Green Finance Advisor of Friends of the Earth (HK)
ESG, which stands for environmental, social, and governance, has transformed from a mere acronym into a tangible reality. In 2025, it is projected to represent a staggering $53,000 billion market, equivalent to one-third of global assets under management. The epicenters of this movement are Europe and North America.
The financial sector has increasingly prioritized the ESG agenda, with the COVID-19 pandemic serving as a catalyst for institutions to integrate these criteria into risk management and product development. Regulators have also made ESG a top priority, and this wave of regulatory action is just the beginning.
Europe, in particular, has taken the lead in implementing ESG regulations. The 5th Anti-Money Laundering Directive, which came into effect in January 2020, provided a legal definition of cryptocurrency and expanded customer due diligence obligations. However, Europe’s regulatory framework for digital assets doesn’t stop there. The forthcoming MiCA (Markets in crypto assets) regulatory framework, expected by 2024, aims to harmonize regulations for various types of cryptocurrencies. It covers aspects such as issuance, trading, settlement, custody, and collateral management for digital assets not currently classified under existing regulations. In parallel, Europe is also witnessing a regulatory surge in sustainable finance, driven by the European Commission’s action plan on sustainable finance published in March 2018. This plan will have far-reaching impacts on financial institutions, necessitating changes in their entire organization, including risk management. For Europe’s largest banks, the challenge lies in integrating ESG criteria into governance, risk measures, stress tests, reporting, and potentially their own funds.
The sustainability concerns that have permeated the economy are now extending to digital assets. With cryptocurrency and non-fungible tokens becoming not just peripheral assets, but have grown to be a significant asset class of its own based on market value. Institutional investors, initially hesitant, are embracing these assets, which have been described as volatile, subject to regulatory uncertainty, and prone to fraud and money laundering. However, the integration of digital assets into ESG-focused financial institutions raises questions about their compatibility with the ESG agenda.
To address the energy consumption concerns associated with digital assets, various solutions are emerging. The first option is the use of renewable energy sources. According to a global crypto asset benchmarking study, 39% of the total energy consumption of proof-of-work (PoW) miners is derived from renewable sources, with hydroelectricity being the most popular. Geographical disparities exist, with North America leading in the use of renewable energy for mining activities. Another alternative is transitioning to more efficient consensus mechanisms, such as Ethereum’s proof-of-stake (PoS). If successful, this migration could reduce energy consumption by a staggering 99.95%, according to the Ethereum Foundation.
Digital assets have the potential to promote financial inclusion and positively impact developing economies. However, along with the increasing demand for these assets, threats and challenges have emerged. Cybercriminals exploit the characteristics of certain digital assets, posing risks of fraud and compromising respect for human rights.
Digital assets also introduce a new mode of governance through decentralization. In traditional finance, small investors often have limited decision-making power, whereas community owners of digital assets can have a more significant say in strategic directions. The rapid growth of decentralized finance (DeFi) enables innovative governance models. However, integrating this vision into the conventional financial and legal systems poses challenges.
Central banks have entered the digital asset arena and are exploring the issuance of government digital currencies, known as central bank digital currencies (CBDCs). CBDCs offer cost reduction opportunities and allow central banks to maintain control over the money supply and interest rates. According to a survey by the Bank for International Settlements, 86% of central banks are actively researching CBDCs. China has taken the lead with the digital yuan, which is currently being tested in several Chinese cities and is set to be launched officially this year. This development coincides with China’s ban on Bitcoin and cryptocurrency mining, as China aims to export the digital yuan and compete with the US dollar. Other countries, including the United States, the European Union, the United Kingdom, and Switzerland, are also exploring CBDCs.
Digital assets are adapting to new requirements by addressing their impact on the environment, society, and the financial system. With the rise of alternative finance, central banks are stepping in and setting the pace with CBDCs, which poses new geopolitical and stability concerns for the global financial system.
Overall, while ESG has been well adopted by traditional security markets such as listed equity and bonds, the next frontier for ESG is in the digital assets space, and there remains much work to do to ensure our financial markets support the sustainable development of our global community.