What is climate fintech and why do VCs love it so much?

VCs love an industry merger. And their new favorite is climate fintech.

More and more fintech investors are looking for climate-related investments – and more climate-focused VC firms are also looking into this intersection.

In the first six months of 2022, startups at the intersection of climate, finance and technology have raised $1.8 billion globally – already 1.5 times the total for all of 2021, according to data from VC firm CommerzVentures.

And Europe is taking a global lead in the sector. In the first half of 2022, European climate fintech startups raised 3.5 times more than their American counterparts – $1.4 billion versus $401 million, according to the same data set.

France in particular is doing well, bringing in $733m in the first half of this year – driven mainly by a $500m round for EcoVardis, a sustainability assessment platform.

So what exact is climate fintech?

Despite the hype, what actually counts as a “climate fintech” is still open to debate. Is it just fintech in more sustainable packaging, or are there companies that want to make a concrete difference to the environment?

These are the sub-sectors that are often included in the term:

1. Carbon accounting

This is software that helps companies measure their carbon emissions, by collecting the company’s environmental measurements on a platform and calculating the associated emissions.

They will also go in and assess the supply chains of companies, collecting Scope 1, 2 and 3 of a company’s footprint (more on what these scopes mean here).

Carbon accounting is by far the best-funded sub-sector within climate fintech. In the first half of 2022, carbon accounting startups brought in 673 million euros globally, according to data from CommerzVentures.

In Europe, it is an increasingly crowded sector. The best-financed player in the sector in Europe is Sweep, a French company that secured a $73 million Series B round earlier this year. There is much debate at the moment about what the next move for the industry is – with some investors waiting for the market to consolidate before picking winners.

2. Management of climate risk

As increased extreme weather disrupts business operations and disrupts supply chains worldwide, companies need to build climate risk into their daily decision-making.

A new wave of European startups has emerged provide businesses with climate intelligence and help them protect themselves against risk. This comes in the form of climate forecasts; artificial intelligence and satellite surveillance; and insurance products, so that companies can understand how they can be affected by various climate threats and how they can minimize losses.

It is the second best-funded subsector, bringing in $385 million in the first half of this year, according to data from CommerzVentures.

One of the largest rounds in climate fintech this year was climate insurance provider Descartes Underwriting’s $120m Series B, led by Highland Europe and Eurazeo.

Other notable European players includes Cervest, a London-based startup that quantifies climate risk; London’s ClimateX, which provides site-specific climate risk forecasts for specific industries; and Lisbon’s Tesselo, which uses satellite imagery and artificial intelligence to estimate the risk and impact of wildfires.

3. Carbon compensation

Carbon compensation – where a company buys carbon credits that represent the removal or prevented emission of CO2 from the atmosphere – is a common tool used by industries struggling to reduce emissions directly, including aviation. Credits are generated from things like direct air capture, forestry projects or carbon sequestration by algae.

The voluntary carbon market is where companies buy credits – in contrast to the compliance markets, where countries exchange offsets and credits.

There are many startups emerging around the voluntary carbon market, be it rating services to determine the quality of a credit or APIs, brokers and marketplaces that help companies buy credits.

It’s a booming industry, but it already has its problems. There are issues around double counting, reliability and longevity of credits. There is also no universal monitoring mechanism for requirements companies can attach to the amount of credits they buy, such as being “carbon neutral”.

4. ESG reporting

Companies and investors are now obliged to track their ESG – environmental, social and governance results.

In the same way as carbon accounting, there are a number of startups working on platforms that enable companies, or investment firms, to measure metrics that fall within ESG.

Many of the platforms also offer audit services, hoping to combat the criticism often leveled at the ESG acronym: that there is little in common between the calculations made by different firms.

Players in the subsector include UK-based Net Purpose, Berlin-based Atlas Metrics and Sweden’s Datia.

5. Climate crypto

There are a number of crypto companies in the climate space. Many of them are centered around carbon credits, which Switzerland Toucan, which tokenizes credits on the blockchain.

It may offer some gains, particularly in terms of preventing double-counting of credits by putting them on the blockchain and making all transactions transparent – although alarm bells have been rung over the quality of credits ending up on crypto projects, and whether adding a new layer of technology does everything to improve the amount of emissions saved.

In Europe, there is SolarCoin, which rewards solar energy producers with coins, and Efforce, a new project co-founded by former Apple founder Steve Wozniak, which is working to use tokens to incentivize energy-saving retrofitting of existing buildings.

6. Impact investment and sustainable banking

Perhaps the most “fintech” subsector of them all, impact investing and sustainable banking, consists of a group of direct-to-consumer startups that want to make it easier for individuals to put their money into sustainable projects.

On the impact investing side, it is Britain’s Clim8 investment platform, which allows customers to invest in share portfolios filtered according to specific climate-related metrics – such as tonnes of carbon dioxide saved, gigawatts of clean energy generated or liters of water saved. About 5000 (formerly called Tickr) similarly allows users to invest in impact-oriented companies and offset their carbon emissions via the mobile app.

Sustainable banking refers to fintechs that ensure that customers’ money is invested in sustainable projects – but indirectly through customer deposits. Some have clearer climate endorsements than others.

Paris-based neobank Helios raised a €9 million round in April for its mobile banking platform, which invests customers’ deposits in sustainable projects, and Germany’s Morning is doing the same. Amsterdam’s bunq also has a “green” focus, allowing users to offset their CO2 emissions by planting a tree for every €100 transaction.

British neobank Tandem has rebranded as a “green neobank” after acquiring “green lenders” Oplo and Allium over the past 18 months – but the bank’s exact climate credentials are unclear.

What are fintech investors saying?

Within all these sub-sectors, fintech VCs have their eyes on carbon credits as the most lucrative and promising in terms of returns. As more and more industries buy in carbon credits, investors tell Sifted that this will open up a “new financial world” in climate compensation.

The startups closest to the money naturally provide the most obvious return on investment. So as demand for carbon credits grows, fintech investors are eyeing up the voluntary carbon market brokers and exchanges that sell the offsets.

Not only is the demand for carbon credit buyers increasing, but the price of a tonne of carbon is rising rapidly. Carbon credit prices currently average $3 to $5 per metric ton, but are predicted to increase tenfold by 2030, to between $20 and $50 per metric ton, according to latest research.

“The ceiling interest rates [the fees collected for each carbon credit purchase] is very high right now, which means there’s great investment potential for brokers and exchanges,” says Nick Sando, partner at Octopus Ventures, which recently invested in carbon accounting software startup Minimum.

This is also the reason why a number of carbon accounting platforms want to call themselves “carbon management”, allowing them to expand into more revenue streams – such as providing a marketplace platform where they can connect the credit buyers with the offset project developers – in the future.

“Many of the accounting platforms realize that they can be a channel to more,” says Sando. “No one has really done this yet, but it’s on everyone’s radar.”

A number of fintech investors say they are skeptical about the lack of complete transparency and definitive regulations when it comes to carbon credits – and the lack of guarantee that the project linked to the credit will be realized.

But in the eyes of others, this risk is a lucrative business opportunity – climate credit insurance.

Not the kind of insurance that startups like Descartes Underwriting provide to protect businesses from climate catastrophe by paying out according to the scale of the event — so-called parametric insurance, which VCs tell Sifted is hard to do well. But insurance products that offer some kind of guarantee on carbon credit deliveries – so a company knows that the money it spends on tree planting isn’t going to waste.

What do climate investors say?

Among climate VCs, there is some skepticism about the extent to which software – and climate fintech within it – can contribute to combating the climate crisis, especially in relation to the emission reductions that hardware innovation can provide.

Clementum, for example, a new climate-tech VC firm that launched this summer, stated from the start that it would never back a software company.

“Software solutions do not enable sufficient direct influence. We need physical solutions to physical problems, says Yoann Berno, founder of Clementum.

Climate fintech makes generalist funds feel more comfortable investing in climate, says Berno, because the economics of SaaS and fintech are something they are comfortable with.

Tove Larsson, general partner at Impact VC Norrsken, agrees that software alone cannot solve the climate crisis, but says some measuring and tracking software is useful.

“We need underlying innovation that usually comes with hardware, but we also need a massive shift in behavior in both individuals and businesses,” she says.

Things like carbon accounting platforms and climate risk software can also help point out which hardware should be prioritized, says Larsson. “Software is critical to measurement and tracking – if we don’t know where we are, how do we know what to address and what hardware solutions should be prioritized.”

Heidi Lindvall, partner in the climate-focused fund Pale Blue Dot, agrees that some software is useful.

“Personally, I see the greatest impact by setting up new financial structures to replace the old polluting ones,” she says – platforms that can help people direct savings and pensions towards greener investments.

So is it good to inject capital into climate fintech?

“Yes, in general it’s good,” says Larsson, “but you also have to be careful to ensure that capital goes to high-quality initiatives.”

Amy O’Brien is a reporter for Sifted. She tweets from @Amy_EOBrien and writes our fintech newsletter — You can register here.

Freya Pratty is a reporter at Sifted. She tweets from @FPratty and writes our climate technology newsletter — You can register here.