Sustainable finance has been playing an increasingly pivotal role for businesses trying to improve their social impact and environmental, social, and governance (ESG) credibility in recent years. Adopting sustainable finance is imperative for businesses aspiring to transition to a net zero future by aligning financial strategies with environmental goals.
There are two types of sustainable finance products: ‘use of proceeds’ and ‘linked.’ Use of proceeds bonds includes green, social, and sustainability bonds and loans, which require proceeds to be invested in projects that have a positive sustainable impact. Meanwhile, sustainability-linked bonds and loans do not need to be invested in specific projects. Instead, these bonds and loans have an interest rate that rises if the issuer misses a pre-defined sustainability target.
The need for sustainable finance regulation
The rise of ‘greenwashing’ scandals has triggered a regulatory crackdown on organizations exaggerating their environmental credentials for marketing purposes. According to GlobalData’s ESG Sentiment Polls Q4 2023, 54% of respondents agreed that, for most companies, ESG is just a marketing exercise. Hence, greenwashing is a concern for many consumers and investors.
The current regulatory frameworks, the Sustainable Finance Disclosure Regulation (SFDR) in the EU and the Sustainable Disclosure Regulation (SDR) in the UK, place restrictions on the use of the terms ‘green’ and ‘sustainable’ specifically to products that comply with clear definitions. Businesses must comply with mandatory ESG disclosure and reporting requirements to prove this, which means that they must ensure their data is readily available and reliable.
The benefits of regtech in sustainable finance
The European Banking Authority defines regtech as “any range of applications of technology-enabled innovation for regulatory, compliance and reporting requirements implemented by a regulated institution” in its ‘Analysis of RegTech in the EU Financial Sector’ paper, published in June 2021. Technologies such as blockchain, artificial intelligence, and the Internet of Things provide the capabilities to effectively handle the increasing volume and complexity of ESG-related regulatory disclosures. This will help accelerate the sustainable finance market as, without reliable ESG data, investors are more reluctant to invest in sustainable finance products.
Blockchain technology can be used to ensure data transparency by allowing stakeholders to trace financial activities throughout the supply chain. Transactions recorded on a decentralised ledger provide an auditable stream of financial flows related to sustainable initiatives. Blockchain also safeguards the integrity of information related to sustainable finance by ensuring the security of data and preventing any potential tampering. The technology further aids compliance with sustainability regulations as self-executing smart contracts on blockchain streamline the process and accuracy of compliance.
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By GlobalDataAI has many regtech use cases for sustainable finance. For example, solutions range from analysing vast amounts of datasets to identify any inconsistencies to addressing any gaps in sustainability disclosures through AI simulations that predict potential outcomes. AI-driven predictive modelling can also help develop risk models that help businesses factor in sustainability-related risks. Natural language processing (NLP) algorithms can also be used for document automation, helping businesses find relevant information for reporting and disclosure requirements quicker.
A multitude of technologies make up regtech. The solutions these technologies offer help streamline and automate regulatory compliance processes, which increase time and cost efficiency for businesses and ensure credibility of ESG claims
