ESG investing has grown significantly over the past few years. It results from investors, businesses, governments, and a range of stakeholders looking to address critical challenges such as climate change, environmental damage, social inequality, and discrimination. According to Statista, the three most common reasons for ESG investments among asset owners and managers in 2021 were brand and reputation, external stakeholder requirements, and improved long-term returns.

What is ESG investing?

ESG investing involves investors applying non-financial factors, namely environmental, social, and governance, as part of their analysis process to identify material risks and growth opportunities. The main focus in ESG solutions is put on the environmental element.

Since the signing of the Paris Climate Agreement, global climate tech investment has skyrocketed, with five times more VC funding in 2021 than in 2016. Europe is the fastest-growing region globally for climate tech, with investment growing faster than the global average: 7.0x vs. 4.9x between 2016 to 2021. According to Net Zero Insights, globally, the capital granted to climate tech organizations had reached $59bn by the third quarter of 2022. This value accounts for 19% of global venture funding in Europe and North America. Funding in climate tech in Europe had also registered an all-time-high investment in October.

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ESG investing trends

The market

Since 2019, there has been an upward trend in sustainable investment options as European investors continue to pour billions into the industry. European investors have invested at least €120bn into sustainable assets. It’s also clear that investors are increasingly interested in how startups are scoring on their ESG policies and practices. 49% of millennial millionaires are making their investments based on social factors.

Another interesting fact is that consumer attitudes are also shifting. 46% of consumers worldwide say they would choose eco-friendly products over a preferred brand. Employee behavior has also shifted as 67% of millennials expect the companies they work for to be purpose-driven and have a societal impact.

Transparency in ESG reporting

In the modern internet age of unlimited information and transparency, labeling something ESG-compliant without backing up the results no longer sits well with investors. In recent years, the industry has been ridiculed for greenwashing. Investors have begun demanding more valuable insights into whether companies were moving the needle on ESG principles.

With a few exceptions, ESG metrics are not commonly part of mandatory financial reporting. However, companies are increasingly making disclosures in their annual report or in a standalone sustainability report showing how these factors are becoming of paramount importance to the business world. Investors want concrete answers about exactly how companies are reducing their carbon footprint and improving diverse and inclusive hiring practices, for example. They're demanding to know: how does that fund make the world a better place?

Startups, such as Greenomy, are empowering corporates, asset managers, and SMBs to measure, report, and improve their sustainability. Yet, still generating and gathering high quality granular ESG data is a blank space in the ecosystem, which the emerging players should address. Minimum is another startup that ensures sustainable reporting. It assists businesses to comprehensively measure their Scope 1, Scope 2, and Scope 3 carbon emissions, plan and execute their Net Zero strategy, and achieve sustainability reporting and certification standards.

ESG companies and innovations

With the growing importance of sustainability, it’s crucial to take a look at some of the main trends around ESG-related innovations. ESG companies and products can help financial institutions plug internal resource gaps and scale up their ESG capabilities.

• Corporate ESG reporting software

The core functionalities of tech-based corporate reporting startups are as follows: (a) data collection through accounting data, (b) streamlining reporting, and (c) managing and improving carbon footprint.

Plan A, a standard ESG reporting software, tends to be compliance-driven, focusing its value proposition on legal certainty and obtaining certification. With the increased pressure on corporates from regulators, shareholders, and customers to report ESG data and create strategic sustainability objectives, newer tech solutions are focusing more on helping corporates with their carbon reduction strategy, in addition to reporting. ESG companies, such as Clarity AI, offer a one-stop-shop ESG reporting software to cover sophisticated end-to-end sustainability use cases (e.g., analysis, portfolio creation, simulation, etc.).

• ESG data providers for investment portfolios

Institutional investors are increasingly pressured to evaluate companies from an ESG perspective and use the results to inform portfolio construction. ESG data providers like Fingreen, Util, and Accern provide financial institutions and asset managers with portfolio screening tools that can screen financial assets by ESG metrics.

• Market sentiment tools

ESG market signals are becoming increasingly important for financial institutions. Market sentiment tools aggregate thousands of data and news sources to spot changing ESG signals in the market. In real-time, enterprise software like Sentifi flags ‘ESG’ events to investors that could produce significant price changes to assets or even require removal from ESG portfolios. Climate X offers climate risk management solutions that help organizations become more resilient to the impacts of climate change. They achieve this by quantifying, at an asset level, the probability and severity of weather events decades before they happen.

• Client communication software

Financial institutions that construct ESG portfolios and products must find new ways of engaging and communicating with sustainability-minded clients, including retail investors who are underserved by traditional wealth managers. Innovation in this space has significantly lagged behind other ESG product offerings. Matter is a startup that hopes to address this by offering portfolio analysis and impact reporting tools to help consumers understand their investments. Tumelo, on the other hand, empowers retail shareholders through its digital platform to positively impact its investments by voting on corporate decision-making. Other startups, such as Doconomy, also cover transaction-level impact generated by a client and communicate using the banking or investment app.

• Impact investing apps for retail investors

The “appification” of investing has been a great boom for consumers with the creation of some very specific investment niches. The most notable one is socially responsible investing (SRI), also known as impact investing. Applications, such as Clim8, focus investment only on sectors that fight climate change to create a sustainable future.

The future of ESG investing

Just in the first half of 2022, Environmental, Social, and Governance mutual funds and ETFs lured a net of $120bn, according to Morningstar data. ESG funds have also shown lower volatility while producing a good return on equity and tending to have better longevity.

With this in mind, global ESG assets are on track to exceed $53trn by 2025, representing more than a third of the $140.5trn in projected total assets under management. In addition, according to a forecast published by Deutsche Bank, ESG investments are expected to grow further and pass the $100trn mark by 2030.

From this, one can conclude that ESG investing is showing highly promising results, attracting more funds and investors. It will especially thrive after the COVID-19 pandemic. Corporates, including banks, must increase their emphasis on ESG while also shaping their corporate purpose. Financial institutions are already pledging to put investment capital to work. Goldman Sachs, for example, is allocating $750bn toward sustainable finance by 2030 and is a third of the way to reaching its goal. Bank of America has pledged $300bn to sustainable investments. Citigroup, meanwhile, committed $1trn to sustainable finance by 2030.

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Over the next 30 years, $30trn of wealth will transfer from baby boomers to their millennial children. This will not only accelerate demand for products from ESG companies but equally raise expectations around sustainability. Financial services providers should expect to supply greater information and data on their portfolios' environment and social impact to end-users. To compete, traditional financial institutions must find new ways of engaging with their client base. They must provide differentiated investment opportunities and develop tools to reach a younger, socially-conscious audience.