How blockchain can help achieve wide-scope sustainability targets

Sustainability and environmental, social and governance (like ESG reporting) has been an essential topic in the market in recent years.

The impactful ripples of COVID-19 have been felt far and wide in the industries. On this account, ESG, a powerful concept, aims to establish standard criteria for companies to report their environmental and social responsibilities. Companies constantly face challenges with increasing investor demands and changing reporting needs, which is also an opportunity to redefine the organization’s value toward long-term value drivers. 

The majority of a company’s value is now reflected in the intangible aspects relating to factors, such as innovation, culture, trust, human capital, sustainability and governance. These concepts are difficult to measure, and most of them are not captured by traditional accounting and managerial reporting frameworks. However, there is a pressing need to do so as shareholders, capital providers and other stakeholders increasingly focus on how companies create long-term value. A recent EY Climate Change and Sustainability Services (CCaSS) survey (2020) of institutional investors found that 98% of investors evaluate non-financial metrics for investment decisions, and 72% do so in a structured manner.

Trust: the building block of successful ESG reporting

ESG reporting is suffering from a lack of trust arising due to the non-transparent connection of the non-financial metrics to tangible assets in the entire value chain. The EY blog article, Six ways companies can enhance their ESG reporting,  highlights the importance of data credibility.

Blockchains thrive in an environment where there are many stakeholders with varied, and sometimes, conflicting needs, and there is no trust, or at least, some friction in collaboration. The technology has been referred to as the “trust machine” and can play a considerable role in reliable ESG reporting in the near future.

Blockchain: a way forward for trusted and standardized sustainability and long-term value reporting

Broadening the scope of ecosystem ESG collaboration with a decentralized utility

One of the main topics of discussion in ESG reporting is what to report and its scope — whether companies focus on scope 1 reporting, i.e., reporting the company’s direct effect, scope 2 or scope 3 impacts, including indirect effects covering the whole supply chain. The difference between direct and indirect emissions varies heavily from industry to industry. For example, direct emissions from an electric power generator company can constitute 97.8% of the overall emissions. In contrast, direct emissions from wholesalers and retailers constitute only 1.3% of the overall emissions.

You can learn more through the EY blog, Why calculating your company’s carbon footprint matters. 

As the importance of ESG metrics increases, so does the demand for reliable data from the entire distributed ecosystem where companies operate today. The need of the hour is a utility that allows sharing of reliable and trusted information between several parties.

Blockchain creates a decentralized technical platform based on trust in the distributed network instead of intermediaries or central authorities. This enables automation of shared business logic in transactions and coordination mechanisms of ecosystems, digitalizing them as a code delivered by the technical and operational layer. This improves speed and efficiency by eliminating intermediaries from the interactions.

Decentralization makes blockchains attractive as a governance technology that facilitates collaboration. Data submitted by one is verified by many before being made persistent. Previously, some of the blockchain implementations have suffered from excessive centralization. Because a central platform provider exercised too much control, eventually failing to attract network participants to join the collaboration.

EY has made significant progress in enabling scalable privacy-preserving transactions on the public Ethereum blockchain. With this approach, the public blockchain networks can be used as a utility to build on real solutions.

Cryptographic chaining and automation for better ESG reporting transparency and auditability

Blockchains can work as a trust layer, integrating data from varying sources and database technologies for enterprise, value chain and ecosystem levels. For that reason, blockchain can be leveraged for cross-industry reporting needs. In addition, with this technology, the data layer becomes timestamped and tamper-resistant.

All transactions in blockchains are chained to each other using cryptography. Consequently, a clean lineage of data can be established across the value chain for transparency and auditing.

One of the earliest use cases of blockchain has been in supply chain management. Blockchain can provide transparency to the provenance of raw materials and goods from source to end-use. To understand this better, consider authenticating the ethical sourcing of cobalt used in batteries for electric vehicles as an example. The mining of cobalt has been plagued using child labor already for decades.

As blockchain technology matures, more complex logic can be embedded into transactions and validated on-chain. Business logic between transacting parties can be automated to occur within the transaction logic and transactions settled at the spot providing near real-time record of transactions. As any logic can be embedded into transactions, thus can sustainability data. This can even be used as criteria for the automatic execution of transactions. 

Peers in the network validate all the transactions in a blockchain, as they are recorded to the ledger, i.e., the data is validated close to the source. How trusted a data is, is decided by how close to the value exchange origin the said data recorded on the blockchain. The convergence of Internet of Things (IoT), intelligent automation and blockchain can create a truly trusted data source connecting the physical to the intangible.

NextGen finance function

In times of crisis, the demand for insight, to seize an element of control in a volatile and fast-changing environment, increases. The research shows how finance is bearing the brunt of increased demands for rich and varied information and insight. 

Based on the EY Financial Accounting Advisory Service Report of February 2021, two-thirds of respondents (66%) say demand for “forward-looking financial analyses and forecasts” has increased over the last 12 months. Stakeholders are also looking for new insight “beyond the numbers” of financial reporting, such as ESG data.

Considering the increasing demand, it can be assumed that the future of the financial core will transform toward a trusted data platform connected to the complete ecosystem of the organization through blockchain. Financial metrics will be combined with ESG data type, providing insights and forward-looking information for the decision-makers. As a consequence, blockchain will play an important role in the intelligent value chain. 

You can find out more here.

End notes and how EY can help

Blockchains constitute social and technological systems and values only in relation to the utility they provide. Many of the benefits of the system can only be realized as a part of a large-scale transformation that needs to be planned ahead. In the case of ESG, blockchains will require significant efforts in redefining finance function, building networks for collaborations, establishing effective decentralized data governance mechanisms for ESG, integrating with existing IT infrastructure and establishing shared standards and taxonomies for ESG reporting. While blockchain can be an indispensable building block in enabling sustainability and ESG reporting, it needs to be well integrated to realize the next-generation finance function transformation.

This article has been created in collaboration with Janis Wichmann, Technology transformation consultant, EY Finland.