A perspective on ESG in FinTech by EY and Rabobank

The global shift towards sustainability and responsible investment is driving rapid progress in Environmental, Social, and Governance (ESG) regulations. Sustainability and responsible investment encompass not only doing good for flora but also for fauna (the ‘E), and include efforts to tackle topics such as poverty, illiteracy (the ‘S’) or integrity (the ‘G’). Businesses, investors, and financial institutions are increasingly integrating ESG principles into their strategies, with regulatory frameworks evolving to promote greater transparency, sustainability, and accountability. Leading this transformation is the European Union, whose Green Deal agenda has catalyzed major initiatives like the Sustainable Finance Disclosure Regulation (SFDR), Corporate Sustainability Reporting Directive (CSRD), EU Taxonomy, and the upcoming Corporate Sustainability Due Diligence Directive and Deforestation Act (CSDDD). These regulations aim to encourage sustainable practices and align corporate activities with broader environmental and societal objectives. It is important to note that on 26th of February, the European Commission has issued the Omnibus proposal, to simplify sustainability reporting rules for companies, reduce administrative burden and increase European competitiveness. The Omnibus proposal covers the CSRD, EU Taxonomy, CSDDD and Carbon Border Adjustment Mechanism (CBAM). Additionally, the CSRD has not yet been incorporated into various local legislations, but it is expected that the first group of companies will proceed with the ESRS reporting.

Compliance with these frameworks is essential for financial market participants, impacting value chains and industries such as payment service providers, who face growing demands for ESG data from clients, partners and society. To help financial institutions manage their material ESG risks, De Nederlandsche Bank (DNB) has provided guidelines focusing on four key areas: Business Model and Strategy, Governance, Risk Management, and Information provision. These guidelines are intended for investment firms, insurance companies, pension funds, and Electronic Money Institutions (EMIs) & Payment Institutions (PIs).

The global trend towards sustainability, combined with increasing regulatory oversight, is prompting a closer examination of corporate disclosures. Companies are under heightened scrutiny for “greenwashing,” where they may exaggerate or misrepresent their environmental efforts. Conversely, “greenhushing” is emerging as firms choose not to disclose sustainability initiatives to avoid potential criticism or accusations of greenwashing. A study by South Pole found that nearly 1,200 companies setting targets through the Science-Based Targets initiative (SBTi) chose not to make these targets public, reducing the availability of valuable data and best practices. Since greenhushing also leads to inaccurate corporate disclosures, it is also considered in the examination of disclosures.

Concepts such as greenwashing, greenhushing and their variations remain a concern in sectors such as payment services. However, many firms are now setting more credible targets and offering greater transparency about their plans to achieve them, fostering both credibility and inspiration in the journey toward sustainability. The following chapter addresses how you can follow their lead

Business model & strategy

In the FinTech sector, where innovation is key, the adoption of ESG practices is becoming increasingly important, driven by customer demand, supplier demand and regulatory evolvements. It is essential to start at the core; your strategy. Firstly, evaluate your existing strategy and consider to what extent ESG is already integrated. This reflection is not just about ticking boxes for compliance; it is about setting a direction that motivates and inspires your team and guides investors, partners and clients.

Next, develop an ESG strategy that aligns with your company's overall mission and objectives while being in accordance with the regulatory landscape. A clear ESG strategy can direct your organization towards sustainable practices integrated into every aspect of your business. A software technology company that demonstrates such a clear strategy is Backbase, where they state that a future proof business strategy should be sustainable. Their ‘Go Big, Go Green’ strategy is centered on building a sustainable future through three pillars: planet, people and partners. When they started formulating their ESG strategy, the complexity around this topic resulted in a split into a long-term strategy and short-term strategy. In the long term, they are investing in a healthier planet by reducing Backbase’s environmental impact. This requires a longer perspective, as their ambition to become carbon neutral is set out in intermediate steps such as setting up a baseline that measures the company’s emissions. In parallel, they are working on a short-term strategy for intermediate results. The support from senior leadership has been instrumental to Backbase in setting out their strategy and working together to realize their ambition. In addition to leadership support, having a dedicated budget for these initiatives is equally important to Backbase. Allocating resources not only enables the implementation of impactful programs but also demonstrates the company’s genuine commitment to making a difference.

The next step is to turn your ESG strategy into specific, actionable business goals. With these drivers of change, define what steps you need to take to adapt the FinTech business model to integrate ESG factors. With these adaptations you ensure that sustainability becomes a core component of your business model and operations, such as product design, service delivery, and employee engagement. Consider the example of Aspiration, a US financial institution that stands for offering green banking alternatives that are good for your wallet and good for the world, by integrating ethical and sustainable practices into its operations. They are known for their commitment to not invest in fossil fuels and for offering a "Pay What Is Fair" fee model, where customers choose their own monthly fee, even if it is zero. The bank also features a cashback rewards program for purchases made at socially conscious businesses.

Beyond integrating ESG into your business model, it is key to track and report on ESG metrics. This is where data analytics and technology come into play, providing the transparency and accountability that stakeholders and regulators expect. With upcoming regulations like the CSRD, organizations are required to report on data across their entire value chain. Therefore, even FinTechs not immediately affected will need to prepare as the demand for ESG data will increase throughout the whole value chain. Utilizing technologies such as artificial intelligence can help in efficiently monitoring ESG metrics. Moreover, automation can help to standardize ESG data collection and reporting processes, saving FinTechs time and resources.

Governance

Building on the foundation of an ESG strategy and integrating that into your business model, effective governance further integrates ESG into a FinTech’s operations. A well-defined governance framework ensures that ESG principles are embedded at every organizational level, from strategic decision-making to daily operations.

A proper governance framework is essential for overseeing ESG integration. This framework should clearly delineate roles, responsibilities, and accountability for ESG across the organization. It starts with awareness and support from the board of directors, who are since 2021 assessed by DNB on their ability to identify, define, tackle and monitor climate-related and environmental risks as part of the fit and proper assessment. Equipped with their knowledge, they set out strategic direction and ensure that ESG perspectives are integrated into decision-making processes. For smaller FinTechs, this may mean appointing an ESG champion within the organization or forming a dedicated ESG committee with direct reporting lines to the board of directors. Next to this, a FinTech could integrate ESG risk expertise into its risk committee to ensure that ESG considerations are incorporated into the company's broader risk management framework. This approach helps mitigate potential ESG risks and increases the company's resilience. At CM.com, the risk & compliance team plays a crucial role in regulatory-driven sustainability integration. Alongside the ESG manager, they form a core team that collaborates with the organization to achieve their ambitions. Periodic reviews and updates of the governance structure are essential for its effectiveness. As regulations change, the governance framework must adapt to new requirements and best practices.

Aligning leadership incentives with sustainability objectives can be achieved by setting climate or footprint goals tied to remuneration policies. For example, Revolut reflects in their Sustainability-related Disclosures that sustainability metrics are included in its renumeration policy, linking bonuses and other financial incentives to the achievement of specific ESG targets (e.g. ESG e-learning completion, proactive sustainability risk management and innovative ESG-related contributions). This alignment ensures that sustainability becomes a core focus for the leadership team. Sustainalytics' research shows investors increasingly seek companies that link ESG targets to remuneration and demonstrate progress with a scorecard and track record. Thus, embedding ESG into your compensation plan may also unlock funding opportunities. Please note that this can vary depending on the changing political climate.

Critically reviewing and ESG-proofing internal policies and procedures is the next step in weaving ESG into your organization. Internal policies and procedures form the backbone of a FinTech's commitment to client demand, ethical behavior and compliance with ESG-related regulations. Developing internal knowledge about ESG at all levels of the organization can be achieved through regular training sessions and workshops. For example, Backbase launched a ‘Go Green’ training for employees to visualize their individual role in achieving the company’s sustainability goals. Another market practice is implementing a code of conduct outlining the company's commitment to sustainable behavior. This guides employees in achieving the company’s ESG goals. For example, CM.com recently rewrote its code of conduct to embed Social Responsibility, focusing on a safe working environment, fair treatment & diversity, and sustainability & corporate Social Responsibility.

After an internal assessment, it is time to extend your focus outward. Regular dialogue with external stakeholders, including regulators, investors, and customers, is essential for staying ahead of the curve and demonstrating the company's commitment to responsible business practices. Effective stakeholder management is particularly crucial to avoid the pitfalls of greenhushing, where companies downsize their sustainability efforts to evade scrutiny. Companies’ ESG efforts should be transparent to acknowledge both the challenges and the achievements. Methods for stakeholder engagement include regular reporting on ESG performance, participation in industry forums, leveraging publicly available frameworks, such as the ones available from The Global Reporting Initiative (GRI), and direct communication with key stakeholders.

Risk Management

For a FinTech to be fully in control of its ESG risks, proper Risk Management of these risks is key. One of the four main pillars described by DNB is related to Risk Management, which can be split into risk tolerance and risk control. The first step is to formulate a risk appetite framework, including an explicit strategy and maximum risk acceptance on specific ESG topics. Mapping the materiality then ensures that all relevant risks are identified and a maximum exposure to these risks is formulated. Collaboration between Legal, Compliance, and Risk is essential as is illustrated by CM.com. By having Legal initially investigate upcoming regulation on ESG and its relevance, defining a strategy together with Risk and Compliance and then deciding on implementation with the ESG team, CM.com uses this strong internal collaboration to ensure a robust risk-based approach. Furthermore, CM.com also focuses on the positive aspects these new regulations bring, as it provides them with clear focal points on which to set up new initiatives, thereby using regulatory development as a catalyst for generating change.

After setting up a risk tolerance, a proper risk control cycle should be set up or extended to monitor the ESG risks and their respective thresholds, linking identified sectors to specific controls evaluated regularly. Once a proper risk management infrastructure is set up, it can be used to manage a myriad of risks, including ESG risks. For example, changing market sentiment can lead to new regulatory requirements and the risk of non-compliance resulting in reputational risks. This can be mitigated by having a dedicated ESG or Regulatory specialist.

Case Study: Risk Management and Compliance with AML/TF, and its increasing role within ESG

Anti-Money Laundering and Terrorism Finance (AML/TF) plays an increasingly important role within the scope of ESG. Transaction monitoring and analysis can be a tool in tackling social exploitation, environmental crimes, or human rights issues related to terrorism. Processing risky transactions from a money laundering or terrorism financing point of view therefore has an inherent ESG risk. Facilitating these transactions carries reputational risk and the risk that funds are used for activities that adversely impact the environment or human rights. A strong AML framework can mitigate adverse ESG results and improve ESG-related Risk Management.

The first step in creating a strong Risk Management Framework is determining the risk tolerance, which should meet the minimum legal requirements. Compliance with the law is a FinTech's license to operate, and a strong framework can track risks closely, such as transactions used for activities that adversely impact ESG goals.

After outlining the risk appetite, the second step is ensuring a proper control framework to monitor these (ESG) risks. Strong in-house tooling can help mitigate risks by keeping these under a close loop. These tools and systems can track risks and map data, helping with reporting requirements. Collaboration between risk, compliance, ESG, and legal can help mitigate risks and create a proper risk management framework.