As the world targets net zero carbon emissions by 2050, investors are pouring trillions of dollars into ESG funds. How will FinTechs play their part in keeping responsible investment on the right track?

This article relates to Shearman & Sterling's upcoming inaugural Digital Finance Summit on November 15-16. Learn more about the Summit.

The world of finance is no longer driven by pure returns and far more investors are considering environmental, social and governance factors when building their portfolios.

Nearly nine out of 10 (88%) institutional investors afford ESG risks the same importance as financial and operational considerations when assessing a business, and almost 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 projected $140.5 trillion in total global assets under management[2].

With so many trillions of dollars attempting to reach projects that support ESG goals, policymakers have introduced a deluge of regulation demanding companies be transparent in everything from carbon emissions to employment practices.

For example, the Taskforce for Climate-related Financial Disclosures (TCFD) requirements are now mandatory in the UK and Japan, which demand the largest companies 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 US[3], as well as proposed rules requiring the financial organizations responsible for managing and investing these considerable sums to demonstrate their ESG credentials[4].

The Sustainable Finance Disclosure Requirements in the EU demand that asset managers and investment advisers make clear how they consider ESG risks in their 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 British government, stated: “FinTech has an important role to play, as relevant ESG data could be collected and processed efficiently using technology solutions.”[5]

It is no surprise then that KPMG reports big global institutions across banking, fund management and insurance have been “highly active” in either building proprietary data analytical capabilities for ESG or acquiring FinTech data aggregators — or a combination of both[6].

One of the key areas FinTech can add value in is bridging the gaps between the differing data reporting standards, terminology and taxonomy requirements, which make it difficult to create comparable metrics.

Distributed ledger technology (DLT) – in particular blockchain - has the potential to provide a safe and transparent tool allowing companies to collect verifiable data and generate trustworthy reports that demonstrate their ESG credentials.

Not only does blockchain offer privacy and transparency it provides data standardization which makes it possible for various devices to communicate with each other and share data without human interference.

That said, popular DLT systems using proof-of-work (PoW) systems to confirm and record cryptocurrency transactions as 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 more quickly and cheaply, and uses less energy, making it more environmentally friendly. Moreover, Ethereum Merge is also being considered an alternative to Bitcoin, from a cost-efficiency 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.