The Singapore Law Gazette

The Integration of ESG and FinTech

Environmental, Social and Governance (ESG) concerns have increasingly become a core business imperative. On local shores, the financial landscape is also experiencing a focus shift onto two driving forces – Technology and Sustainability, and green fintech as a progeny of the two. This article will briefly note international trends in the financial services industry, and explore how local adoption of green fintech seeks to address ESG concerns. Focusing on three main ideas – the financial regulatory landscape, promoting sustainable finance, and promoting gender-inclusive finance – this article explores potential benefits of green fintech implementation, and alludes to potential concerns.

Introduction

Globally, with rising regulatory enforcement, increasing consumer focus, and the G-7’s push towards mandatory climate-related financial reporting in line with the recommendations by the Taskforce on Climate-related Financial Disclosures (TCFD), Environmental, Social, and Governance (ESG) concerns have increasingly become a core business and political imperative. This global embracing of sustainability is palpable even in the Asia Pacific region, with Baker McKenzie’s 2021 report “From Strategy to Action – Advancing ESG in Asia Pacific” finding that almost half (46%) of 800 business leaders surveyed now focus on approaching sustainability issues more seriously than before the COVID-19 pandemic, and 90% responding that ESG is at least part of the discussion when their companies consider acquisitions or other investment activities.¹”From Strategy to Action – Advancing ESG in Asia Pacific”, September 2021, Baker McKenzie Asia Pacific Business Renewal Series <https://www.bakermckenzie.com/-/media/files/insight/publications/2021/07/apbr_from-strategy-to-action–advancing-esg-in-asia-pacific_19-july.pdf?la=en&hash=FFD2F3B1B53736DC26E39969BDFD2A92>

These developments should be viewed against the global backdrop of the push towards carbon neutrality, with net zero commitments looming around the corner. Since the Paris Agreement in 2015 to maintain global warming to no more than 1.5°C, countries have been working towards halving carbon emissions by 2030 and reaching net zero by 2050. Consequently, ESG considerations are reaching a crucial tipping point in the next few decades, with transformational execution coming to the forefront as a focal point to address the greatest challenge that mankind faces.

Our local shores are no exception, with the recent emphasis in the Singapore financial landscape being shifted onto two of the key driving forces shaping the future of financial services today – Technology and Sustainability – and green fintech as the progeny of the two.

We focus on three major and exciting ideas in this green fintech space, both from a public and private perspective:

Idea 1 – Supporting Strong Legal Standards, in Both Disclosures and Regulations

With Morningstar reporting ESG fund inflows hitting record highs of nearly US$ 22 billion back in the first quarter of 2021, and assets under management totalling more than US$ 330 billion as of September 2021,²Alyssa Stankiewicz, “The Number of New Sustainable Funds Hits an All-Time Record”, October 2021, Morningstar <https://www.morningstar.com/articles/1062299/the-number-of-new-sustainable-funds-hits-an-all-time-record> it is clear that investing in ESG and sustainable finance remains hugely popular and there is a huge momentum in financial markets. But broader investor exposure / demand and market salience begets a higher need for increased consumer protection and hence regulation.

A current lack of ESG disclosure standardisation and quality ESG data hampers the ability of investors to meaningfully compare and understand the relevant disclosures, and increases the real risk of greenwashing. Exacerbating the problem for multinational organisations is the fragmented nature of ESG regulation, especially across the Asia Pacific region, with no clear and consistent taxonomy and a lack of universal adoption of global ESG standards / frameworks.

Recognising the ESG disclosure standardisation issues, the Monetary Authority of Singapore (MAS) has been actively pushing for the adoption of well-regarded international reporting frameworks, such as the Financial Stability Board’s TCFD recommendations³See MAS’ Guidelines on Environmental Risk Management for Banks, Asset Managers and Insurers. Available at <https://www.mas.gov.sg/regulation/regulations-and-guidance> for climate-related disclosures for all financial institutions from June 2022, and through the future implementation of mandatory reporting being aligned with the International Sustainability Standards Board’s standards. Alongside these, MAS has been pushing for stricter guidelines for retail ESG funds, to better standardise labelling and guard against greenwashing risks.

Besides a top-down, “pull” approach to improve the adoption of consistent ESG approaches and in recognition of the inherent need for good quality data to achieve consistent and accurate outcomes, MAS has also concurrently adopted a bottom-up, market driven “push” approach though cooperation with the private sector to improve access to ESG data and analytical tools to evaluate ESG risks. Take for example, the development of Hashstacs’ blockchain-powered, industry-wide ESG Data and Certification Registry, which it is developing in partnership with MAS’ Project Greenprint. This ESG Data and Certification Registry forms a single optimistic data point in the broader ESG ecosystem of enabling green and sustainable finance – through its aim of improving access to tamper-proof and quality ESG data on sustainability projects across multiple industry sectors via an aggregated platform. Amongst others, the ESG data will include sector-specific, industry-recognised certifications, which aligns with MAS’ broader push to develop trusted ESG data flows through the development of the local digital ESG infrastructure, in anticipation of future scaling of such green fintech solutions beyond Singapore. As part of building up the local digital ESG infrastructure, ⁴For more details on MAS’s approach to green fintech generally and Project Greenprint, please refer to MAS’s webpage on green fintech at <https://www.mas.gov.sg/development/fintech/Green-FinTech> MAS has also concurrently tied-up with, amongst others, (1) Google Cloud under the Point Carbon Zero Programme to create a world-first open-source cloud platform dedicated to climate finance in order to improve access to accurate and granular climate-related data,⁵”MAS and Google Cloud Launch Point Carbon Zero Programme to Catalyse Climate FinTech Solutions”, July 2022, Monetary Authority of Singapore <https://www.mas.gov.sg/news/media-releases/2022/mas-and-google-cloud-launch-point-carbon-zero-programme–to-catalyse-climate-fintech-solutions> and (2) the Singapore Exchange to launch ESGenome, a digital disclosure portal to report and access structured ESG data.⁶”MAS and SGX Group Launch ESGenome Disclosure Portal to Streamline Sustainability Reporting and Enhance Investor Access to ESG Data”, September 2022, Monetary Authority of Singapore <MAS and SGX Group Launch ESGenome Disclosure Portal to Streamline Sustainability Reporting and Enhance Investor Access to ESG Data>

No doubt, such developments which aim to promote ESG data quality and consistency will be welcome amongst financial institutions, reducing the cost of compliance and allowing for better tracking and analysis of sustainability commitments, impact measurement, and management of ESG financial products. The ideal end-state being that financial institutions are able to achieve better clarity in ESG disclosures and to better meet the increasingly standardised ESG disclosure rules, thereby alleviating new regulatory burdens and regulatory enforcement risk (these being the top two ESG-related risks facing Asia Pacific businesses as surveyed,⁷Ibid note i. with local word on the street being that ESG rules tend to keep general counsels up at night), and supporting mobilisation of capital to sustainable projects while reducing greenwashing risks.

Legally, it will be of interest to witness how regulators around the world will employ a calibrated implementation of higher ESG disclosure standards over time, as the supporting ESG digital infrastructure grows and data challenges and taxonomic issues wane.⁸Already, the European Sustainable Finance Disclosures Regulation is making waves in global markets. For more details, see “Sustainability-related disclosure in the financial services sector”, European Commission <https://
finance.ec.europa.eu/sustainable-finance/disclosures/sustainability-related-disclosure-financial-services-sector_en> The micro-scale policy approach adopted will be crucial in achieving a balance to ensure meaningful ESG disclosures without over-incentivising boilerplate and/or defensive disclosures. At macro-scale, the lessons from implementation of such disclosures in the context of sometimes diverging interests will no doubt have important lessons for lawmakers globally. While it is always tough to make crystal ball predictions, it is likely that the calibrated implementation for such mandatory climate-related disclosure⁹MAS expects to consult on these disclosure requirements for financial institutions once the ISSB standard is finalised. See Ravi Menon, Managing Director, Monetary Authority of Singapore, “From Green Finance to Transition Finance”, Remarks at the MAS Sustainability report 2021/2022 Media conference (28 July 2022) <https://www.mas.gov.sg/news/speeches/2022/remarks-by-mas-managing-director-mr-ravi-menon-at-the-mas-sustainability-report-2021-2022-media-conference> for financial institutions¹⁰Ibid. These should be considered in parallel to the mandatory requirements for listed companies to disclose climate-related risks from 2023 onwards, and also future disclosure. in Singapore will be structured via gradual prescriptive updates and details added to the existing Guidelines on Environmental Risk Management over time.¹¹This is currently for banks, insurers and asset managers. See note iii. While these do not have the force of law, they do impact MAS’ overall risk assessment of a financial institution and are useful as a guiding tool to shepherd financial institutions towards MAS’ broader policy objectives. The hard-line approach would be to provide for prescriptive stipulations into notices, which have the force of law. What is no doubt clear then, is that this is a nascent area of law that is constantly evolving and growing in importance.

Idea 2 – Promoting Sustainable Finance

Another budding idea in the green fintech space stems from sustainability finance solutions, in particular sustainability-linked financing. Such ESG-contingent financing often aims to incentivise a borrower’s sustainability performance by featuring sustainability-linked goals and key performance indicators that are tied to key terms of the loan (such as interest margin, repayment schedules, etc.). The recent proliferation is stunning. The United Nation’s Principles for Responsible Investment reports that the sustainable loan market (which includes sustainability-linked loans) has grown exponentially from just US$6 billion in early 2016, to US$322 billion in late 2021. As of September 2021, sustainable lending represented more than 10% of the global corporate syndicated loan market, 90% of which were sustainability-linked loans.¹²Sehoon Kim et. al., “Sustainability-linked loans: A strong ESG commitment or a vehicle for greenwashing?”, July 2022, United Nations’ Principles for Responsible Investment <https://www.unpri.org/pri-blog/sustainability-linked-loans-a-strong-esg-commitment-or-a-vehicle-for-greenwashing/10243.article>

As with most ESG developments, greenwashing risks abound. Similar to the equity flipside where ESG retail funds are sometimes accused of playing up empty ESG promises to boost capital raising abilities, so too does the debt market face such issues where sustainability-linked debt financing are potentially used for virtue signalling with empty promises. Understandably, concerns abound over such ESG risks, with constant market / bank vigilance being demanded through ongoing ESG monitoring, and ESG contingencies in said loans being enforced or renegotiated.

On this front, the Singapore government has been actively developing the both the market and digital infrastructure concurrently. Besides innovative market grants,¹³”MAS Launches World’s First Grant Scheme to Support Green and Sustainability-Linked Loans”, November 2020, Monetary Authority of Singapore <https://www.mas.gov.sg/news/media-releases/2020/mas-launches-worlds-first-grant-scheme-to-support-green-and-sustainability-linked-loans> through their recently announced NovA!,¹⁴”AI Utility NovA! to Unlock Opportunities for Green Financing and Combat Greenwashing”, June 2022, Monetary Authority of Singapore <https://www.mas.gov.sg/news/media-releases/2022/ai-utility-nova-to-unlock-opportunities-for-green-financing-and-combat-greenwashing> MAS hopes to integrate and harness the power of natural language processing techniques to reduce the time required for and automate the process of compiling, analysing and reporting on the designated types of ESG activities as disclosed in sustainability documents, and thereby assess the sustainability performance of Singapore’s real estate sector. The initial focus will be on enhancing financial institutions’ ability to assess a company’s environmental impact and identify environmental risks. The idea then, is that financial institutions are able to build upon NovA!’s insights for their ESG risk assessment, for the purposes of their disbursements of sustainability-linked loans, at the loan origination, underwriting and servicing stages.

In the local private space, the effervescence of green fintech news abounds. In May 2021, Deutsche Bank Singapore and Hashstacs announced their proof-of-concept completion on the use of the distributed ledger technology for sustainability-linked bonds, so as to achieve end-to-end bonds lifecycle management (coupled with rapid smart contracts issuances and integrated with modern payment modes).¹⁵”Deutsche Bank and Singapore fintech STACS complete ‘bond in a box’ proof-of-concept on the use of DLT for digital assets and sustainability-linked bonds”, May 2021, Deutsche Bank <https://www.db.com/news/detail/20210518-deutsche-bank-and-singapore-fintech-stacs-complete-bond-in-a-box-proof-of-concept-on-the-use-of-dlt-for-digital-assets-and-sustainability-linked-bonds?language_id=1> A few months before that saw Bluecell and Hashstacs announce a partnership to support, amongst others, sustainability-linked loans, under which Bluecell will integrate its live end-to-end loans matching engine to Hashstacs’ sustainability-enabling technology infrastructure, as powered by distributed ledger technology.¹⁶”Singapore FinTechs Bluecell and STACS announce collaboration towards industry-wide blockchain-powered infrastructure to support effective green and sustainability-linked loans”, March 2021, Hashstacs <https://stacs.io/singapore-fintechs-bluecell-and-stacs-announce-collaboration-towards-industry-wide-blockchain-powered-infrastructure-to-support-effective-green-and-sustainability-linked-loans/> Here too, we see active partnership efforts underway by the Singapore government, which is not necessarily tied only to the sustainability-linked loans space. For example, in 8 July 2022, UOB announced its Green and Sustainable Deposits solution with GIC, whereby deposits are deployed to green loans under UOB’s sustainable finance frameworks (which in turn are aligned with the UN Sustainable Development Goals (SDGs)).¹⁷”UOB pilots Green and Sustainable Deposits solution with GIC”, July 2022, United Overseas Bank < https://
www.uobgroup.com/uobgroup/newsroom/2022/uob-green-deposits.page?path=data/uobgroup/2022/235&cr=
segment> A possible future scaling option would be to adopt sustainability-linked loans alongside the green loans under this deposit product.

One can only imagine the possibilities when such private sector sustainability finance solutions eventually converge with blended finance, which MAS has recently been espousing.¹⁸Ibid note ix. Here lies outsized opportunities, as the improved assessment tools for ESG related financing risks can be scaled and combined with such transition finance / climate financing mechanisms to achieve multiplicative effects. Through the synergy of public and private capital in blended finance, this would further assist to de-risk and improve project bankability of certain classes of sustainability projects in developing regions. This will allow private sector funding to be leveraged through partnerships with traditional development funding from public and philanthropic avenues, with the overall aim being to help attain global ESG goals by assisting to help fill Asia’s transition financing gap.

Of course, the devil will be in the details. In the private sphere, amongst others, current legal concerns surround the design and drafting of enforceable contractual suitability performance targets, that do not necessarily trigger an event of default or review event like usual financial covenants, but which prolonged breach may result in a form of higher margins or fees, and/or re-classification as it will no longer be a sustainability-linked loan. Ultimately, only time will tell as to the market equilibrium reached between borrowers and lenders as to negotiated positions, and the popular contractual design styles that will emerge. In the public sphere, what we do see locally, is regulatory encouragement couched at a high level to preserve lender flexibility¹⁹Ibid note xii. – with the requirement for grants for sustainability-linked loans at pre-origination stage being tied to either (a) ESG evaluation scores, or (b) alignment with internationally-recognised principles with at least two sustainability performance targets tied to the environmental objectives of the UN SDGs or Sustainability Linked Loan Principles, as externally reviewed.

Idea 3 – Promoting Gender-inclusive Finance

Turning to the last point, instead of focusing again on the service or the product aspect of green fintech, it would be interesting to look at green fintech as a driver of ESG, especially the social aspect (the “S” in ESG), from an entity-level and service provider / product producer perspective. Here, there is an interesting global development at the intersection of gender-inclusive finance and fintech generally – in which the call for gender equality at the executive level / leadership tier is resonating louder and louder. This will be a crucial concurrent development in the space, because as one IMF Working Paper reports,²⁰Purva Khera et. al., “Women in Fintech: As Leaders and Users”, July 2022, International Monetary Fund Working Paper <https://www.imf.org/-/media/Files/Publications/WP/2022/English/wpiea2022140-print-pdf.ashx> greater gender diversity in the executive board level is correlated with better performance of fintech firms. There is much room for improvement on this, as the same IMF Working Paper notes that, across 5,256 fintech firms across 83 countries, there are significant gender gaps in leadership based on female founders (10 – 15%) and female directors (7%) on the board.

Singapore has thus far established itself as one of the most progressive countries on gender equality in Asia Pacific, but there remains significant scope to reduce the gender gap further as compared to other advanced economies (especially in leadership positions), with estimations that Singapore could increase its GDP by as much as 5% ($20 billion) a year by moving towards gender parity. The fintech industry is no exception, with gender parity at managerial and professional level in the local finance and insurance sector generally being low. ²¹”The power of parity: Advancing women’s equality in Asia Pacific”, April 2018, McKinsey Global Institute <https://www.mckinsey.com/featured-insights/gender-equality/the-power-of-parity-advancing-womens-equality-in-asia-pacific> The Singapore Exchange is also leading the way in this regard: from 1 January 2022 onwards, it has mandated that board diversity policies (which expressly includes gender) for all listed issuers must be disclosed, coupled with concrete timelines and plans for implementation.

Development of gender-inclusive finance will be crucial from a green fintech perspective, both directly and indirectly. Directly, beyond potential performance improvement as mentioned above, what better way to bridge the “fintech gender gap” (from a customer / digital financial inclusion perspective, as green fintechs are increasingly deployed in society) that is currently present,²²Sharon Chen et. al., “The fintech gender gap”, March 2021, BIS Working Papers No. 931 <https://www.bis.org/publ/work931.pdf> than with female fintech industry leaders developing, marketing, and supplying financial products that may better suit women’s needs.

Indirectly, gender-inclusive finance will also be a core building block that needs to be embedded into the local digital ESG infrastructure underlying green fintech, especially before it starts to grow in size and complexity. Underlying so many of the upcoming financial innovations will be integrated applications of algorithms and modern machine learning tools, which will allow for automated extraction of emergent information from huge pools of data (including customer data). But these benefits bring along with it hidden costs, and the same algorithms that deliver value to society can also concurrently further entrench undesirable societal biases through algorithmic bias. Promoting gender parity is one way to break up homogeneous groups and decision-making, thereby facilitating the detection and mitigation of such algorithmic biases (both gender-based and non-gender based biases) which might otherwise sneak through (for example, through early detection of non-representative data to prevent inefficient derivative conclusions about the general population, which would result in unintentional externalities being imposed onto underrepresented segments of society – like women in the context of fintech usage). The idea then, is that more accurate algorithms would promote more efficient implementation of green fintech solutions throughout society.

In the future, when such green fintechs are scaled up and extended to emerging economies – where 1.7 billion around the world remain unbanked, mostly poor, mostly women – in a bid to address both sustainability issues and inclusive finance generally (i.e. inclusive green finance), such foundational improvements to gender-inclusive finance will start to shine when the outreach of such green fintech firms and the penetration of such green fintech services are going to become dependent on crossing an effective level of female participation.²³Globally, women are often over-represented in informal, insecure and low-income segments of economics. Thus, outsized opportunities exist in promoting financial inclusion amongst this segment of the population, especially in developing countries. For more details, see “Facts and Figures: Economic Empowerment”, June 2018, UN Women <https://www.unwomen.org/en/what-we-do/economic-empowerment/facts-and-figures#:~:text=Women%E2%80%99s%20economic%20empowerment%20includes%20women%E2%80%99s,economic%20decision%2Dmaking%20at%20all>

Conclusion

Exciting developments abound in the green fintech space, as both the private and public actors seek to leverage on its attributes as key drivers and powerful enablers of building a more inclusive and sustainable society. Emphasis lies on harnessing the benefits to ESG of such technologies, while hedging against the risks of fraud abuse and greenwashing, and of under-represented segments of society being left behind, as the finance industry turns its collective energies towards the transition to a carbon-neutral future. Thus, this nascent area of finance, coupled with the forthcoming proliferation of further flexible rules that will increasingly require integration of ESG considerations, will usher in a greater era of both opportunity and responsibility for the finance industry to strive towards larger purposes.