11 Mar

UNEP Blockchain Publication: Roadmap for Integration of Climate Finance and Accounting


Context & Summary

OpenEarth was invited to contribute a chapter to a special report produced by UNEP and the Social Alpha Foundation. The report ‘Blockchain for sustainable energy and climate in the Global South’ was published on January 2022. Access the full report here >

As opposed to write about a concrete pilot developed on the ground, our contribution focused more on how to use systems thinking to identify transformative solutions in the blockchain and digital technology space. In fact, Martin Wainstein’s chapter on the report (page 42, chapter 3.1)   actually lays out the core principle that OpenEarth uses to drive innovation and development — big picture system dynamics and evaluation of digital platforms as leverage points for system transformation.

If you want to learn more about the innovation approach taken by OpenEarth, and why we focus on integrated climate accounting and finance, we strongly recommend checking out this report. For an overview summary you can also watch the webinar presentation here (min. 40 onwards)

Roadmap for Integration: Closing the loop in climate finance and accounting

Martin E. Wainstein | Executive Director, Open Earth Foundation

Cross published from UNEP

Large technological disruptions, such as cars replacing horse carriages, have been driven by new innovations whose economics produce affordable and exponential adoptions from multiple actors across supply chains (Seba, 2014). The results are economy-wide socio-technical transition that change the fundamental paradigm between people and machines. The clean energy disruption is no exception. However, a unique aspect of the current climate & energy transition is that the ultimate driver is not coming from the innovations themselves, rather it’s from the imminent planetary scale environmental collapse. For the first time in human history, it is the finite nature of our Earth system that is forcing us to transform our economy and infrastructure across the globe towards a low-carbon alternative.

To achieve the climate transition at the scale and speed needed, we must ensure that all system dynamics linking elements such as climate finance, action, value creation and policy, are aligned in reinforcing feedback loops. This means more of one thing influences more of something else; linking a chain of action-reaction elements unleashing exponential change (Sterman, 2001). Managing these complex systemic processes at a global scale is challenging. However, a second unique aspect of the climate transition is that we may have the tools to do precisely this. This is because the most recent technological disruption, the digital disruption, has produced tools that can help us influence how dynamic global systems connect. Particularly, distributed ledger technologies (DLT) can directly help link systemic feedback loops. They can do so by helping establish consensus on digital records across large networks and allowing these records to execute causal effects through ‘if-then’ statements in smart contracts (Wainstein, 2019). The challenge is to build a global digital infrastructure with an integrated system designed to meet the net-zero goals.

So far, this report has covered the role of DLTs like blockchain can have on innovating decentralized energy management, climate finance and carbon management. This article focuses on how we must leverage the technology to weave these aspects together into a cohesive system that radically accelerates the clean energy transition. In simple terms, more financial capital needs to flow towards on-the-ground climate action, producing tangible climate value that needs to translate into robust climate records. Robust climate action records, such as mitigation outcomes, should trigger more capital flow. Figure 1 shows this process using a system dynamics feedback loop.The next sections describe how technology in network platforms can automate the connections between these core elements. Clean energy finance, with a focus on solar will be used as a main example.

Linking bottom-up climate action with top-down financial instruments like climate bonds

To ensure a sustainable flow between financial capital and climate actions, such as solar energy deployment, two main processes need to connect. The first is to ensure there is a steady pipeline of investable projects across a broad spectrum; from decentralized small-scale community projects to large utility-scale projects. The second is for large institutional investors to mobilize capital into portfolios that includes that broad project spectrum. This allows investors to ensure heterogeneity in project typologies and hedge their position by diversifying risk. Technology platforms that allow these two processes to link are open investment marketplaces. Blockchains, through crypto currencies and contractual automation, can be leveraged by such digital platforms to remove frictions and allow complex marketplace interactions to scale without compromising trust.

Based on this layout, we can identify three main opportunities for digital platforms. Figure 1 provides a visual representation of where these platforms lay within the system. The first one, which we can call ‘Origination Engines’ are designed to empower virtually any community member to be a climate action entrepreneur. They can do this by simplifying the origination process that translates an opportunity, such as a potential site for solar energy deployment, into a securitized investable project ready to issue a public offering. The origination process for securitized projects requires robust feasibility assessments and high legal and bureaucratic upfront costs. However, these complex financial offerings can be significantly democratized by: creating digital templates of the legal processes using smart contract, providing cryptographic trust on the underlying mathematical models that simulate a project’s performance (eg. solar financial models) and embed the process on intuitive user interfaces. A concrete example of a solar energy Origination Engine using common business data standards was recently launched by Raise Green, a regulated investment portal (RaiseGreen, 2020).

With a diverse group of the local community engaged into climate action, and ensuring platforms are designed to local context and capacity, a country or region can ensure a steady pipeline of investable projects; leveraging collective intelligence and creating green jobs. But rather than having to seek for investors individually, project developers can use marketplaces; one-stop shop portals where registered investors (local and international alike) can select projects that meet their impact, risk and financial return requirements. If the digital records corresponding to the project profile are properly tabulated by the origination engines, then marketplaces can provide project transparency to investors as well as valuable network effects such as reputation scores. In the United States, for example, Republic uses blockchain in the context of a financially regulated investment marketplace that allow non-traditional investors to invest in securitized projects (Republic, 2020).

To truly scale financial capital flows, large investors can’t be expected to review each individual project. This is where public sector climate commitment and central banks can provide support by issuing climate bonds, which can be leveraged to underwrite the pipeline of projects that meet specific quality criteria (Marke 2018). According to a report from the Green Digital Finance Alliance, the end-to-end digitalization and blockchain automation of climate bonds can lead to a 10x costs reduction throughout the full lifecycle of the bond (SDFA, 2019). To meet this value proposition, Evercity, an impact tracking blockchain company, has launched an open source project for climate bonds using web3 DLT technology (Evercity, 2020). Once a successfully digitized bond process is templatized, it can be replicated in other jurisdictions with slight adjustments, thus falling under the Paris Agreement’s technology transfer rules. This is particularly relevant for enhanced North-South and South-South Cooperation to help less developed nations that could roll out financial instruments that can boost their economy by supporting community-scale projects.

Figure 1. Digital platforms linking bottom-up climate action with large-scale financial capital

Driving climate action value through improved digital business models

The previous section describes how digitization and automation can help both democratize climate action across communities, creating new developer jobs, and mobilize capital through sophisticated financial instruments and marketplaces. However, once a project is funded and built, developers or project originators, need to operate the project through a prolonged time period, which introduces significant operating and maintenance costs. In the case of securitized solar projects, for example, a developer may need to operate a solar project anywhere from 5 to 20 years, managing the project’s legal corporate structure (often termed a ‘special purpose vehicle’). A solar project company requires managing yearly legal compliance, tracking power purchase agreement contracts, submitting invoices to its electricity off-takers, processing operation and management costs, issuing and selling renewable energy certificates, and process a capitalization table to provide dividends back to its investors. Historically, securitized solar projects have only been eligible for economies of scale where installations are over 10MW in capacity. A digital platform that allows contractual, compliance and payment automation into its business process can allow securitized project as small as 20 to 50 kW. To help the solarization of the Puerto Rico island after Hurricane Maria destroyed the centralized grid, Yale and MIT launched the Open Solar project to accomplish this level of digital automation into solar projects (Wainstein, 2019).

Once securitized climate action projects are deployed, there may be opportunities for joined operations that can further increase the collective value of projects. In the solar and smart grid example, this directly translated to aggregating decentralized energy resources (eg. solar, batteries and electric vehicles) into microgrids or virtual power plants. Here again, a different digital platform can provide automation for managing a higher level of complexity, which include electricity market trading, arbitrage optimization for batteries, and grid services that provide higher grid resilience. Blockchain platforms can help drive business models for a participatory smart grid (Wainstein 2019).

Figure 2. Digital platform opportunities to streamline deployed climate action projects

Digital MRV and Nested Accounting to link action records back to financial capital

Once financed climate action projects are deployed and operating, measuring and quantifying their climate value is the essential next step—whether its quantifying their mitigation or adaptation value. Independently verifying and certifying the projects by third parties has historically been a cumbersome and costly process. However, several digital technologies can now be leveraged to significantly reduce these costs and streamline the process of Measuring Reporting and Verification (MRV). The use of internet-of-things (IoT) sensors, satellite data and artificial intelligence all play a role in integrating real-time data streams into trusted blockchain records. The records attesting to the underlying climate value creation can be digitally audited by approved actors and turned into unique certified assets, which can be traded or retired without the risk of double counting (Group 2018). In the solar energy space, this digitalization process is already transforming the process of issuing Renewable Energy Certificates (RECs) with platforms like the Energy Web Foundation or Cleartrace.io.

Units like RECs or mitigation outcomes (i.e. Paris Agreement MOs) can be traded across jurisdictions (subject to country approvals) but eventually should be retired and accounted by a specific actor; either the project developer or the buyer of units. Most project developers and carbon credit buyers are private actors rather than public entities. However, the Paris Agreement applies exclusively to sovereign nations (i.e. the parties to the agreement), not private actors. Its accounting process requires countries to present their emissions and mitigations records vis-à-vis their Nationally Determined Contribution (NDC) in a mechanism called the Global Stock Take. In order to directly include all private sector climate actions and units into the Paris Agreements, their credits should to roll-up to the country level and become part of the national greenhouse gas inventory.

In order to seamlessly integrate climate data from non-state actor (i.e. private firms, cities and provincial governments) with state level accounting, the Yale Open Innovation Lab has focused on establishing a framework defined as nested accounting (Wainstein, 2019). This involves geographically tagging all climate action data and units in the context of spatially nested jurisdictions. By leveraging the architecture of a spatial web (Deloitte, 2020), this allows that once a unit is retired (i.e. removed from the market) a spatial contract identifies and accounts the unit to all relevant jurisdictions; all the way up to the national and international level. Each jurisdiction, defined by its geographic polygon, becomes a registry by default, not necessarily using a conventional database, but rather by queries of actions within the geographic space.

Figure 3 illustrated the nested accounting process whereby non-state actor data roll-us to the national context. This process also helps close the loop from the accounted actions back to the source of financial capital. Private investors, which may or may not acquire the carbon unit as part of their investment, receive a certification of impact but also ensure that the impacts are included in the international Paris Agreement efforts. From the lens of a central bank, who for example may have provided issuance and liquidity to climate bonds that financed solar energy deployment, this process ensures that the sovereign nation’s funds are used to both create local green jobs and directly contribute to the country’s fulfillment of the NDC.

Through a constellation of digital platforms that provide automation via linked records and rules, we can envision a roadmap where system dynamics, linking climate finance and accounting, unleash the exponential actions and change needed to undergo a full socio-technical transformation to address the climate crisis.

Figure 3. Linking climate value back to financial capital through digital MRV and nested jurisdiction accounting of climate credits

Watch the report presentation webinar

(OpenEarth chapter overview in min 40 onward.)

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Jul 2022

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