The largest investment firms are demanding ESG
According to a recent study featuring in-depth interviews with the majority of global investment firm leaders, Environmental, social, and governance (ESG) is now a top priority for these firms. This is largely because a lack of compliance with ESG has been found to negatively impact a company’s long-term profits.
Larry Fink — CEO of the world’s largest asset manager BlackRock — reiterates this point in his latest open letter to CEOs, where he suggests that taking a stand on vital social causes is crucial to an organization’s long-term profits. Mr. Fink also specifies that short, medium, and long-term targets for greenhouse gas reductions will be critical to the long-term economic interests of a company’s shareholders.
As we are currently involved in over 900 social impact projects, it’s safe to say we absolutely agree with Mr. Fink on this. The causes he alludes to represents challenges the world has never faced before, and failing to effectively deal with these challenges will surely have negative impacts for even the largest businesses.
Water shortages, climate change, rare-earth mining, and other critical factors pose an enormous risk to the natural environment as well as macroeconomic stability, and so are increasingly important for both shareholders and consumers. Idle companies who fail to take an effective stand on these issues will be seen as complicit in the problem and are likely to suffer financially as a result.
For multiple reasons, this is something the IT-heavy FinTech sector should take note of.
FinTech has an emissions problem
Largely due to the high energy usage involved, IT-heavy industries such as FinTech have an emissions problem. With ESG becoming a top priority for global investment firms in recent times, this problem increasingly represents not only an environmental challenge, but a financial challenge as well.
Thankfully for Fintechs there are effective IT-based solutions already available that can enable them to comply with ESG. As Fintechs are by definition already more digital than traditional banks adaptation and incorporation should be easier for them. To better understand these solutions, it is first important to understand the exact nature of the emissions involved.
In the case of FinTechs, most emissions are Scope 1 and Scope 2, with IT contributing an enormous amount of Scope 2 emissions. This is because emerging technologies are increasingly very computer intensive, and most FinTechs build on emerging technologies such as machine learning, so the process involves a great deal of purchased energy production. Training a single AI model for instance can emit as much CO2 as five average cars emit across their entire lifetimes.
And emissions are not the only environmental impact involved here.
Not just an emissions issue
FinTech companies also contribute to other environmental issues. Water-usage is a big problem, with just one mid-sized data center using roughly as much water as three medium-sized hospitals.
While the mining of rare earth elements used to make various tech devices is also very damaging in terms of pollution and biodiversity loss. Although it’s rare for FinTechs to directly produce these kinds of physical devices, such devices are required to access FinTech products, meaning the two are inevitably interconnected.
So for both environmental and financial reasons, embracing ESG has never been more important for the FinTech industry.
When Scope 3 emissions are taken into account, this importance grows even further.
Scope 3 emissions
The emissions caused by organizations in an investment firm’s portfolio are formally counted as Scope 3 emissions — or ‘financed emissions’ — in the investment firm’s own carbon footprint.
This can lead to potential fines for the investment firm, and also affects a firm’s ability to reach its 1.5-degree and net-zero goals.
Therefore, in order to reach their emissions goals and avoid potential fines, investors need to focus their investments on carbon-friendly companies.
This underlines the clear need for all companies, FinTechs included, to comply with ESG as soon as possible if they wish to continue attracting investment.
ESG reporting is a good place to start.
ESG reporting
So far, ESG reporting has not been widely adopted within the FinTech industry, but there are solutions available that could quickly change this. As FinTechs tend to concentrate mainly on their product and rarely on additional tasks and services, it makes sense for them to partner with an external specialist for something like ESG reporting.
A company called Plan A in Germany for example has built a tool that automates and manages ESG reporting all in one spot. This makes it easy for companies without reporting in place to implement it quickly, something that would fit quite well with the typical FinTech mindset.
Hence it is possible for any FinTech companies eager to comply with ESG to begin reporting swiftly and easily. There are also various Green IT solutions currently available that can help all FinTechs start lowering their emissions right away.
Further solutions: How green IT can help FinTechs comply with ESG (and save money)
The Cloud
When it comes to reducing IT-related emissions, as FinTechs either scale or die, moving infrastructure over to the cloud is usually the best option in terms of efficiency. There are also financial benefits involved too.
The predominant pay-as-you-go and pay-for-what-you-use pricing models offered by cloud providers allow companies to scale easily without the need for significant upfront investment. While overall IT support costs are reduced because the cloud provider takes on the burden of security and maintenance. Companies that plan ahead by switching to the cloud today — before upcoming ESG regulations are introduced — will also save on the inevitable additional costs involved with scrambling for a last-minute solution to government imposed restrictions.
As all major cloud providers support carbon neutrality by offsetting CO2 emissions, moving to the cloud not only leads to cost savings, but also offers a quick and efficient way for FinTechs to reduce both their Scope 1 and Scope 2 emissions.
Additionally, key cloud providers such as AWS and Azure both plan to use 100% renewable energy by 2025. While GCP has already declared itself carbon-neutral, suggesting that the cloud is itself quickly becoming a green solution.
Other green IT solutions
As well as moving to the cloud, there are other ways that embracing Green IT can help FinTechs lower emissions and comply with ESG.
Powering Data Centers with Green Energy:
If for whatever reason converting existing data centers to a cloud-based solution isn’t preferable, FinTechs can still reduce their Scope 1 or 2 emissions by opting to power those data centers with green energy.
Incentivizing Customers:
Certain types of FinTechs, investment apps for example, could lower emissions by incentivizing customers to make certain types of investments. By offering consumers rewards when they invest in carbon-friendly companies through their apps, these kinds of FinTechs could reduce their Scope 3 investment-related emissions.
Introduce Solutions for Carbon Tracking and Offsetting Internally:
Instead of opting for a third-party carbon tracking/offsetting solution similar to the ones offered by cloud providers, FinTechs could also develop their own internal solutions. If developed effectively, this should help to significantly reduce Scope 1 and Scope 2 emissions.
Specific, Ready-Made Solutions:
Ready-made solutions like OakNorth’s credit intelligence platform can help FinTechs address climate-related issues effectively and holistically. Utilizing such platforms will help reduce emissions, as well as tackling other forms of climate risk.
Whichever solutions they embrace to do it, there’s no doubt that complying with ESG is something FinTechs need to start doing today.
The time for ESG is now!
Data from BCG’s FinTech Control Tower — which features up-to-date FinTech company data from over 26000 sources — reveals that FinTech investment reached juggernaut proportions in recent years. 2021 alone saw no less than $140 billion of equity financing taking place.
However, this scale has proven unsustainable. 2022 saw funding decrease quarter on quarter which we’re also seeing in 2023. This decline in investment has been seen across the entire VC industry and is more a symptom of investor uncertainty (as macroeconomic conditions change) than falling confidence in FinTechs. 2022 was still a record year for FinTech, seeing a 58% rise on 2020 investment levels.
With investments becoming more selective and both the public and investment firms increasingly demanding sustainable practices from companies, coupled with immense regulatory pressure to reduce carbon emissions on the horizon, FinTechs need to start taking ESG seriously now if they want the investment to continue.
Because in the current reality clients are prioritizing environmentally-friendly products and services, investment firms are prioritizing green investments, and unsustainable business practices are damaging the environment.
All of these pressure areas will only continue to increase moving forward, so to succeed as a Fintech it is not enough to have an interesting product or a clever business plan.
The product must also be green, and the business plan must be able to attract green capital. Working to protect the environment is now expected from companies, so if they want to be successful, FinTechs need to take genuine action.
The clearest immediate way this IT-heavy industry can achieve this is to do away with local data centers, and shift to a more sustainable, more carbon-friendly cloud solution.
Doing so will represent a ‘win-win-win-win’ scenario; for FinTechs, investment firms, customers, and the environment.
To learn more about how tech is accelerating the transformation of the financial services industry, check out BCG Platinion’s Fintech and Digital Banking Podcast here.
About the Authors
Boris is a Managing Director in the Dubai office of BCG Platinion.
He has worked with leading global organizations to drive their digital agenda while being laser-focused on customer value at the same time. His experience ranges from highly strategic tech DDs and IT strategy definitions to driving digital transformation program, as well as agile customer journey re-imagining projects. Boris is a leadership member of BCG Platinion Financial Institutions practice area and coordinates BCG Platinion’s Neobanking & Fintech initiative.
Annika Melchert is a Principal at BCG Platinion based out of Dubai. She is leading the internal initiatives “Architecture Chapter” in Middle East as well as the “FinTech & Neobanking Group”. Driven by her passion for modern banking she worked with several fintechs and incumbent banks on their technology build, integration strategies, and digital transformations. Besides, she is hosting the “Fintech Files Podcast”.
Christian supports his clients in their critical IT initiatives, ranging from designing and building Fintechs, to transforming incumbent IT organizations to be ready for managing IT programs at scale. Christian has over a decade experience in transformational IT consulting and focuses himself on enabling new methods and agile ways of working within companies using a wholistic view. He is part of BCG Platinion’s financial institutions practice area.
