Is there a net-zero case for fintech?

Climate change-based financial services technology, or climate fintech in short, is playing a critical role in the financial services sector as part of the transition to net zero, as demonstrated by the flurry of investment from asset owners and financial institutions this year.

But, as with any emerging sector, understanding how it fits into the broader climate finance agenda can reveal its limitations.

“As nations and societies commit to decarbonisation, a whole new set of tools are immediately needed to measure and account for emissions, calculate and price their externalities, and allocate – as well as trade – allowances,” says Alexandre Moreillon, principal at specialist fintech investor CommerzVentures.

This has given rise to a growing number of climate fintech start-ups. Climate fintech is a broad term that can be categorised into two main segments, according to Irena Spazzapan, managing partner at start-up funding firm Systemiq Capital.

“The first are the B2B platforms helping financial institutions to get better data ESG/impact analytics around their portfolio companies, to enable better investment and divestment decisions.

“These include ESG analytics platforms, such as Clarity AI and Arabesque, supply chain tracking platforms that help to manage Scope 3 emissions and sustainability risks – such as Circulor and EcoVadis – physical and transition climate risk analytics companies, and insurtech solutions that are protecting real assets from physical climate risk,” she explains.

The second category, the B2C sector, comprises the platforms helping consumers to reduce their carbon footprint through their purchasing behaviour.

A done deal?

So far this year, climate fintechs have attracted a large pool of capital and have also generated increased M&A activity.

According to a recent report published by international corporate finance advisory Hampleton Partners, Environmental, Social and Governance Technology M&A Market Report’, there were 93 tech deals globally that targeted an ESG firm in the first half of 2022, up 173% on the first half of 2019.

Lolita White, a senior analyst at Hampleton Partners, notes that amid the increased regulatory scrutiny and corporate responsibility in the race to net zero, businesses’ ESG reporting has been exposed as “not yet up to scratch”.

She explains that companies’ need to improve their use of ESG tech to support real-time recording, analysis and reporting of ESG data has stimulated interest in climate fintechs as M&A targets.

Among those businesses with a stake in climate fintech are asset managers and pension funds.

Spazzapan cites several examples of asset owners that have become active as users and investors in climate fintech companies, such as BlackRock and Deutsche Borse, both of which are backers of Clarity AI, a sustainability analytics and data science platform.

"WTW [Willis Towers Watson] backed Butterwire, Blackstone invested in Xpansiv and our ESG analytics company OpenInvest was acquired by JPMorgan, with a push to improve the direct indexing offer around sustainability,” she says.

But, she acknowledges: “This is still a relatively new space that didn’t exist until a few years ago, so it will take a few more years for these companies to be ready to attract more late-stage capital.”

Supporting investment decisions

For asset owners and pension funds, there are several reasons why taking a stake in a climate fintech makes business sense.

One of these is that institutional investors are increasingly turning to ESG data and reporting platforms to help guide their investment decisions and facilitate their own reporting, as CommerzVentures’s Moreillon points out.

“In addition, holders of physical assets – e.g. infrastructure or real estate funds, or mortgage lenders – are under increasing pressure by regulators to calculate and factor in climate risk in their risk management framework,” he adds.

Ransu Salovaara, CEO of regenerative finance specialist Likvidi, predicts that within the next 10 years, “pretty much all” of the financial services sector will be “somewhat sustainable, with all investors having some ESG aspects on their mandates”.

Salovaara says: “I fully expect that all stocks and bonds will soon have an ESG reporting mandate that will enable investors to have access to a greater knowledge pool that they can use to support their investment decision making.”

Carbon offsets

There has been some speculation that pension funds, for example, are investing in climate fintechs to offset their own carbon emissions.

Spazzapan notes that while these types of ESG data and analytics solutions are an essential catalyst for asset owners to move their portfolios to net zero, "we cannot forget that the real economy transition away from fossil fuels and intense land-use practices needs much more than just fintech solutions”.

“It’s common practice for financial institutions to purchase carbon offsets, as these are typically a cheap way to reach net zero. However, we believe that a volumetric approach to net zero makes little sense without a more holistic approach to a net-positive economy,” she says,

Instead, Spazzapan calls on institutions to channel these same funds into “real” decarbonisation efforts and to use offsets “only as a last resort for the harder to abate emissions”.