As the world aims for net zero carbon emissions by 2050, investors are pouring trillions of dollars into ESG funds. How will FinTechs play their part in keeping responsible investments on track?
This article relates to Shearman & Sterling’s upcoming opening Digital Finance Summit on 15-16 November. Learn more about the summit.
The financial world is no longer driven by pure returns, and far more investors consider environmental, social and governance factors when building their portfolios.
Nearly nine in 10 (88%) institutional investors consider ESG risks as important as financial and operational considerations when evaluating a business, and nearly two-thirds (64%) of individuals invest based on their beliefs and values[1].
Bloomberg predicts ESG assets will exceed $50 trillion by 2025, representing more than a third of the estimated $140.5 trillion in total global assets under management[2].
With so many trillions of dollars trying to reach projects that support ESG goals, politicians have introduced a flood of regulations requiring companies to be transparent about everything from carbon emissions to employment practices.
For example, Taskforce for Climate-related Financial Disclosures (TCFD) requirements are now mandatory in the UK and Japan, requiring the largest companies to report their carbon emissions across their operations and supply chains to help investors make environmental assessments.
The Securities and Exchange Commission is considering implementing similar legislation in the United States[3]as well as proposed rules requiring the financial organizations responsible for managing and investing these significant sums to demonstrate their ESG credentials[4].
The disclosure requirements for sustainable finance in the EU require asset managers and investment advisers to make it clear how they assess ESG risk in product marketing.
Technology will be critical in supporting this significant shift to ESG investing, and there has been notable input from the FinTech sector.
The Kalifa Review of UK FinTech commissioned by the UK Government stated: “FinTech has an important role to play, as relevant ESG data can be collected and processed effectively using technology solutions.”[5]
It’s no surprise that KPMG reports that large global institutions across banking, fund management and insurance have been “very active” in either building proprietary data analytics capabilities for ESG or acquiring FinTech data aggregators – or a combination of both[6].
One of the key areas where FinTech can add value is bridging the gap between the different data reporting standards, terminology and taxonomy requirements, which make it difficult to create comparable metrics.
Distributed ledger technology (DLT) – particularly blockchain – has the potential to provide a safe and transparent tool that allows companies to collect verifiable data and generate reliable reports that demonstrate their ESG credentials.
Not only does blockchain offer privacy and transparency, it provides data standardization that enables different entities to communicate with each other and share data without human intervention.
That said, popular DLT systems that use proof-of-work (PoW) systems to verify and record cryptocurrency transactions used by Bitcoin have extreme energy requirements.
In response to widespread criticism, an alternative mechanism called proof-of-stake (PoS) is gaining ground. PoS can process transactions faster and cheaper, and uses less energy, making it more environmentally friendly. Moreover, Ethereum Merge is also considered an alternative to Bitcoin, from a cost-effectiveness and environmental impact perspective for ESG-conscious and climate-minded investors.
Such FinTech advances will need to continue if companies and their investees are to keep up with ESG reporting requirements, and to help financial organizations avoid accusations of greenwashing.
