Green Deriveum
The Green Financing Gap:
Green financing gap is an issue identified by numerous academics like Donovan [1], Sachs [2], Farhad [3] and others. The problem has been recognized by vast array of international institutions like the UN[4], OECD[5], WEF[6], IEA[7], IRENA[8], EC[9].
Green finance is key to building climate resilient organizations and societies, and for climate change adaptation and mitigation. One of the biggest challenges we still face is how to finance climate resilience and sustainable growth. Public funding in Europe is estimated [9] to cover just 35% of the needs.
Unfortunately, investment in new technologies is risky and private funds are reluctant to participate in the green transformation [3]. This leads to lack of sufficient financing mechanisms that will allow green technologies to be scaled up.
Creating tools to mobilize private capital for the Green Deal is paramount for its success.
The Solution:
In a nutshell mobilize EUR 1 billion in private capital.
An innovative hybrid collateral based on blcokchain/DLT and specifically designed to mitigate the issue of insufficient debt insurance[13][14][12] for projects contributing to the Green Deal, Green Deriveum was developed in the regulatory and technical sandbox of ECB/BoL and powered by R3 Corda.
By utilizing a smart contract Green Deriveum will allow debt insurers to block a certain amount of money as collateral for a fixed amount of time and ensure that the collateral will transfer to the debt investors should a default take place. If there is no default the insurer will retain ownership of the collateral and will be able to convert it back to cash immediately.
This rather straight-forward process is currently impossible, due to the rules governing the traditional collateral classes (currencies, securities, and commodities)[10]. Thus, when implemented, Green Deriveum will have the capacity to drastically change the dynamics of the bond insurance market.
Green Deriveum is aligning the interests of each of the market participants and is giving them a direction. Projects need financing to fuel the green transformation. Investors crave fixed returns with certainty, and insurers are looking for higher yields. By providing certainty to all parties, we will facilitate the deal between them and mobilize private capital that otherwise would stay on the sidelines.
Due to our Methodology only projects contributing to the Green Deal will be able to access the collateral. Thus, we will also provide a direction to serve the self-interest of the market participant, as well as the interest of the society and the environment.
Green Deriveum will also considerably upgrade the toolkit available to regulators (ECB/BoL). The ECB will be able to monitor risk build-up and effectively deploy an array of new measures, including freeze outs, pricing out and risk capping by individual institutions, both in the EU and in third countries.
Green Deriveum is an innovative blockchain collateral class – a hybrid specifically designed to answer the need of the debt insurance market.
The solution was developed in the technical and regulatory sandbox of the European Central Bank/Bank of Lithuania. As you know B2B financial solutions are regulated by the Central Banks, thus we had the privilege to have built our technology together with its future regulators (ECB/BoL).
The collaboration with the Sandboxes of the Global Finance Challenge:
The solution we are developing, and applying for in this Challenge, is uniquely targeted towards the Green Transformation of the economy. As such we would be very interested to explore collaborations with Green Loans applications, including creating a quote and identifying green washing.
The Central Bank will hard-cap our solution for the Green Transformation at roughly EUR 1 billion for an observation period of 5 years, after which it will be revised. To maximize our impact to Green Projects we want to experiment with integrating your Green Loan APIs in our solution. That will create an easy short-cut for us to separate green projects and preclude non-qualified projects from using the collateral.
We envision our collaboration with the Green Loan App(s) not only as a technical integration of the apps in our solution, but also as a conceptual joint work to outline the shape of the Green Transformation in terms of technologies and sectors that could be most impactful.
Utilizing the knowledge and expertise of the financial institutions owning the Global Open Finance Challenge will be a great value for us, narrowing down the scope of our solution and focusing it to maximize it environmental impact.
Additional information:
Competition
Due to the Pittsburgh Reform [10] currently an escrow for debt insurers does not exist and its creation is a market disruption. Green Deriveum utilizes blockchain to act as an escrow. Its automatic nature also reduces the clearing process from 40 days down to 3.
Similar solutions are developed by a few competitors – fintech companies like Ivno and Deka, while some behemoths like Deutsche Borse are also interested. Still there are several major advantages our solution boasts.
First, our business model is targeting the insurers, rather than the issuers. Secondly, the commodity-like nature of Deriveum provides for price adjustments and ensures regulatory tools upgrade our competitors may not mimic.
Lastly, we see our competitors as collaborators since the green financing gap is estimated at €350 billion/yr[9]. The green financing instruments can currently fill only up to 20% of that gap [7] and new proposals are urgently needed.
Existing solutions and their limits
More often than not, weighty green projects need a basket of different financing mechanisms, de-risking instruments and channel enablers to be materialised.
When it comes to green financing de-risking instruments, there are a number of these that are deployed by public actors at the project level to a greater or lesser extent, such as Co-investment (Equity Fund), Cornerstone stake (Fund Level), Loan, Loan guarantee, Revenue guarantee, Co-financing, Anchor investment in CDOs, etc. to name a few. All of the above have their upsides and downsides [15][5] – a shared characteristic is they are limited by the fact that they use public funds to achieve their objective and they are also limited in their scope, as they are applied piecemeal.
Regardless of any particular instrument’s effectiveness, the fact remains there is still a gap in funding to be filled and essential supranational organisations recommend the development and implementation of more innovative green finance instruments.
Why now?
The 2021 UN Climate Report sounds the alarm on the climate emergency. We as a species need to step up now. The urgency needed to transform our economy cannot be understated.[11] This is a monumental task that requires innovation from every corner – from new energy consumption, to transportation, to building and manufacturing, to financing the needed infrastructure. We as a team strongly feel that our solution can have a significant impact towards this goal.
Blockchain can make a great difference in the finance world – it can create new methods for managing risks, end rehypothecation of financial assets and open the market to more players, reducing costs [12]. Green Deriveum is a decisive step in aligning the financial incentives for the industry with the social and environmental needs of the XXI century and it was made possible quite recently.
There is a convergence of several economic, legislative, and technological factors that makes this the right moment to support the green transformation.
Who cares about our innovation?
Green Deriveum is aligning the interests of each of the market participants and is giving them a direction. Projects need financing to fuel the green transformation. Investors crave fixed returns with certainty, and insurers are looking for higher yields. By providing certainty to all parties, we will facilitate the deal between them and mobilize private capital that otherwise would stay on the sidelines.
Due to our Methodology only projects contributing to the Green Deal will be able to access the collateral. Thus, we will also provide a direction to serve the self-interest of the market participant, as well as the interest of the society and the environment.
Green Deriveum will also considerably upgrade the toolkit available to regulators (ECB/BoL). The ECB will be able to monitor risk build-up and effectively deploy an array of new measures, including freeze outs, pricing out and risk capping by individual institutions, both in the EU and in third countries.
Target Market
The Commission estimates the green projects financing needs at €595 billion/yr, where €357 billion/yr are to come from private investors. Of the existing finance instruments, debt finance through bond issuance addresses one central need of green projects – long-term funding (patient capital). However, recent developments and emerging risks resulting from regulatory and monetary policy changes post 2008 financial crisis (without effective de-risking tool insured debt plunged by 70% from its heights) are putting the corporate bond markets in general under stress [14], which is being exacerbated by the reduction of bond insurance capacity, caused by the scarcity of collateral following Basel III and Eurosystem APP [12].
Thus, our targeted market is the corporate (and potentially municipal) bonds market – especially Green, Social and Sustainability Bonds, where we see a potential for growing the market once investors (wealth, pension funds) find themselves able to de-risk via Green Deriveum.
Foundations for success
Presently, there is a wide consensus about the acute lack of sufficient quality collateral[12] and at the same time according to the same report ‘…the potential of the technology [DLT] could be harnessed in order to continually improve the existing infrastructures over time.’.
The macro-economic uncertainty left by the Pandemic is causing wide-spread concerns in the debt markets. The able and skilful actions of the ECB and other central banks anchor macro risks for the moment, but as they themselves warn that risks are on the upside. Which is likely to further increase demand for debt insurance.
Lastly, our solution provides an excellent financial incentive for each participant to use it. Risk distribution gives investors certainty, insurers – high yield and the projects that need financing can obtain it at a reasonable rate. Each of those elements is clearly calculable and as soon as the mathematics click the parties will act of their rational self-interest.
Reference list:
[1] Donovan, C.W. Renewable Energy Finance: Powering the Future; World Scientific Books; World Scientific Publishing Co. Pte. Ltd.: Singapore, 2015;
[2] Sachs, J.; Woo, W.T.; Yoshino, N.; Taghizadeh-Hesary, F. Importance of green finance for achieving sustainable development goals and energy security. In Handbook of Green Finance: Energy Security and Sustainable Development; Sachs, J., Woo, W.T., Yoshino, N., Taghizadeh-Hesary, F., Eds.; Springer: Singapore, 2019;
[3] Farhad Taghizadeh-Hesary and Naoyuki Yoshino Sustainable Solutions for Green Financing andInvestment in Renewable Energy Projects; Energies Journal, MDPI, 2020;
[4] United Nations, Inter-agency Task Force on Financing for Development, Financing for Sustainable Development Report 2021.(New York: United Nations, 2021), available from: https://development nance.un.org/fsdr2021.
[5] OECD (2021), “De-risking institutional investment in green infrastructure: 2021 progress update”, OECD Environment Policy Papers, No. 28, OECD Publishing, Paris, https://doi.org/10.1787/357c027e-en.
[6] The Green Investment Report, The ways and means to unlock private finance for green growth 2013, WEF
[7] IEA (2020), World Energy Investment 2020, IEA, Paris https://www.iea.org/reports/world-energy-investment-2020
[8]Unlocking Renewable Energy Investment: The role of risk mitigation and structured finance, IRENA
[9] COMMISSION STAFF WORKING DOCUMENT Identifying Europe’s recovery needs Accompanying the document COMMUNICATION FROM THE COMMISSION TO THE EUROPEAN PARLIAMENT, THE EUROPEAN COUNCIL, THE COUNCIL, THE EUROPEAN ECONOMIC AND SOCIAL COMMITTEE AND THE COMMITTEE OF THE REGIONS Europe’s moment: Repair and Prepare for the Next Generation SWD/2020/98 final
[10] https://www.bis.org/cpmi/publ/d101a.pdf Technical Committee of the International Organization of Securities Commissions: Principles for financial market infrastructures, Bank of International Settlements Report 2012
[11] IPCC, 2021: Climate Change 2021: The Physical Science Basis. Contribution of Working Group I to the Sixth
Assessment Report of the Intergovernmental Panel on Climate Change [Masson-Delmotte, V., P. Zhai, A. Pirani, S.
- Connors, C. Péan, S. Berger, N. Caud, Y. Chen, L. Goldfarb, M. I. Gomis, M. Huang, K. Leitzell, E. Lonnoy, J. B.
- Matthews, T. K. Maycock, T. Waterfield, O. Yelekçi, R. Yu and B. Zhou (eds.)]. Cambridge University Press. In
Press.
[12] Deutsche Börse AG, Deutsche Bundesbank, How Can Collateral Management Benefit from DLT? Project ‘BLOCKBASTER’ (January 2020)
[13] OECD (2017), Mobilising Bond Markets for a Low-Carbon Transition, Green Finance and Investment, OECD Publishing, Paris, https://doi.org/10.1787/9789264272323-en.
[14] Çelik, S., G. Demirtaş and M. Isaksson (2020), “Corporate Bond Market Trends, Emerging Risks and Monetary Policy”, OECD Capital Market Series, Paris, www.oecd.org/corporate/Corporate-Bond-Market-Trends-Emerging-Risks-and-Monetary-Policy.htm
[15] Hussain, Mustafa Zakir.2013. Financing renewable energy options for developing financing instruments using public funds (English). Washington, D.C. : World Bank Group. http://documents.worldbank.org/curated/en/196071468331818432/Financing-renewable-energy-options-for-developing-financing-instruments-using-public-funds
