Can fintech help shift the trillions?

We are going through two of the greatest changes since the Industrial Revolution: first, the transition to a more sustainable economy; and second, a digital revolution affecting almost every aspect of our lives – and disrupting the entire financial ecosystem.

These two drivers are interlinked. With the need for the reallocation of capital flows to more sustainable companies and projects, fintech and other new technologies – such as artificial intelligence (AI), big data, blockchain, remote sensing and the Internet of Things (IoT) – have the potential to bring sustainability firmly into the mainstream.

Here are three ways of how fintech have the potential to drive change in sustainable finance:

• providing better sustainability data and analysis, allowing for much enhanced alignment of portfolios with climate goals 

• empowering retail investors

• building confidence and reducing transaction cost through the development of more robust sustainable market infrastructure

Better data, better analysis

“Shifting the trillions” is about mobilising the vast power of global finance to drive the transition to clean growth and resilient development. The passage from climate-damaging investment to a sustainable economy will require more systematically integrating environmental, social and governance (ESG) factors into investment decisions and processes.

Whilst exclusionary-screening, typically based on investment values (e.g. tobacco, defence), represents the largest sustainable investment strategy globally ($15 trillion as of 2016), ESG integration was one of the fastest growing strategies between 2014 and 2016 ¹. This marks a clear shift in the conversation from value investing to ESG integration, which underlines how investors are increasingly looking at ways to better and more systematically incorporate ESG risks and opportunities into their investment processes and strategies.

In particular, following the Paris Agreement, the need to better integrate climate data has been driven by a number of initiative, such as Article 173, France’s landmark law on climate risk reporting, or recommendations of the Task Force on Climate-related Financial Disclosures (TCFD). Both the French law and the industry-led initiative flag the importance of better assessing the exposure of companies to transition and physical risks linked to climate change.

In light of these developments, it is increasingly critical for investors to access better quality ESG data and build advanced analysis. Unfortunately, ESG data disclosed by companies is far from perfect. Company-reported data is often not comprehensive or granular enough to allow for the accurate understanding of ESG performance, while traditional indicators are not sufficiently robust. For instance, reporting the carbon footprint of a company is an insufficient proxy for understanding its preparedness for climate-related transition or physical risks. Moreover, company reporting is frequently done on an annual basis only.

Fintech is at the frontier of developments that allow for the extraction of more information based on existing and new data sets. By deploying AI and machine learning, new fintech solutions can bolster existing corporate reporting by generating much more advanced ESG signals on a company’s performance, which can be updated on an almost real-time basis.

With respect to climate metrics specifically, some fintechs are developing solutions to better assess climate-related risks and opportunities of companies, providing forward-looking analysis that draws on public databases and the internet to derive the best information on companies. Indeed, following recommendations from the TCFD, we are a seeing a shift from a pure carbon footprint-focused approach of companies to an assessment of the alignment of these companies with various transition scenarios. To provide more forward-looking information based on the assessment of various climate risks to which companies are exposed, fintechs such as 2º Investing Investing Initiative and 427 are also developing solutions using more granular information, such as asset-level data. This can then be correlated with other data sets – such as macro, eco and socio-economic scenarios as well as with climate scenarios – ultimately allowing for a more accurate view of how both climate-related transition and physical risks can impact companies’ performance.

By drawing on the power of big data, AI, and machine learning, fintechs are becoming suppliers of more advanced ESG analytics, which can then be used by investors to assess the alignment of their portfolios with the objectives of the Paris Agreement, i.e. holding global average temperature to below two degrees. This, in turn, allows for more informed investment decision-making processes and portfolio construction in line with this two-degree scenario.

Empowering retail investors

European household savings represent over 40% of total financial assets in the European Union (EU) and, according to a Natixis Global Asset Management survey in 2017 across 22 countries, 70% of retail investors think that environmental and social objectives are important factors in investments. This means that retail investors represent a potential key driver of demand for inclusion of ESG into global finance opportunities. One of the EU High-Level Expert Group (HLEG) recommendations was to give retail investors the tools to allow them to invest in sustainable funds with greater ease, which would require systematically asking retail investors about their extra-financial preferences in addition to their financial preferences.

One space to watch is the development of Robo-advisors providing online advisory services. Robo-advisors, or digital advisory platforms using algorithm-based inputs, could provide sustainable investment advice to retail investors based on their ESG preferences, which would then match their preferences with the right ESG funds. This would require that customers have clearly defined ESG investment objectives, but this barrier could also be overcome with the development of an appropriate ESG questionnaire. This type of potential development in the fintech space is already being scrutinised by fintech firms and think tanks, such as the 2° Investing Initiative.

Providing better ESG information to retail investors is a growing concern for banks. For example, BNP Paribas is currently working as part of the Banking Environment Initiative (BEI), convened by the University of Cambridge Institute for Sustainability Leadership, on the development of a Proof of Concept for pension savers. Through the use of a digital app drawing on big data, AI and Robo-advisors, it could identify the investment composition of their pensions and determine its ESG performance. Depending on the analysis, they could decide to shift their investments to match their ESG preferences. These types of fintech developments could be highly disruptive for the financial sector insofar as they have the potential to completely break down the traditional investment value chain.

Building confidence, reducing transaction cost: more robust sustainable market infrastructure

Sustainable investments come with a number of challenges. Compared to traditional investments, investors in green debt need the assurance that the funds are being used for what they are being claimed for. This implies the need for issuers to be in a position to demonstrate a solid track record of green projects and the capacity to report effectively on the expected environmental benefits of the projects being financed. These expectations can act as barriers for issuers that are not well known by investors and which may lack the capacity to report in a standardised fashion – especially if they are operating in the emerging markets.

Some fintech solutions, such as blockchain technology, can help reduce risk by allowing for better data collection and improved transparency through traceability and storage of data. For instance, the Stockholm Green Digital Finance initiative is working on a project to help drive forward the market for green investments.  The Green Assets Wallet project is looking at supporting the scaling of green debt by providing validation of projects’ green claims, providing a system to aggregate impact reporting data through blockchain technology, in turn supporting new issuers in demonstrating credibility to investors.

Looking to the future

Whether it is bringing sustainability to the global finance mainstream through more powerful data and analytics, empowering retail investors with better ESG information or enhancing the integrity of green debt flows, these are but a few examples of what technology can do – and we are probably only scratching the surface of the many ways fintech could be used. It is therefore not surprising to see intergovernmental organisations and industry-led initiative putting green fintech on the agenda of green finance and sustainable development. The UK Green Finance Taskforce, for example, recommended setting up a Green Fintech Hub.

Shifting the trillions will require a global effort drawing on many technological solutions – some of which could be potentially very disruptive for the financial industry. For the banking sector, those actors best able to understand these current trends are those that will play a pivotal role in the transition for a more sustainable economy.


[1] Source: 2016 Global Sustainable Investment Review