FinTech Startups Need A Responsible Finance Strategy To Help Avoid Pitfalls As They Navigate ESG
There has been a lot of research showing environmental, social and governance (ESG) issues can be valuable for investors and also beneficial for companies’ own operational performances. Much of the evidence has focused on large, publicly listed companies that report more ESG data, especially those listed in developed markets.
There has been a consistent gap in understanding how well these results translate to other companies, however. This was filled recently by a study conducted by Bain & Company and EcoVadis looking at how ESG performance impacted 100,000 companies, 95% of which are privately held. The result is consistent with other evidence, especially on issues related to emissions, renewable energy, workforce issues, and risks embedded in supply chains.
ESG is frequently, although not universally, found to be a positive for companies’ operational performance, even though it is thought to work against performance. Taking one example, companies with higher employee satisfaction grow faster and are more profitable than companies whose employees are less happy at work. The difference is meaningful – companies with good ESG rankings on this metric gained up to 5 percentage points higher revenue growth over a three-year period and 6 percentage points in higher margins.
Another new study, from IBM, finds a similar view in terms of the relationship between stronger operating performance and good ESG with a different set of companies. They looked at a different set of ESG indicators and found that companies that had progressed on the integration of ESG into their business had 10% higher revenue growth than laggards and delivered 5% higher shareholder returns.
These results are encouraging, but come with some qualification, especially for companies with more limited resources and less experience on ESG. For such companies that have made the decision to focus more on considering ESG issues, it can be daunting to take the first steps and to prioritize what to focus on at the start.
We’ve certainly seen this among the FinTech startups that have participated in our Responsible Finance FinTech program. The range of ESG issues that could be addressed for startups in the Middle East, North Africa and Türkiye and for those considering expanding to the region is often much wider than the capacity of even a small financial institution, let alone a FinTech startup.
There’s often not a lot of direction about what investors value from startups. Most venture capital investors are still getting their feet under them in dealing with their limited partners’ expectations about what ESG issues to prioritize when they make investments. The Principles for Responsible Investment only recently provided guidance from the experience of their signatories coming at the issue from the limited partner perspective.
Here are 3 things that startups should consider when approaching ESG.
Checklist fatigue is real
Among larger companies that have received years of attention on ESG issues, one of the biggest challenges is being overwhelmed by the volume of requests for ESG information, often in different formats from different investors. The same risk is present for startups, but the level at which it becomes overwhelming is much lower.
IBM highlights in its report what impact that has on companies: “Rather than strategically harnessing ESG data—using it as a tool for identifying opportunities to innovate and improve—many organizations are narrowly focused on meeting immediate compliance demands. To deliver better business results, leaders need to see ESG transparency through a new lens.”
A compliance mentality spreads the focus on ESG across too many boxes to check
ESG has become incredibly ubiquitous in a relatively short period of time, and that shows up in how effectively companies are using it. IBM surveyed companies and found that “almost all (95%) organizations have developed ESG propositions, but only 41% have made progress against them. Just 1 in 10 say their progress has been significant”.
Becoming focused on ESG is just the first step, and without the right approach from the beginning can open a company up to a deluge of requests to prioritize a wide variety of topics. Not all of these will be financially material, or represent a material impact on stakeholders. Trying to manage the deluge without preparation leads to the aforementioned ‘compliance’ approach, resulting in the big gap between the number of companies developing ESG plans and those making significant progress.
An overly broad ESG focus pushes companies onto an endless treadmill pursuing more data
When the adage that ‘what gets measured, gets managed’ is overlaid on companies that have taken too big a first step with ESG leads to a perception that the main gap facing companies in their ESG integration efforts is a lack of data. IBM’s survey found clear evidence of this: “Executives name inadequate data as the greatest obstacle—even more of a hurdle than regulatory barriers and inconsistent standards.”
Lack of ESG data – and especially good quality data – does represent a constraint on companies’ abilities to understand ESG issues, especially those that are beyond the four walls of their business. But sometimes the desire for more data can also be a reflection that the focus on ESG issues is not well targeted, or is over-broad.
All of these cautions about avoiding a ‘compliance’ mentality or spreading a business too thinly on ESG are especially important for FinTech startups because they have more limited capacity and can only devote resources to things that are directly relevant to supporting growth. For companies that have decided to take the step into ESG, they have already seen the situation where decisions have to be made in the face of uncertainty in other areas of their business.
Having experience in situations of making decisions with substantial uncertainty about the future should reinforce the importance of focusing on a few key criteria. This allows for working with the information that is readily available now, and prioritizing where to focus on incrementally improving its accuracy, timeliness and scope, to provide more decision-useful insights. It works much better than endless searches for more and more data on too broad a range of criteria.
