ANZ Finance blog | Bigger Than FinTech: The Less Obvious Innovation Transforming Finance

Bigger Than FinTech: The Less Obvious Innovation Transforming Finance

Published 29 October 2021

By Dr Peter J Phillips, Associate Professor (Finance & Banking) University of Southern Queensland

The Less Obvious Innovation Transforming Finance -- McGraw Hill ANZ Finance Blog – ESG assets

Finance is continuously evolving. Many of the things that people think are new, have been tried and applied by finance academics and professionals (between whom there is a close link) a long time ago. Most of this innovation takes place beyond the gaze of ordinary people, in the private domains of the Masters of the Universe. Sometimes, an innovation breaks through into popular discourse. And when this happens it can give those who finally spot such an innovation the false impression that everything in finance has been ho-hum up until now. Meanwhile, traders have been busily applying themselves for years trying to overcome that pesky thing known as the speed of light, which so egregiously delays information flows. Or using satellites to see if carparks are busy.

The focus on technological innovation is understandable. But it can distract us from seeing other innovations that are sweeping through finance theory and practice. While FinTech is a word that’s on everyone’s lips, up until now it has attracted relatively scant theoretical-empirical attention in the literature. One reason for this, perhaps, is that it represents new ways, facilitated by new types of companies, of performing existing finance functions (e.g., money transfers or portfolio management). The institutions are new, but the functions are not.

"ESG assets, according to Bloomberg, will hit $53 trillion by 2025 and the ESG industry is growing by annual amounts greater than the total current value of the entire FinTech industry. Not surprisingly, a lot of papers have been written about ESG."

Nevertheless, the money flows into the FinTech industry are strong. $91 billion flowed into FinTech investments in 2021, according to Forbes. And there are estimates among various commentators online that suggest the FinTech industry is worth around $5 trillion, with further growth expected. What “non-tech” area of finance could possibly compete with this? The answer is ESG. ESG assets, according to Bloomberg, will hit $53 trillion by 2025 and the ESG industry is growing by annual amounts greater than the total current value of the entire FinTech industry. Not surprisingly, a lot of papers have been written about ESG.

Corporate finance theory introduced CEOs to shareholder value. In doing so, the corporate world was transformed by the drive to create shareholder value. Corporate fiefdoms were dismantled. Enormous bureaucracies streamlined. Waste curtailed. Plants closed. Jobs were lost. Some companies were destroyed by hostile takeovers. Factories were moved overseas. Much that was good, and a lot that was bad, was done under the banner of shareholder value creation. Decades on, investors still desire value. ESG doesn’t overturn this fundamental objective of corporate finance. It adds to it an important question: how is that value created? And there is a growing list of things, from pollution to labour exploitation, that investors will no longer ignore in the pursuit of shareholder value.

"ESG is broader. It goes beyond the environment to reconsider all the sources of shareholder value."

ESG stands for environmental, social and (corporate) governance.

While “climate risk as business risk” focuses on companies’ efforts to improve their environmental sustainability records, ESG is broader. It goes beyond the environment to reconsider all the sources of shareholder value. These are things that have traditionally been out of sight, out of mind, such as the working conditions in far-flung factories or the commitment of the company to its consumers’ and clients’ values. Fundamentally, the biggest change traces to a basic insight: ESG risks have increasingly come to be perceived as business/portfolio risks. Fund managers are paying attention to the ESG dimension of the companies in their portfolios because there is a tremendous business opportunity in attracting a new generation of young investors who are concerned with ethical investment and consumption. Companies seeking capital from fund managers cannot undermine those fund managers’ ESG commitments to their own investors. As such, companies that pay attention to the ESG dimension of shareholder value creation may find it easier to raise capital than those who don’t.

Business opportunities. Capital flows. A sustainable future. The ESG story is an attractive one. It is also a deeper story than FinTech. ESG may eventually reshape the investor’s relationship with various core components of finance theory and practice. Can we include, for example, ESG risk in traditional measures of portfolio risk (i.e., standard deviation)? Or do we need to add a dimension to Markowitz’ portfolio theory: mean-variance-ESG? I tried to do this as a young researcher (see, Why Do We Invest Ethically?) Or deeper still. We know that the internet and cryptocurrency mining use vast amounts of energy. Will ESG reshape, or even overrule, certain types of financial innovation? Or will the kings of crypto hold sway?

I wonder if, post pandemic, there will be a 1980s style boom. People emerged from the malaise of the 1970s with newfound vigour. If history repeats itself, the direction in which they channel that fresh vigour will probably shape the remainder of the 21st century.

Discussion Questions

Do you think that ESG will transform (or has transformed) finance? Or will ESG be incorporated into existing products and simply be another box that investors can tick on their fund application forms?

Further Reading

In Chapter 5 of the text, we talk about issuing shares to the public. As mentioned above, ESG factors can shape access to capital. You might be able to investigate further and see just how capital flows are shaped, if at all, by ESG innovations.