The ante has been upped in climate and ESG compliance claims. Moving beyond simply tracking ESG targets, firms now face significant regulatory risk and punitive fines if their public statements differ from what they can prove.
Specifically, regulators are targeting financial firms that have been involved in greenwashing – the act of disseminating false information to investors that present an environmentally friendly public image.
Recently, regulators highlighted Deutsche Bank and Goldman Sachs as two firms that had engaged in greenwashing and investor disclosure conflicts. Entities like these are the tip of the iceberg. Sarbanes-Oxley-like climate reporting is coming: it is already in place in the EU, the UK, Japan and Canada for asset managers, while the US is in proposal stages for issuers/borrowers and asset managers. This follows Task Force on Climate-Related Financial Disclosures and Scope 1, 2 and 3 reporting.
Given these regulations, banks, asset managers and insurance companies have the greatest burden to bear, and many of them are now grappling with this reality. These businesses will be compelled to provide climate reporting disclosures not only for the company they run and manage (Scope 1 & 2), but also for those they buy from (upstream) and those they sell to (downstream), known as Scope 3.
Here is how Scope 3 will affect the financial sector:
- Banks will report their own greenhouse gas emissions footprint, as well as that of their commercial loan book clients. The European Central Bank, Abu Dhabi Global Market, Malaysia, the UK and Basel regulators have already issued guidance for bank stress tests based on the price of carbon. Those that don’t meet their stated goals will face a higher cost-of-capital spread between capital for sustainable and non-sustainable ends – a gap that is widening each year (up from 5 basis points in 2018 to 23-28 bps in 2021; this year it is on track to reach 30-50 bps).
- Asset managers must incorporate climate compliance information across all their investments and provide reporting to their board of directors, and in turn to their investors. Much in the same way that they manage risk with daily marks to their books, asset managers will need compliance information to meet the TCFD compliance regulations that the EU, the UK, the US, Japan and Canada are implementing.
- Insurance companies need to collect compliance information from their clients to facilitate climate disclosure, and, as part of their Scope 3 reporting, they need to provide this information to reinsurers where climate risk interacts with the global capital markets in the Catastrophe (CAT) Bond market.
With so many different types of assets, across so many different entities, it’s a challenge for the corporations and governments that are responsible for collecting and reporting the billing and Internet of Things (IoT) sensor information (which enable the recipients of that data to see live updates) to calculate daily reporting on risk, the same way they manage portfolio P&L and report that to the firm’s books and records. This is the problem that banks, asset managers, insurance companies and regulators need a solution to in order to suck the oxygen out of greenwashing and deliver a climate-resilient economy.
Breaking down the information complexity, there are two problems to solve. The first is aggregating data from the hairball of assets in an enterprise ecosystem for carbon accounting. The second is to route the data so that each stakeholder (upstream and downstream) may meet their compliance requirements and deliver Scope 3 (stakeholders being regulators, asset managers, banks, insurance and credit rating agencies).
Web 2.0 and the traditional corporate API (Application Programming Interface) ecosystem isn’t built to handle this level of complex data aggregation and connectivity, and deliver that to multiple stakeholders simultaneously. When you think of the multi-stakeholder ecosystem, not only would you have significant time and cost limitations to deliver that technology, but if one link in the API chain changes or goes down, the entire system fails for all of the upstream and downstream stakeholders.
What is needed, and should resonate well with asset managers, is a market data-like ecosystem where one company can publish their data to other permissioned stakeholders. Using blockchain to tokenise assets (a web 3.0 technology), an enterprise can link a single asset and its financial information and IoT sensor information together, or a group of assets together using a hash or a reference ID. Similar to how a stock symbol or a CUSIP equates to the delivery of market data, the same can be achieved with tokenised assets (whether public or private) for each asset’s operating and climate compliance information.
In climate compliance reporting, there are triangulations of reporting between the company (Scope 1 & 2), its supply chain partners (Scope 3), and the third compliance stakeholder (the regulator, bank, insurance company, asset manager or credit rating agency). These three parties create a triangulation of data flow that can only efficiently be delivered with market data feeds and blockchain.
Given the complexity and sheer numbers of end reporting entities, aggregating and accounting GHG (TCFD Compliance) is quite complex; however, once aggregated in a portfolio, companies can tokenise their portfolio of TCFD information, converting it to stream as market data, delivering real-time consensus and real-time verifiability. This enables the permissioning of data to a wallet or portfolio by using a hash and allows portfolios of data to report climate disclosures. As a change occurs in the tokenised portfolio, the downstream data links are updated congruently. This ultimately minimises the burden of integration, and alleviates concerns for all stakeholders, from boards of directors to regulators and investors.
Let’s examine how this works in one of the more complex examples – commercial banks. Banks need to aggregate and report climate compliance information not only for themselves, but also across their loan books, which can represent upwards of 700x their internal carbon footprint.
Not only are commercial and community banks of a certain size initially compelled under Scope 1, 2 and 3, but there are also market opportunities to penetrate the infancy of the climate-resilient market by offering sustainability-linked loans, with feeds that link up to a carbon credit liquidity. This new “kit” includes sustainability-linked loans for geothermal, solar, wind, electric vehicles and the like, while providing banks with the tools to deliver compliance and reduced cost of capital based on the market differentiation between brown and green/sustainable assets.
By offering this product and delivering climate compliance, the bank would qualify for a lower cost of capital for their own sustainability-linked loans. Those sustainability-linked loans can be bundled and securitised into larger pools of capital, with all underlying loans providing linked performance to the entirety of the loan portfolio.
This framework starts with the basics of loans but can be carried over to other assets like corporate, municipal and sovereign debt with climate compliance predicated on net-zero targets and TCFD compliance as necessary to access a lower cost of capital in the sustainability-linked bond market, which has seen exceptional growth, from $50 billion in issuance in 2018 to more than $1 trillion last year. The CFA institute estimates that this market will reach $50 trillion by 2025.
Because asset managers and banks have similar reporting requirements to aggregate and report asset performance across all their portfolios (for public and private assets), as well as to report to all of their stakeholders, both need the same “market data” construct to provide the transparency needed for climate compliance.
Certainly, there have been many other innovative claims for blockchain that have fallen on deaf ears, but the simplicity of the distributed routing logic is core to blockchain: all a recipient or sender needs is either a hash (like the stock symbol or CUSIP) or a wallet/portfolio address to send or request information. Traditional corporate API frameworks are not the right instrument for this problem as they can’t deliver real-time consensus, real-time verifiability in a “market data” construct.
The stakes are high and that’s why fines are starting to be issued. The reality is that the climate and our economic future are tied together. A lower inflation world is on the other side of this and future fossil fuel shocks. Oil and natural gas are not going away any time soon, but the sooner we can get the train on the right tracks going in the right direction, the sooner this economic flywheel can start spinning with compliance resulting in cost of capital benefits for stakeholders.
No different than how the mRNA delivered 21st century innovation that provided a new way to map the covid virus to produce a vaccine, blockchain is an innovation to solve the multi-stakeholder data aggregation and routing complexity across diverse asset ecosystems for climate compliance. Blockchain is necessary for the climate-resilient economy to emerge and serve as the backbone for the Industry 4.0 economy, where capital will be priced based on carbon compliance.
Whether a firm decides to pursue this path will say how they view their role in Industry 4.0 and whether they want to be a part of the climate-resilient future or part of the past. Asset managers are demonstrating tremendous leadership by providing a cost of capital discount for compliance. Those that receive it have a responsibility to do their part or face the wrath to come.
Darren Wolfberg is co-founder and CEO of Blockchain Triangle, a digital finance platform for funding and managing climate and infrastructure assets, based in New York