The Center for Digital Asset Finance (CDAF) at the University of Michigan integrates digital twins of smart infrastructure with financial innovations such as fintech to solve financing problems for critical societal infrastructure services such as energy, water, transportation and housing, along with digital infrastructures such as networks and communications servers. Funded initially by Ripple, a fintech company, the CDAF is maturing and expanding its reach.
CEE Prof. Peter Adriaens leads smart infrastructure financing programs and provided an update on some of the latest research the team is using to develop these innovations.
A key underpinning of smart infrastructure finance is the structuring of contractual agreements among parties engaged in physical supply chains and informational data value chains. As Prof. Adriaens explains, “infrastructure decisions have become more digital, whether applied to public-private partnerships, project finance structures, or data markets, and define how investment decision-making, payouts and financial risk management are executed. A great example is the recent $1.1 million Defense Advanced Research Projects Agency (DARPA) award, with CEE Prof. Seth Guikema to map, quantify and price economic, political, and environmental risks in major military supply chains. The ultimate goal is to develop software with other partners to create risk management strategies, contractual valuations, and agreements between stakeholders.
An environmental application is agriculture. “We recently received a $1.2-million grant with two agencies over three years to fund a project to completely rethink how we finance agriculture in the Great Lakes basin and tie the financing to sustainability objectives,” Prof. Adriaens said. “Sustainability-linked financing is a new term in the practice. This project has been the focus of an on-going collaboration among UM, LimnoTech, Croatan Institute, and Blockchain Triangle, one of the partners in the center which has a blockchain-based data platform to link environmental data with financial contracts. Specifically, we are interested in understanding how farm assets should be repriced for contaminant emissions risk using data fusion of land transactions and farm characteristics, as well as hedonic pricing models. Since currently, farm land value increases with contaminant levels due to cash crop yields, we are structuring new financing models with interest-rate adjusted loan products such as sustainability-linked loans and green farm bonds.”
The goal of sustainability-linked financing is to encourage investors to be environmentally-minded when investing in their projects and to make it fiscally sensible for them to do so. Agriculture in the United States is financed through private loans and the farm credit system. Farm credit is derived by sales of bonds to Wall Street investors, the use of proceeds funds farm credit banks who, in turn lend to farm credit associations and farmers.
According to Prof. Adriaens, the agricultural impact of nutrient runoff and climate change is significant, resulting in a total of nearly $2bn tons of carbon-equivalent emissions in the Great Lakes region alone. Instead of relying on government subsidies, this project develops asset pricing models to engage the capital markets to drive behavioral change.
“Currently, neither private capital nor farm credit is conditioned to encourage sustainability conditions, resulting in environmental liabilities,” Prof. Adriaens said. “The 56,000 tons of nitrogen and phosphorus leaking into the Great Lakes from Michigan farming alone is an example of this.”
Applications for smart financing in the civil infrastructure space are growing as well. The CDAF is working with the Ford Motor Company, Cisco, Blockchain Triangle and Integrated Roadways to develop new business and financing models for Connected Automated Vehicles (CAVs) and how they engage with infrastructure. “We just had a change in Michigan law that allows for certain sections or lanes of public roadway to be set aside for CAV digital infrastructure and driving,” Prof Adriaens said. “This is a first in the nation, and will support continued development for CAV adoption.”
“In collaboration with Ford and Integrated Roadways, we are developing new cash flow and financing models for next generation digital roads in a ‘three-legged industrial ecosystem’ comprising car makers, IT providers and the telecommunications industry,” he said. “An industry that makes a device (car) with connective capabilities, inherently incurs costs from engaging with the other major players (IT and Telco).”
Prof. Adriaens said that the argument that car ‘data’ enable more seamless driving and reduced carbon emissions while potentially allowing for payments in an ‘infrastructure support as a service’ environment, calls for new financing and business models for car makers and the IT ecosystem.
“We have an exciting collaboration with Nuveen, the investor for the teachers pension fund TIAA,” Prof Adriaens said. “They are the nation’s third largest owner of muni bonds in what is currently a $3.9 trillion worth of municipal bond market. These bonds are used to build schools, roads, water systems, airports, multifamily housing and transportation, among other infrastructure assets.” Prof. Adriaens noted that his group, in a partnership with a data science team at LimnoTech, works with Nuveen to build and test ESG (Environmental Social and Governance) models that overlay investment considerations. The team examines if an infrastructure investment is equitable and environmentally friendly, among other criteria, and builds the ESG models for Nuveen, which will then reprice the risk of municipal bonds as they bundle and sell these products to their clients. “This is a major undertaking,” Prof. Adriaens said. The team is essentially transforming the way in which American infrastructure is funded and valued, and how investment decisions may have implications for underrepresented groups which traditionally have not had a seat at the table when choices are made that affect their socio-economic outcomes.
The team is also working with CEE Interim Chair Yafeng Yin and Prof. Stuart Batterman in the UM School of Public Health on a Cornell University-led USDOT Center grant to study the connection between transportation infrastructure and health impacts. Prof. Adriaens highlighted the local example of the Ambassador Bridge connecting Detroit, Mich., and Windsor, Ont. “The bridge enters a part of Detroit that is identified as an asthma cluster due to high levels of particulates,’ he said. “Often, the infrastructure of exit- and on-ramps tends to be in poorer parts of town, contributing to health issues that negatively affect the quality and length of residents’ lives. “ The new Gordie Howe bridge connecting Detroit and Windsor took these issues into consideration in the placement of its toll plazas.
Another project led and funded by Business Finland and Nokia, with global partners across Europe and the US, will focus on the development and testing of data markets from information derived by sensors and digital infrastructure in smart cities. Again, the core focus is on the underlying (digital) contract agreements among the various public and private parties along the data value chains. This project will last for three years.
“Finland has been a frontrunner in this area since my sabbatical leave in 2014,” Prof. Adriaens said. He noted that Finland was among the first implementers of Mobility as a Service, a transportation online platform that engaged the city, private companies and the startup sector. The country was also an early mover in the adoption of and investment in financial technology (FinTech, the focus of Prof. Adriaens’ center) for automated (smart contract payments) in all types of industrial applications. Prof. Adriaens also highlighted the importance of networking. “Incidentally, the whole Finland program came about serendipitously, after meeting a program manager of the Research Institute of the Finnish Economy (a think tank in Helsinki) at the Sheraton hotel in Palo Alto. I was there for an NSF ERC site visit review, got to talking to this Finnish chap and the rest is history,” he said.
Prof. Adriaens’ center also is collaborating with the Illinois Institute of Technology and University of Illinois on an NSF Regional Innovation Engine grant focused on ‘Web 3.0’ workforce development and economic transitioning. Given the financial and commodities markets in Chicago, the emphasis of the program is on decentralized finance (DeFi) in Chicago, while Ann Arbor will focus on digital transformation of transportation and water infrastructure. As he said: “DeFi focuses on using smart (automated) contracts on a blockchain, as opposed to centralized finance, which engages banks, brokerages and other entities. Think of using Venmo instead of routing payments through the UM Credit Union.” Development on the Phase 1 of the project is anticipated to start in January 2023 with the initial $1 million, and Phase 2 could potentially see up to $160 million in future funding.