger, reducing the chances of manipulation and increasing trust among stakeholders. The immutable nature of DLT means that once a transaction is recorded on the ledger, it cannot be altered or deleted. This can prevent malicious actors from misrepresenting how funds are used, so that green finance funds are not diverted to non-sustainable projects.
• Streamline auditing and compliance: With all transactions transparently and immutably recorded, auditing becomes far simpler. Instead of manually sifting through records, auditors can quickly verify the authenticity of transactions on the blockchain. Compliance checks, which assess whether conditions of sustainability-linked instruments are met, can be automated and streamlined using DLT.
• Enhance stakeholder confidence: The transparency and security provided by DLT can bolster confidence among stakeholders, including issuers and investors. Knowing that green finance instruments are backed by technology that delivers authenticity can lead to greater participation and trust in the market. The convergence of green finance and DLT has the potential to revolutionize the sector by making sure funds are genuinely used for intended sustainable purposes. For investors, this translates to a higher level of confidence in their green investments, leading to more impactful and genuine sustainable outcomes.
• Deliver cost effectively: DLT can reduce administrative costs in the long run by automating many compliance, auditing and reporting processes, making sustainable finance more affordable and attractive.
• Support small to medium enterprises (SMEs): DLT can democratize access to green finance, allowing SMEs to participate in sustainable investments more readily. This would be particularly beneficial in regions like Europe where SMEs play a significant role in the economy. (For more on how technology could support SME finance, see How tokenization and data notarization could unlock SME potential .)

Hurdles in the DLT-driven green finance landscape

While DLT offers immense promise, its incorporation into sustainable finance has been somewhat restrained. Barriers arise from the need for technological, operational and regulatory overhauls, concerns about interoperability, data privacy and scalability, and other such factors:

• Adoption barrier: While DLT has significant potential, its full-scale adoption in the financial industry requires a considerable technological, operational and regulatory shift.
• Interoperability: Different DLT systems need to communicate seamlessly with each other, especially in a global financial market.
• Data privacy: Making sure sensitive financial data remains confidential on a transparent and immutable ledger is crucial.
• Scalability: As with many technologies, scaling DLT to handle the vast number of transactions in the financial sector is a challenge. Solutions are in the works, but this remains a key consideration.
• Regulatory alignment: It's essential that DLT solutions align with not just one country's regulations, but have the flexibility to adapt to multiple regulatory environments.
• Skills gap: The financial sector would need a workforce trained in both finance and DLT, which might necessitate retraining and skill-development initiatives.
• Initial implementation costs: The upfront cost of integrating DLT into existing financial systems can be high, potentially hindering immediate adoption by some institutions.
• Integration with legacy systems: Another challenge in implementing new technology solutions like DLT is how they integrate with or replace existing systems. This especially true for financial institutions, because many have old and often complex infrastructure.

The current landscape of DLT in green finance

As the green finance arena burgeons, DLT has made notable inroads, but its adoption is still nascent. Some important initiatives shaping the current state of the market include:

• Pilot projects: Various financial institutions and technology firms have embarked on pilot projects to test the efficacy of DLT in tracking green investments, validating its capabilities in real-world scenarios.
• Collaborations: Recognizing the transformative potential of DLT, several banks, technology companies and environmental agencies have formed alliances to explore its application in sustainable finance, from supporting the legitimacy of green bonds to verifying carbon credits.
• Regulatory interest: Some governments and international bodies have shown keen interest in DLT as a tool for enforcing green finance mandates, prompting discussions about potential regulatory frameworks.

Some notable instances where DLT has been employed in sustainable finance include:

• World Bank's Bond-i Project: The World Bank and the Commonwealth Bank of Australia jointly created the first public bond to be created, allocated, transferred and managed through its entire lifecycle using DLT. The Bond-i project, which stands for Blockchain Offered New Debt Instrument, raised funds for the bank’s developmental activities, with a focus on global sustainability.
• Banco Bilbao Vizcaya Argentaria (BBVA) and green bonds: BBVA issued a structured green bond using DLT for the negotiation and placement processes. The bank used blockchain technology to provide transparency in the process, keeping both the issuer and investor informed about the green bond's impact.
• Energy Web Foundation: This global nonprofit organization launched the Energy Web Chain, a public, open-source blockchain designed to support and verify various energy-related transactions. This platform helps make sure renewable energy assets, such as wind and solar farms, are genuinely producing green energy and streamlines energy trading processes.
• SolarCoin: It's a global rewards program for solar electricity generation. For every MWh of solar electricity produced by a solar installation, the owner receives one SolarCoin (SLR) in a digital wallet. The blockchain is used to verify the authenticity and origin of energy generation.

Despite the enthusiasm, the broader market's full-fledged adoption of DLT remains cautious, largely due to aforementioned challenges.

Charting the future of authentic green finance

The future of the financial sector seems increasingly intertwined with genuine green aspirations, aided by the synergistic forces of stricter regulations and trailblazing technologies like DLT. But success in this realm requires a collaborative spirit, uniting technology providers, regulators, financial institutions and a plethora of other stakeholders. As sustainable finance and its supporting technologies evolve, staying ahead becomes imperative, not just as a competitive maneuver, but as a strategic move to future-proof ventures.

With transparency and authenticity poised to attract a broader investor base, early adopters could reap reputational, operational, and financial benefits, making it crucial for industry players to stay updated, embrace DLT and champion genuine green investments. Asset managers and pension funds should stay informed about these technological advancements, consider DLT solutions for their operations and actively support genuine green investments.

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For more on digital assets, see Governing digital assets – a guide for directors .

?The views in this article are mine. The insights reflect an engaging and sparring discussion between me (as governance and risk expert, and accomplished author) and Open-Source AI ChatGPT (as know-it-all and so-so author). Copyright: Mark Watson

[1] Nodes are computers or systems within a DLT network that maintain and validate transaction records. By decentralizing the verification process across multiple independent nodes, the system provides credibility and reduces the risk of fraudulent activity. For investors, this means that transactions and fund allocations are transparently verified by multiple parties, bolstering confidence in the integrity of the investment.