Climate fintech is much more than just a buzzword. It’s an emerging segment that harnesses the benefits of digital finance with climate action. Fintech as a broad category has already disrupted banking, and now climate fintech stands to do the same in the environmental, social, and governance (ESG) realm. Stakeholders, from founders to investors, are stepping up to bring this market segment into the mainstream and streamline processes for market participants.
Climate fintech is expected to be a major catalyst in bringing the planet closer to carbon neutrality. While fintech has changed the way that financial services operate, it alone does not always consider the environmental outcome. That is where climate fintech comes in, bridging the gap between fintech and the fight against climate change.
In this blog article, we will explore the future of climate fintech, why now is such a critical time to advance these innovations, and how it stands to accelerate decarbonization. We will also consider some of the challenges that are up ahead for adoption and the role of emerging technologies in providing solutions to those hurdles.
Table of Contents
The world is in the midst of a transition from fossil-fuel-based energy to renewable power, and this shift is commanding trillions of dollars in investment. Climate fintech is among the sectors gaining traction. Last year, climate fintech startups raised $2.9 billion in capital in 2022, a fresh high for this emerging market segment.
And while climate fintech is an up-and-coming market, it has already begun to show signs of maturing through activities like M&A. For example, in early 2023, climate tech startup Doconomy purchased Dreams Technology, which is focused on financial well-being. The combined company is looking to bridge the gap between behavioral economics and climate action.
Even major tech companies are getting in on the action, including payments platform Stripe. It launched Stripe Climate, which is designed to help businesses shrink their carbon footprints as they expand. With a few clicks, users can send a fraction of their sales to support emerging technologies dedicated to removing carbon from the atmosphere.
They are far from the only ones. Carbon Collective is another industry player, and it links a user’s investments to fighting climate change. For example, it gives investors greater exposure to sustainable equity and fixed-income securities and helps them to divest from companies that are contributing to climate change, like oil and gas drillers.
Other areas in which carbon fintech is focused include –
- Carbon accounting
- Impact investing
- Climate risk management
- Sustainable banking
- Carbon credits trading
- Supply chain analytics
The $2.9 billion that poured into carbon fintech startups last year was more than twice as much as was directed into this market segment in 2021. European companies are out front for raising capital, at $1.7 billion across over 120 deals vs. $1.1 billion across fewer than 50 transactions in the U.S. Carbon accounting, where an organization’s carbon impact can be measured and quantified, and carbon offsetting are both popular niches.
The development and adoption of financial products are keys to the path to net-zero emissions. One way to look at it is through the lens of financial product innovation, which is a catalyst for investment into climate fintech.
For example, The Lab, which develops financial solutions to attract investment into climate action, is behind a blockchain climate risk crop insurance for farmers. It’s a digital index platform that measures how crop production is impacting climate change through a more transparent insurance product.
Another area of innovation is sustainable energy bonds, which are designed to raise funds and direct the proceeds toward projects whose mission is sustainability. Separately, solar has made its way into the securitization market, where investors can gain exposure to solar-fueled asset-backed securities.
You are also seeing consumer product innovation in areas like credit cards, where the spare change from daily transactions is directed toward renewable energy projects and battling climate change.
As the grid transitions from fossil fuels to renewable energy, climate risk assessment and reporting are other areas that have been thrust into the spotlight. These apply to various categories, including legal, technology, market, reputation, etc. It’s up to organizations to prepare for this shift despite the unknowns, such as the speed at which it will occur.
Risk modeling is not easy. As the New Energy Nexus Climate Fintech Report stated, “One regulation or calculation adjustment can spell the worst day for solar or the best day in history for the coal industry.”
Big data is helping, as it supports industries like insurance to predict things like weather patterns so that they can better evaluate the fallout from catastrophic weather events. Insurers are on the front lines of climate risk and therefore play a major role in the shift to ESG.
The ECB’s Christine Lagarde has expressed a need for data to fill the gap in pricing risk surrounding climate change and biodiversity loss.
In response, Richard Peers, founder of Responsible Risk Solutions, has suggested a planetary computer comprised of an ecosystem of satellites, sensors, and blockchain technology — all fueled by artificial intelligence (AI) to create a standardized format. With something like this, stakeholders would be able to better assess the climate risk before making decisions or starting activities.
As the planet moves toward decarbonization, there are also some headwinds facing climate fintech that cannot be ignored. For one, the regulatory guardrails are not completely established in the fintech industry, let alone sub-categories like climate fintech. As a result, innovators run the risk of having to go back to the drawing board once regulations and policies are established.
The industry is moving extremely quickly, which introduces challenges to the regulators, who are not known for moving fast. For climate fintech to be successful, it requires the involvement of various stakeholders, including policymakers.
One of the issues facing ESG behavior, in general, is a lack of industry standardization. As a result, market participants, including investors, have been left confused about what constitutes a proper ESG asset or behavior.
Companies report their ESG disclosures in ways that are relevant to them, but a lack of standardization makes it difficult for investors to make comparisons and assess risk property. For the most part, ESG reporting is voluntary in nature, which means that not everybody is doing it. Those who are reporting do not do so in the same way. Until these challenges in the broader fintech and ESG realms are solved, climate fintech may not be able to reach its full potential.
Before investors direct their capital to an emerging segment like climate fintech, they’ll want to ensure that the data they are receiving is accurate, which is why transparency and accuracy are so vital when it comes to carbon data and reporting.
ESG data-related spending was projected to hit $1 billion in 2021 and has been growing at a rapid clip — 20% annually. Global ESG assets are on track to hit $53 trillion by 2025 and could represent more than 33% of global AUM, amplifying the need for accuracy in data reporting.
Market participants are incentivized to collaborate and work toward a solution on standardization. Otherwise, they run the risk of damaging their brand by reporting questionable ESG disclosures that could otherwise be viewed as greenwashing.
The rapid pace at which tech innovation is happening stands to benefit emerging sectors like climate fintech.
One area that holds a great deal of promise is blockchain and decentralized ledger technology. Blockchain is a public ledger through which transactions and data are distributed, encrypted, secure, and immutable. The blockchain may no longer be brand new, but it has a host of applications that have yet to be realized, including in climate fintech.
The blockchain makes transactions faster, more transparent, and cheaper without the need for third parties to provide verification. Blockchain and DLT technologies can introduce similar benefits to climate fintech and help to proliferate the adoption of this segment.
For example, blockchain could introduce greater cost savings in activities such as debt issuance, including green bonds, incentivizing companies to tap the capital markets and giving investors an opportunity to participate. As it applies to debt issuance, the blockchain reduces the need for counterparties, resulting in cost and time savings. Transactions are distributed and settled more quickly than is otherwise possible, while the blockchain’s transparency results in faster verification times.
In addition, these technologies can help on the data front by speeding up the processing of information and making it available much faster while introducing greater transparency along the way.
Climate fintech has a key role in the future of decarbonization, which could only reach its potential through the involvement of the financial system. In fact, climate impact requires the participation of all stakeholders, from investors to legacy finance to regulators to entrepreneurs to developers.
Through activities such as lending, product innovation, blockchain technology, data analysis, and more, climate change is taking a leading role in the shift toward a more sustainable future.
While there are challenges that have yet to be solved, the industry is continuing to move forward, and infrastructure is being updated to make the adoption of climate fintech more of a reality. Stakeholders have begun to recognize the opportunity and are responding by embracing and investing in climate fintech solutions.