Fintech and ESG: a desirable crossover
Wardynski & Partners, Warsaw
Wardynski & Partners, Warsaw
The environmental, social and governance (ESG) technology market has been growing rapidly over the last couple of years, with numerous acquisitions by big players of fintech companies operating in the ESG area (MSCI’s acquisition of Carbon Delta and JP Morgan’s acquisition of OpenInvest, to name but two).
At the same time, there has been significant venture funding (eg, Carbon Delta secured CHF1.7m of funding before being acquired by MSCI), and one may expect ESG Fintechs to seek public listings in the future. A trailblazer in this respect is Aspiration Partners, a US digital bank providing personal finance with a focus on charity, sustainability and the environment. It will be the first listed ESG-focused Fintech. One of Aspiration Partners’ initiatives is called ‘Plant Your Change’, enabling customers to round up their payments to the nearest whole dollar and plant trees using the surplus. In the first year of this option’s launch (up to April 2021), Aspiration’s customers are said to have helped plant over 10 million trees – a truly eco-friendly and sustainability-invested way of providing financial services.
These market developments show that there are clear benefits to the ESG–Fintech marriage. How can Fintech and ESG work together to boost change in the business world?
Why and how do Fintech and ESG intertwine?
ESG is all about considering and measuring not only environmental, but also social and governance aspects of business. It is not just about how a company manages the effects of its operations on the environment (in terms of waste management, gas emissions, treatment of animals, etc), but also how it deals with and includes the ‘S’ and ‘G’ factors in its business plan: human rights, diversity and inclusion, labour standards, bribery and corruption, and whistleblowing schemes, to name but a few.
The disruptiveness and the drive for technological innovation that Fintech brings to the heart of financial services attracts the attention of ESG agenda-setters. They acknowledge the importance of the financial sector and of technology in achieving ESG objectives. Take, for example, the European Commission’s Action Plan: Financing Sustainable Growth of 2018 and the European Green Deal of 2019. These documents clearly show that financial and technological considerations are at the crux of ESG and are the perfect enablers and prerequisites for doing business sustainably.
The Financing Sustainable Growth Action Plan focuses on the financial area and ‘aims to connect it with the specific needs of the European and global economy for the benefit of the planet and our society’ by:
- reorienting capital flows towards sustainable investment;
- managing financial risks arising from climate change, resource depletion, environmental degradation and social issues; and
- fostering transparency and long-termism in financial and economic activities.
The Green Deal emphasises that digital technologies (such as artificial intelligence, 5G, cloud and edge computing, and the internet of things) are ‘a critical enabler for attaining the sustainability goals in many different sectors’ because they ‘can accelerate and maximise the impact of policies to deal with climate change and protect the environment’.
The EU is not the only body that has noticed these dependencies. In fact, the United Nations Environment Programme (UNEP) first compared the connection between ESG and Fintech to that of the strands (or helixes) of DNA, meaning that these two go hand in hand. It is clear, therefore, that the combination of finance and technology may foster sustainable transformations in our economies. ESG–Fintech interactions are already noticeable in the following areas in particular:
- new, sustainable Fintech products and services focusing on any of the three components of ESG;
- financial inclusion initiatives;
- Fintech’s ESG compliance solutions (in particular relating to data and reporting); and
- impact investing.
Fintech: opportunities (and risks) in deploying ESG across industries
At the EU level, ESG regulations are multiplying at an astonishing rate (with yet more to come around the globe), but the area still faces many challenges. One example is the risk of greenwashing when a company’s ESG disclosures are not in line with its business practices. Not only is this a huge reputational risk for the company, but it is also a financial risk for its investors who took ESG factors on board when assessing the underlying risk and making the investment. Greenwashing is, to a large extent, a consequence of the challenges associated with ESG data, such as:
- inconsistent methodologies and data sources;
- low granularity of data;
- low frequency of data updates; and
- the high costs of time-consuming data gathering.
This is where Fintech can make a difference. Artificial intelligence (AI) and distributed ledger technology (DLT) solutions, as well as big-data analytics, may allow large quantities of ESG data to be processed. This may contribute to better data quality, transparency and reliability, while also reducing costs and the time required to gather and analyse a company’s ESG track record.
Examples of this include a data exchange utility platform created by ESGTech, which facilitates meeting ESG disclosure and benchmarking requirements, and Klima.metrix, which prides itself on its mission ‘to build the easiest and quickest footprint calculation software for companies, according to common global calculation standards’. Nossa Data, another Fintech, uses AI to understand a company’s standing in terms of ESG data and provides insights for improving ESG disclosures.
These same technologies could also assist the market and its supervisory body with market participants’ disclosure obligations, following from EU legislation such as the Sustainable Finance Disclosure Regulation (SFDR), the Non-Financial Reporting Directive (NFRD), and the future Corporate Sustainability Reporting Directive (CSRD), as well as national laws that are particularly cumbersome for companies that operate globally. The RegTech and SupTech solutions they could provide would facilitate in-house ESG-compliance monitoring and external ESG-compliance supervision.
On the other hand, the same technologies which could contribute to more effective and reliable ESG reporting raise concerns in terms of their computing power and capacity demands – in particular AI and blockchain, especially if based on a proof-of-work (PoW) instead of a proof-of-stake (PoS) protocol. This translates into a high consumption of electricity, which is obviously against ESG objectives. Moreover, an increasingly recognised risk associated with AI or robotics involves the social consequences of these technologies. There is no denying that they pose a real threat of large-scale job losses, which could in turn increase unemployment and deepen inequalities. This aspect must be considered, and is a risk that must be identified and managed when implementing innovative technologies in a business’s operations.
Reporting and disclosure issues aside, another area of synergy between ESG and Fintech lies in how fintech can redirect capital to ESG-cognisant business ventures, ensuring financial inclusion of unbanked and underbanked individuals and SMEs. The former objective can be achieved using crowdfunding to enable a wide range of investors to earmark their funds for ‘green’ companies and, at the same time, make the financing more accessible and affordable for such entities. This is the approach being taken by LITA.co, which accepts as investment targets only those companies that meet one or more of the Sustainable Development Goals of the UN’s 2030 Agenda for Sustainable Development.
The latter goal of ensuring financial inclusion is achievable through various solutions developed by Fintech companies, such as online platforms providing loans to financially underserved groups. For instance, ONEFi has created an app called Carbon, which democratises access to finance by leveraging data and technology to helping cover unexpected expenses or urgent cash needs. PalmPay plans ‘to help 100m+ Africans advance their lives through access to relevant, reliable and affordable financial services within the next three years’. It will do this by providing a financial ecosystem with no entry-level requirements except for a smartphone. Pula, a global InsureTech, ‘delivers innovative agricultural insurance and digital products to help smallholder farmers endure yield risks, improve their farming practices, and bolster their incomes over time’. Unfortunately, the beneficial effect on financial inclusion may be hindered by the fact that such solutions often require internet access and a mobile phone. To reap the greatest benefit, wide access would have to be provided to the technology.
The above shows well how the key advantages of financial technologies – such as increased transparency, big data analytics capabilities, improved risk management or increased access to financial systems – could foster ESG-aligned business models.
ESG’s impact on Fintech
Not surprisingly, ESG may also impact how Fintech companies do business. More and more Fintechs are going ‘green’ and providing ESG-soaked products or services. The aforementioned Aspiration Partners is just one example. Others include Cooler Future, an investment platform providing wealth management services with a positive climate impact, or Good Money, which promises that clients’ deposits will not be invested in fossil fuels or rainforest destruction.
The last years have also brought a shift in the preferences of investors, who are increasingly considering the ESG factors of their investments. The Global Impact Investing Network (GIIN) estimated the size of the impact-investing market in 2020 at $715bn, which represents an increase of more than $200bn compared to the end of 2018 (and despite the impact of Covid-19). There is a plethora of articles about how millennials are driving this change in investment; multiple studies show that investing in ESG-conscious companies might be less risky and provide comparable or even higher returns than conventional investing. Taking ESG into consideration when investing not only enables ‘making an impact’ and expressing one’s values, but can also significantly mitigate risks of losses caused by a business’s ESG-related problems in the long run (such as costly environmental/employee lawsuits or supervisory penalties).
It is not only millennials or retail investors that take ESG into account in their investments. Things are changing in the venture capital and private equity (VC/PE) sectors, with some of the biggest asset managers incorporating ESG into their investment processes (such as BlackRock). In the EU, the Taxonomy Regulation will facilitate more comparability of ‘green’ financial products offered by financial market participants and provide a common understanding of environmentally sustainable commerce. However, there is still room for improvement in the VC/PE sectors. A recent study by Amnesty International shows that, while VC/PE funds consider certain ESG topics in their technology investments, there is still very little consideration given to human rights issues – a significant component of ESG’s ‘S’ area.
Products and impact investing aside, all the above is affecting and will impact Fintech companies. It will require them to look at their business models more closely in terms of ESG compliance if they wish to get a slice of the impact-investing cake – or simply emerge from a due diligence process without turbulence. In fact, changes are already leading to innovative and sustainable ways of doing Fintech business. Blockchain-backed companies are just one example of improvements in sustainability, with some of them implementing a more eco-friendly PoS protocol instead of the traditional PoW (and its justifiably disquieting carbon footprint). The new expectations of investors may finally translate into more accessible and affordable sources of financing for those who have done their ESG homework early in the process.
It is clear that Fintech and ESG go together very well and can drive positive change in each other. Fintech can facilitate an ESG transformation of businesses and ESG can motivate Fintech companies to become more sustainable.
Nevertheless, many issues still need to be addressed so that full advantage can be reaped from ESG’s potential and Fintech’s synergies. Technological shortcomings (such as the need to reduce energy consumption) and regulatory uncertainties around various innovative business models are slowing the process down, but it is promising that discussions have already started around this topic.
 Action Plan: Financing Sustainable Growth (EU Commission, 8 March 2018), see https://eur-lex.europa.eu/legal-content/EN/TXT/?uri=CELEX%3A52018DC0097.
 The European Green Deal (EU Commission, 11 December 2019), https://eur-lex.europa.eu/legal-content/EN/TXT/HTML/?uri=CELEX:52019DC0640&from=PL.
 Ibid, ss 2.1.3 and 2.2.3.
 Fintech and sustainable development – assessing the implications. Summary (UNEP, December 2016), 3, see https://wedocs.unep.org/bitstream/handle/20.500.11822/20724/Fintech_and_Sustainable_Development_Assessing_the_Implications_Summary.pdf?sequence=1&%3BisAllowed=.
 Fintechs and the ESG data challenge (BNP Paribas, 2019).
 EU Sustainable Finance Disclosure Regulation (SFDR) 2019/2088; EU Non-Financial Reporting Directive (NFRD) 2014/95/EU; EU proposal for Corporate Sustainability Reporting Directive.
 Sizing the Impact Investing Market report (Global Impact Investing Network, 2018), https://thegiin.org/research/publication/impinv-market-size; 2020 Annual Impact Investor Survey (Global Impact Investing Network, 2020), https://thegiin.org/research/publication/impinv-survey-2020.
 Regulation (EU) 2020/852 of the European Parliament and of the Council of 18 June 2020 on the establishment of a framework to facilitate sustainable investment, and amending Regulation (EU) 2019/2088.
 Risky Business: how leading venture capital firms ignore human rights when investing in technology (Amnesty International, July 2021), www.amnestyusa.org/wp-content/uploads/2021/07/Risky-Business-How-Leading-VC-Firms-Ignore-Human-Rights-When-investing-in-Tech-Final-1.pdf.