Fintech is Set to Take on the ESG Challenge

By Anton Kaidorin, financial services consultant at SoftServe

Fintech innovation is poised to deliver another societal breakthrough as it helps money managers and investors unlock the complexities of ESG investment obligations, following its success in liberating many of the global unbanked through mobile payments and inclusive finance programs.

Just as mobile money, then e-money and open banking, transformed economic activity in developing economies by empowering new micro-businesses in the late 1990’s and early 2000’s, the deployment of more sophisticated data management and analytics is now set to deliver the benefits and opportunities that sustainable investing have long promised.

Unlock Complex Puzzles

The key strength of Fintech innovation is its ability to unlock individual parts of complex jigsaw puzzles, without becoming overwhelmed by the wider strategic objectives. By delivering connectivity and communications for the conduit of payments, technology providers created new economic links that forged supply chains, accelerated money turnover, and empowered communities. This resulted in a massive drop in the unbanked population from over 60% in 2000 to just over 30% by 2021, with a significant knock-on impact that lifted millions of people out of poverty in those countries.

We are currently at the start of the journey where Fintech’s now have the opportunity to transform ESG due diligence and profiling into the tools that create and empower a sustainable financial ecosystem. This will have benefits and ramifications far beyond asset managers and corporate boardrooms, eventually filtering through to business and employment practises that change lives and communities of millions more across the globe.

More Consistency Required

Many early ESG initiatives have been hampered by inconsistent approaches and conflicting policies that have made the process too opaque. The longer-term success of ESG will depend entirely on the quality of data used, how it is analyzed and how it is applied to investment decision making. Most of these solutions have so far been based on disclosures, external ratings, and analytic reports from various consulting firms. Not only is more consistency and standardization required, but the information net will have to be cast far wider.

I believe that we will soon see (in 1-2 years) a critical “complexification” of existing ESG profiling models through significantly deeper analysis of the processes, materials, workforce, value chains, etc… being deployed across business and commerce. This will be led by the increasing importance of the application of ESG standards in the capital management frameworks of heavily regulated financial services like CIB and insurance.

Moreover, I believe that ESG profiling will become an integral part of the compliance and investor relationships functions of corporates, as part of their continuous reporting, that investors and borrowers will demand to ensure the higher transparency and periodicity of the ESG risks. It is also likely that investor relationships will require ideal ESG profiling solution capabilities to incorporate awareness of specific products and/or services to understand the impact of these on the entire ESG rating of the firm.

Comprehensive Analysis

Such deep analysis will require significant IT investment from both sides, not least the deployment of big data processing, AI/ML, MLOps and their integration to ensure the comprehensive analysis of structured and unstructured data. But the net effect will ensure much wider benefits, particularly in regards the cost of capital and more transparent valuations for corporates and better pricing for financial institutions and other investors.

However, this situation is going to become more challenging before it is more widely accepted as the future of ESG pricing will continue to be led by uncertainty about new regulations. This has already led to many risk managers and quants realizing that they need to start thinking about the integration of the ESG factors into the “CAPMs”, risk models and pricing models. In addition, the probable promotion of ESG by the ECB and other central banks as “Pillar 4” factors, may lead to significant changes in pricing due to wider changes in regulatory capital management, portfolio limitations, etc.

New Math

As a result, such changes will likely have a significant impact on the pricing of investment and loan capital that potentially may even require the creation of more specific ESG-related financial math. This could mean that models with a current market-based approach, for example French-Fama multifactor models, would not be sufficient, especially for loan capital, as they would not allow a quantitative presentation of the ESG parameter dynamics of a given specific corporate.

Specific Expertise

Right now, the widening adoption of ESG practices offers a blue ocean of opportunities for the Fintech’s with strong data management skills and specific ESG expertise that will be available for banks and other financial institutions to leverage and partner with.

Many Fintech’s already support banks across areas such as ESG profiling, climate risk analysis (including climate models and satellite image recognition, etc.), much as they have done over the years with inclusive finance and collaboration programs for the underbanked and unbanked where data management has also been key.

And it is critical to emphasize that data is still the cornerstone for any ESG initiative today. Fintech companies that therefore want to succeed in this environment will have to be “ready-to-go” with a range of tools such as NLP solutions for unstructured data processing, ESG “qualitative to quantitative” industry specific solutions, as well as other regulatory and custom reporting solutions. Fintech can offer a lot in the world of ESG, as they have proven capable of doing before. And they will have an exciting future if they can again prove that they have the practical and cost-effective answers the banks need with minimal disruption to existing structures and working practices.

About the author:

Anton Kaidorin is a financial services consultant at SoftServe. He spent more than 10 years in commercial and investment banking before placing a focus on IT for the past nine years. His deep knowledge of investment management, risk management, and compliance allows him to design and implement unique, custom financial services solutions.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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