Climate change is one of the most critical challenges humans need to overcome. Financial institutions play a major role in the world’s shift to a greener future, and many are stepping up to the plate to prioritise sustainability across their operations.
For instance, the International Monetary Fund (IMF), the World Bank, and the OECD recently collaborated to release a new report on climate-aligned finance. Elsewhere, Lloyd’s of London teamed up with Moody’s Analytics to set the gold standard in greenhouse gas emissions accounting, Deutsche Bank and the European Investment Bank launched a €400m collaboration, aimed at supporting sustainable transformations at medium-sized companies, and NatWest released an AI solution to enhance ESG data for SMEs. Finally, Allianz announced plans to be carbon-neutral within its internal operations by 2030 and reach net-zero in its investment and Property and Casualty underwriting portfolios by 2050. These are just a handful of the developments from this month within the finance world.
The importance of ESG has sprouted a burgeoning ESG FinTech sector. In 2022, there were 114 deals in the space, an increase of 46% on 2021. The US was the home to the largest share of these transactions, accounting for 25%. These are still the early days of ESG FinTech, so FinTech Global asked players in the industry how the sector will evolve in the coming years.
Rising technology
Saumya Mehrotra, associate principal, sustainable index product management at Deutsche Borse group’s Qontigo, stated that emerging technologies can help the ESG FinTech sector offer greater transparency, real-time monitoring and complex data capabilities. AI and NLP could help firms sift through vast amounts of ESG data, identifying patterns, risk and opportunities that might have been missed by a human analyst.
Thanks to the widespread hype around tools like Chat GPT, there has been a resurgence in excitement around AI technology in the market. Having been a buzzword for many years, companies are again excited exploring the range of capabilities offer and how they can solve major challenges. To that extent, it is no surprise that AI is expected to play a pivotal role in the future of ESG FinTech.
Erik Bernstrup, product manager at Nordic ESG software and advisory firm Position Green, said, “AI will play an essential role in the future of ESG FinTech. It can provide insights into gaps, augment missing data, identify latent opportunities, and ultimately accelerate the sustainability transformation of businesses.”
Echoing this, MassMutual Ventures principal Alix Brunet said, “ML and AI are transforming climate risk and sustainability data analysis, forecasting and decisioning – translating carbon and environmental data into actionable information. It’s a really exciting area of development right now.”
However, AI is not the only technology that will help to shape ESG FinTech. Brunet also highlighted the importance of computer vision, which has a particularly promising future in waste management. “With computer vision, the waste management sorting process can be completed quickly, accurately and safely. It also enhances efficiency, lowering operational costs by reducing or eliminating the need for materials to be sorted manually.”
The evolution of data collection
Data is vital to the implementation of ESG strategies. Whether for investing or monitoring compliance, ESG data collection is an important part of the sustainability strategies. Fredrik Davéus, founder and CEO at Swedish financial analytics API developer Kidbrooke predicts the market will see increased API-based B2B offerings that boast data or data aggregation combined with analytics that can be plugged into incumbent financial institutions.
He added, “More data will be collected automatically from the accounts and finance systems at ever larger scale. This is already available in the Nordics from specialised firms plugging into SaaS accounting offerings.”
Hari Menon, partner and SVP at AI powered wealth and ESG solution provider IntellectAI, is also confident the data collection process will become automated, powered through advanced extraction and machine learning models. “This will be exponential progress given the hyper advancement of AI landscape and various LLMs. Only the most complicated cases or exceptions will need a level of manual intervention. The ESG AI model will become more explainable and traceable to give more confidence to the users over time.”
Position Green’s Bernstrup envisions a future with greater data collection. “We will see increasing amounts of data collected from companies aiming to comply with regulations and meet future investors’ growing demand for more sustainable investments. That requires a dynamic reporting structure that can be adjusted over time. The demand for AI will grow as a function of the vast amount of ESG data being collected and analysed.”
MassMutual Ventures’ Brunet added that as the breadth of sustainability data sources expand climate and environmental data modelling teams desire integrations with multiple specialised data sources for greater accuracy and interdependencies analysis. With this, MassMutual Ventures is experiencing a lot of interest in data collection methods aimed at enhancing existing technologies and processes within business to scale capacity and improve granularity.
Market challenges
As the world puts more focus on ESG priorities, there will be a greater regulator pressure for firms to ensure they are meeting specific targets. Regulation has already increased, particularly in the wealth management world, with firms required to ensure they are clear about the climate impact of investments. Governments around the world are exploring greater regulation, which means fines will follow for those that fail to comply. As ESG becomes more complex, ESG FinTech companies will need to ensure they maintain trust and transparency with their clients.
Position Green’s Bernstrup said, “ESG FinTech platforms continuously need to ensure that reporting structures are aligned and comply with ESG regulations and standards. As customers will use the reported data to support ESG claims, any data or reporting error may have significant negative impact on their brand and business. ESG FinTech platforms need to be able to demonstrate transparency to customers and auditors with regard to underlying calculation methods, data sources and emission factors.”
In the same vein, Mehrotra said, “Adopting standardised reporting framework can help ESG FinTech Platforms maintain consistency and comparability. Third-party audits can help ensure trustworthiness and blockchain integration can help validate and secure ESG data.”
As companies increase their reliance on AI technology, they will need to ensure their output continues to be trusted. AI might seem infallible but there is significant risk when using the technology, particularly when using a blackbox system that does not allow users to see how decisions were made. Relying on these types of technology increase the risk of incorrect decisions being made whether it is based on poor data, bias or an error. IntellectAI’s Hari added, “Explainable unbiased AI models will be the holy grail for ESG FinTechs to ensure transparency and trust.”
Trust is not the only challenge that is facing ESG FinTech companies. As with any bourgeoning market, there is a risk from competition. MassMutual Ventures’ Brunet stated that competition is already fierce in the market, from incumbent platforms and new entrants.
“Currently, automation levels and accuracy are the key factors determining the most useful platforms. We expect to see consolidation over the next few months as established platforms and data services providers have been very acquisitive, snapping up smaller providers.”
Finally, Position Green’s Bernstrup noted that platform providers bear part of the responsibility to ensure reported data is not misused in false ESG claims. He emphasized that it falls to FinTechs to ensure their reporting structures for regulatory requirements and frameworks are consistently aligned with the regulation.
Continued compliance
As mentioned, the world is currently exploring more regulation. This means ESG FinTech companies must be ready to adapt. According to Hari, the most granular of platforms will be the most successful. “This is what will enable the platforms to evolve with changing regulations, geographic challenges, market changes and industry evolution.”
Adaptability was what Bernstrup considered to be important to managing evolving compliance landscapes. He said, “It is essential that ESG FinTechs continuously develop dynamic software to account for the evolution of sustainability and ESG regulations and standards. A static or single-model platform will not be able to support the market needs as customers’ sustainability ambitions evolve. To support customers’ with accurate ESG claims, ESG FinTechs need to acquire the expertise and knowledge to ensure that the collection and presentation of ESG data are compliant with regulations.
One thing that was clear from the respondents is that Europe is leading the way for ESG, thanks to its active efforts in building regulation. Kidbrooke’s Davéus said, “EU is leading when it comes to regulation, so if this can be a source of innovation it can help. Otherwise, a lot of innovation is happening in the MENA region since the financial infrastructure in many ways is a greenfield area.”
In a similar vein, Hari mentioned that “Europe is set to dominate this space, with the UK swiftly following.” Following these two would be Australia, Canada, the US, and then the rest of the world. However, while ESG is a global mission Hari believes that “we might see a lot of innovation trialled in the European region first.”
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