18 May 2021

Digital technologies, the driver for the development of green bonds

By: Carlos Arcila Barrera, CFA, CAIA, SCR
Professor of Finance at the Faculty of Administration of the Universidad de los Andes
Associate Researcher - Sustainable Finance Center, Universidad de los Andes
Chief Investment Officer - Sigma Advanced Capital Management

"By integrating blockchain with other technologies such as the Internet of Things (e.g., sensors), Big data, machine learning, and/or natural language processing, it could be possible to increase the transparency, liquidity, and verification of the impact of green bonds."Prof. Carlos Arcila B, CFA, CAIA

Digital technologies, as well as sustainability, are strategic priorities today for companies. Although these strategies are usually seen separately, the connection between them creates a powerful integration in opportunities, setting and meeting the goals of sustainability, efficiency, and the development of new businesses.

The financial sector, which has been one of the most innovative and active in meeting the sustainable development goals, has a transcendental opportunity to take advantage of these new technologies and align them with its sustainability goals. One case where technology and sustainability play an essential role is in developing the green bond market.

What are green bonds, and what are they for?

Green bonds are debt securities issued by a government or a company, where the resources raised from the issue must be used exclusively in green projects. These projects, which are classified by different taxonomies (including the European or Chinese taxonomy), include projects involving: Renewable energy, energy efficiency, transportation, and species preservation, among other environmental projects. Transparency, impact measurement, and resource management are essential in this market guided by voluntary principles such as the Green Bond Principles, developed by ICMA and in which they set the transparency, reporting, and validation guidelines.

These securities typically have a second verification and must report the use of financial resources in projects as well as an impact measurement report, allowing investors to validate that their resources were used correctly and generated the desired impact.

The development of the green bond market in Colombia has begun to exhibit promising growth, driven by issues from the country's leading banks (Bancolombia, Davivienda, Banco de Bogota) as well as institutions such us Bancoldex, which has taken on a leadership role in these issues. However, the market is still small, demand very high, and the country's carbon neutrality goals are ambitious, necessitating significant investment and resources. All of the preceding present a challenge for us in promoting this market more aggressively, obtaining the capital that allows companies and the country to meet development goals, minimize the risk of climate transition, and allow more investors to access these securities.

Digital technologies and their role in the development of the green bond market

The use of emerging digital technologies can improve efficiency, decision-making and increase the competence of organizations. An example is blockchain, which can impact the structuring, distribution, transfer, payment, and settlement of green bonds by simplifying complex processes and having verification and record-keeping available.

Likewise, blockchain allows the reduction of times, operational risks, intermediaries, and costs, through the use of smart contracts. According to the report 'Blockchain: Gateway for sustainability-linked bonds,' from HSBC and Sustainable Digital Finance, blockchain technology would allow potential savings of 10 times the costs of issuing bonds, achieving that projects and companies of all sizes can issue these securities, creating opportunities for a broad portfolio of green and sustainable projects. Although this concept sounds futuristic, the World Bank, Banco Santander, and BBVA/Mapfre, among other global institutions, have managed to issue green and traditional bonds using this technology 100%.

Furthermore, integrating blockchain with other technologies such as the Internet of Things (e.g., sensors), Big data, machine learning, and/or natural language processing could increase the transparency, liquidity, and verification of the impact of green bonds, by allowing real-time monitoring of the evolution of each project, validating and verifying the use of resources and the impact that these securities are generating.

How does blockchain change the way green bonds are traded?

The use of blockchain also provides liquidity benefits by lowering trading amounts, thereby broadening the range of investors. Through "tokenization," which allows dividing the investment amount of a bond, which is typically large, interested individuals would be able to invest according to their economic capacities. A person with a hundred thousand pesos ($30 USD approx.) could buy a green bond. As more players enter the market, more savings and money may be channeled into the market.

Similarly, it would be possible to democratize the actors who can issue these securities, attract more resources, and promote sustainability goals for projects of various sizes. Small and medium-sized projects could be securitized or aggregated into a "pool" of projects that would have credibility, lower issuance, automation, and transparency costs due to the use of these technologies.

In conclusion, the integration of digital technologies and sustainability constitute a tremendous strategic opportunity in the financial sector and other industries. The convergence of these two trends will enable the promotion of environmental projects, mitigate the risk of climate transition, support the development of the green bond markets, attract more participants in issuance and investment, and channel more resources toward meeting the sustainable development goals and a low-carbon economy.