While environmental, social, and governance (ESG) have quickly become important factors in discussions about innovation, is the sector growing quickly enough in the FinTech world?
While the importance of the ESG sector shouldn’t be measured by its market value, it is a good indicator of how much importance firms are putting on it. To that extent, according to a report from management consultancy Opimas, the market for ESG data is expected to top $2.1bn in 2024, up from $1.9bn in 2023. ESG data is the backbone of ESG processes, whether it is to measure a firm’s impact, insights on potential investments, or support for ESG-related reports.
Lindsay Schreiber, Head of Data at IntellectAI, said, “The financial technology (FinTech) sector is thriving, with ESG Fintech emerging as a particularly promising niche. In recent years, especially post-COVID, the increasing focus on ESG has spurred a surge in the number and variety of players entering the ESG fintech industry. While financial institutes are backing ESG tech startups, corporations and consulting firms are also developing their own ESG fintech applications and platforms.”
While the sector is in a strong position, ESG is a key driver for sustainability and equality within business. Given that, is the sector progressing as quickly as it should be?
While most areas of FinTech suffered a dry spell in funding during 2023, ESG FinTech remained relatively stable at $28.8bn, according to KPMG in Pulse of Fintech 2023 report. Schreiber noted that while the trends are promising, there are still questions about its pace of growth. “Firstly, growth projections are for the future, yet the need for solutions is immediate. Secondly, even rapid growth may seem insufficient given the enormity of the climate crisis.”
Schreiber added, “ESG FinTech is projected to attract $123.7 billion USD in investment by 2026. Whether this growth is fast enough to address the urgency of climate change and social issues remains to be seen. However, one thing is clear: the time for action is now to mobilize funds and technology to address global sustainability challenges.”
ESG FinTech can provide financial services companies with powerful capabilities. For instance, there are tools for carbon footprint tracking, centralized ESG data management systems, sustainable investment platforms, and green lending platforms to trace financed carbon. By implementing these types of services, companies can ensure they are supporting the evolving market and new customer expectations.
They are also crucial to ensure firms are able to stay compliant with the evolving regulatory landscape, which is putting more focus on ESG issues. A prime example of this is the EU’s new Corporate Sustainability Reporting Directive (CSRD). The regulation requires companies to publish regular reports on the social and environmental risks they face and how their operations impact the environment. ESG FinTech tools are critical to ensure firms can efficiently and accurately complete these new reporting standards.
Schreiber added, “Financial institutions can play a critical role in combating climate change by integrating Climate change and sustainability considerations in their investment decision. By significantly increasing their investment in ESG FinTech solutions, they can be instruments of positive change.
“A robust, climate-focused FinTech sector can serve as the financial engine propelling us toward a more sustainable future. The time for action is now, and financial institutions must ramp up their investment in ESG FinTech to meet the immense challenge of our changing climate. The investment trend has to reach critical mass to deliver the promise of ESG FinTech today.”
How ESG FinTech can capitalise on its potential
As ESG issues continue to attract a lot of focus, the ESG FinTech sector is likely to continue to grow. A recent report from KPMG, which got responses from 111 banks from more than 20 countries, found that insufficient and inaccurate data was the most common challenge firms faced with their ESG processes, with 82% of respondents highlighting it. To overcome this challenge, these banks are adopting flexible target operating models for ESG data, defining data sources and quality hierarchies, collaborating closely with ESG FinTech data providers, and building internal data analysis capabilities.
Schreiber noted that as capital markets increase their demand for high-quality ESG data from listed entities, the potential for ESG FinTech is immediate and substantial. However, there are a number of challenges that need to be addressed for the sector to fully realise its potential. “For ESG Fintech to deliver quality and become a viable FinTech stream, it must overcome inherent uncertainties in ESG data.”
The first challenge Schreiber pointed to was regulatory and policy cohesion. Current ESG regulations are fragmented and subject to interpretation. Goalposts are also often easy to move, for instance some states in the US are reversing ESG regulations while others are implementing more. Similarly, some countries are changing their sustainability goals in favour of short-term growth. To ensure the ESG FinTech sector can grow, there needs to be clear, consistent global regulations from governments, which could provide stability and boost investor confidence, thereby incentivizing greater investment in ESG FinTech solutions, Schreiber explained.
In a similar vein, there needs to be greater standardisation for ESG data collection, boundaries and reporting methods. Inconsistencies are impacting transparency and make it tougher for comparing ESG investment options. “Standardization would level the playing field, enabling more informed investment decisions and facilitating automatic measurement, tracking, and goal-setting in ESG,” Schreiber said.
The next biggest challenge is with technological advancement. Schreiber noted that emerging technologies, such as big data analytics, AI and blockchain can create more sophisticated ESG FinTech solutions. For instance, AI could assess climate risk for investments, while blockchain could ensure greater transparency and security for ESG data.
Finally, Schreiber urged for greater collaboration between FinTech startups, financial institutions, and environmental and social organisations. “This collaboration can lead to more effective solutions, knowledge sharing, and broader market reach. For instance, ESRS digital XBRL tagging exemplifies how various stakeholders can collaborate to create an ecosystem with wider adoption and market reach.”
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