What is ESG and Why it’s Relevant Today?

What is ESG and Why it’s Relevant Today?
18 October 2022

Being cognizant of sustainability and the ability to do business or any line of work that is not only in compliance with environmental conservation and protection but also how an organization is socially responsible and how it is governed, in terms of its policies, the treatment meted out to the employees is essential nowadays.

The epitaph of being an environmentally and socially compliant organization is coveted and looked at not only by potential investors but customers alike. A lot of the large-scale organisations now align themselves with conservation policies so as not to affect or degrade the environment, make policies that are socially responsible, that are fair towards their employees, suppliers and whosoever works and is associated with the organisation.

The general jargon has now evolved from CSR (corporate social responsibility) to ESG (environmental, social, and governance). Used mostly as a marketing ploy in the past to garner a “greener” brand persona, times have changed as customers, investors, and all business partners now look at how an organization works and how its operations not only affects the environment but a host of different factors.

To understand this, it is pertinent to understand what ESG is and how it’s gained prominence in the recent past. ESG can be best defined as a characterised framework that helps stakeholders understand where their organization stands with regards to managing risks and opportunities pertaining to the environment, social and governance criteria. The term has evolved and taken shape from previous movements that focused on businesses and their operations from the lens of sustainability and their effect on society, the environment, and the people associated with them. This now affects how many investment and capital allocation decisions are made. Organisations allot budgets to alleviate their impact on the environment, make pragmatic governance policies that are employee friendly, and engage in business endavours that are in line with social responsibility.

As ESG becomes increasingly prominent around the world, it is very important to focus on and understand its global nuances and how it is a priority for CEOs and Directors since it resonates with investors around the world, region by region. Companies that follow and adhere to ESG standards agree to conduct themselves ethically in those areas and can draw on a range of ESG strategies, tactics, and ESG solutions to do so.

What falls under each category of ESG? It is better to list down what constitutes each section to show how policies can be made for each.

Environmental issues
To preserve the natural world, the following issues can be looked at. Each organization should introspect and see how they can make a difference, how it can be mitigated, what they can do to raise awareness about it, and how they can influence their customer base to adopt change.

  • Climate change
  • Carbon emission reduction
  • Water pollution and water scarcity
  • Air pollution
  • Deforestation
  • Greenhouse gas emissions

Being socially responsible
Being socially responsible is now mostly a prerequisite for companies since protection of minorities and their rights, gender diversity, mental health, and other pertinent issues now take precedence. Whether you look for employment or investment in an organization, there’s now a litmus test that each company must pass as accountability is now a requirement. The issues that are looked at are as follows:

  • Customer success
  • Data hygiene and security
  • Gender and diversity inclusion
  • Community relations
  • Mental health

Governance issues
The governance aspect of ESG entails apt hiring procedures, fair compensation, employee management, best practices with external parties and channels are a lot more. Following are a few examples:

  • Board of directors and its makeup
  • Executive compensation guidelines
  • Political contributions and lobbying
  • Venture partner compensation
  • Hiring and onboarding best practices

As countries and companies from around the world have onboarded the bandwagon of ESG, it is equally important in the realm of FinTech, like any other organization. The current surge in environmental, social, and governance (ESG) investing has influenced a material shift in the financial services sector. The global move toward investing billions of dollars in green and sustainable instruments, serious efforts to address ESG as a risk factor by financial institutions, corporations and banks restructuring themselves to adopt net zero pledges, and FinTech companies venturing into the domain of addressing climate change issues is palpable and gaining momentum. Interest from VCs in ESG-based FinTechs has peaked in the last two years. Mastercard issued a report which stated that venture funds deployed approximately 2.5 times more equity into ESG-related FinTechs in 2020 relative to what they invested in 2019 (from $700m to $1.8bn). This trend will continue as earlier stage ESG FinTechs mature (and need more growth equity) and more innovative FinTechs enter the market to address unmet ESG needs in the financial services industry.

In the last few years, there has been a significant shift in how banks operate as some of the largest banks are on the trajectory of conservation and have pledged to reduce emissions that pertain to their work and operations. They have also committed to alter their lending and investment portfolios to produce a net zero carbon footprint by 2050.

A compelling example of a FinTech using ESG to market as well as to address environmental issues is Aspiration Bank, a US-based, online-only FinTech that offers a ‘Spend and Save’ cash management account (CMA) where the deposits are not used to fund any oil and gas projects. It also offers a zero-carbon footprint credit card whereby the firm claims to plant a tree every time a purchase is made from the card.

Structural changes can be seen in FinTechs related to lending, payment, investing trading, risk analysis and many other areas as well. Fintech companies and start-ups as well as traditional financial services players can utilize ESG to cater to an untapped market, those customers who want to make the future better by aligning with companies whose manifesto and values align with theirs; to work and do business in a way that helps conserve the environment and our planet, companies that value employees and make policies that are fair, with equal representation, fair wages, zero discrimination and a company that is not assisted with any untoward controversies.

While much of the ESG focus of investors has been on renewable resources and recycling to date, financial services firms have many ways to advance ESG goals while providing valuable services to consumers and businesses. Given the digital nature of the industry, FinTechs and traditional financial institutions can do well financially by doing “good” for society.

ESG and fintechs: how firms are benefiting from an ESG focus