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The digital finance and sustainability nexus: In search of a conceptual approach to “sustainable digital finance”

Written by: Maria del Carmen Sandoval Velasco

Climate change, technological innovation and digitalisation are some of the biggest megatrends that are not only having a relevant impact on societies around the world but are also shaping our future. The climate crisis, largely caused by unsustainable human practices and economic activities, the extreme use of fossil fuels for energy production, environmental degradation and overconsumption of natural resources is extensively damaging our planet. The digital revolution has also transformed the way societies are interconnected, as well as the way individuals interact and make use of different services and is also having a significant impact on how different businesses operate and function, and in general on the economy, society, business practices and the functioning of public sectors. Digital technologies such as Artificial Intelligence (AI), Machine Learning (ML), Big Data and the Internet of Things (IoT) have played a key role in these changes as they have transformed social interaction practices, helped automating work, processing and analysing data very quickly, offering and facilitating distinct types of services, and becoming –  in general more and more pervasive in many areas, including the finance sector.

In this context it is therefore not surprising that the twin drive towards sustainability and digitalisation became central issues of the international and EU policy agendas in recent years. At EU level, several relevant initiatives and legislative pieces have been launched in these areas, mainly reflected in the Digital Finance Strategy and the Sustainable Finance Action Plan.  The former primarily stems from the importance and need for a digital transformation in the financial sector and, in particular, seeks to establish a comprehensive regulatory framework to enable the adoption of distributed ledger technologies (DLTs) and crypto-assets in the sector (EC 2020). And the latter, “aims to support the financing of the transition to a sustainable economy by proposing action in four number of areas: transition finance, inclusiveness, resilience and contribution of the financial system and global ambition” (EC 2021).  In this regard, it is widely recognised that the financial sector can play a key role in the transition to a low-carbon economy and contribute to mitigate the effects of climate change by different means (e.g. providing capital, channelling resources, promoting green finance). Also, according to the Commission, the digital transition appears key to mobilising and directing finance in support of the objectives of the Green Deal.

But where can we find the intersection between sustainable and digital finance? Is it possible to talk about something called “sustainable digital finance”? What exactly do we mean by this?

Broadly speaking, the notion of sustainable or “green” digital finance refers to the use of digital technologies (Fintech) to achieve certain ESG objectives or promote sustainability initiatives in the finance sector. The Green Digital Finance Alliance, has also described green digital finance as the processes of “harnessing emerging technologies and digital tools to create new services, products, strategies and commercial models that work to create offers focused on the green finance demanded by today’s users” (Singh 2022:7).

Still, it appears essential to build a comprehensive conceptual framework to better understand this linkage. This is a complex task – especially given the wide variety of concepts and taxonomies of green and sustainable products and activities and the lack of universal definitions, ratings and approaches to ESG – but a necessary one. In the following lines I would like to share some reflections on the need to build this conceptual approach by highlighting some preliminary ideas, presenting some questions and outlining some of the existing difficulties.

Within the (little) current literature on the topic, it is possible to identify that the idea of sustainable digital finance includes two main features or dimensions: one, relating to how technology has the potential to serve and promote sustainable finance; and the second, related to how to make digital finance technologies more sustainable.

It therefore appears important to unwrap both ideas.

1) Technology for sustainable or green financing refers to the emergence of digital innovations in the field of sustainable finance. Over the last decade, digital, data-driven and internet-enabled technologies have transformed many aspects of financial services, leading to the emergence of what is called “green fintech” or “climate fintech.” Examples of the latter are Fintech start-ups specialising in green digital payments, crowdfunding platforms with a sustainable approach, green digital investment solutions, deposit and lending solutions, among others. For many, Fintechs have also played a key role in promoting financial inclusion, as they provide access to specific financial services and products beyond traditional banking services, which are within the reach of many people.  In Europe, the number of green Fintech start-ups has been increasing in recent years, with Switzerland being the most relevant sustainable Fintech hub,  creating an important fintech Startup ecosystem – which is continuously growing (Climate Fintech Report 2022).

However, this leads to the question of how Fintech activities can be classified as truly green or sustainable. In general, many consider the argument related to the “alignment with ESG criteria” to classify some services, activities, products or types of investment as green or sustainable. The main problem we face is that there are too many labels and indicators that define, categorise, rate and measure differently ESG factors – and this ambiguity represents a big challenge for decisions makers, financial institutions, big and small companies.

Moreover, AI and ML techniques are also being used to analyse companies’ or financial institutions’ exposure to climate and environmental risks (risk identification), to assess their ESG performance and to help them meet specific ESG disclosure and reporting requirements. Similarly, satellite and ML data are increasingly being used to analyse environmental risks and help companies visualise their exposure to specific climate or environmental risks. But what is the environmental impact of these technologies, or how “sustainable” are they, and how can we measure it? The latter brings us to the second idea within the notion of sustainable digital finance: the “greening” of financial technologies.

2) Greening or “making more sustainable” financial technologies

In reflecting on how to make financial technology “more sustainable” or “green”, it can be said that understanding exactly what this means is not an easy task, especially given the lack of universal concepts and the existence of many ESG metrics, indicators and benchmarks. Neither is there much attention or research pointing to examples of how to ensure that digital transformation in the financial sector is (or can be) sustainable. However, one can highlight some considerations that could bring us closer to the idea of ensuring that digital transformation in the financial sector is sustainable: 1) the need for specific universal frameworks or criteria to be able to assess or measure the environmental footprint of digital technologies in the financial sector; 2) answering the question of how to label the sustainability “quality” of specific financial products or services; 3) how key digital technologies that are increasingly used in finance (i.e. DLT; blockchain) can be assessed in terms of their environmental and sustainability impact; 4) identifying existing use cases and practices.

There is much room for a broader debate on the issue of “sustainable digital finance”. Against many concepts, definitions and purposes, a collective understanding and a common narrative is lacking. Therefore, building a solid conceptual framework seems a fundamental and quite significant task to answer also other relevant questions: To what extent can digital innovations in finance contribute to achieving the SDGs and moving towards a climate-neutral economy? How does the use of digital technologies in finance contribute to making the financial system more “sustainable”? What kind of digital tools have proven to be useful and effective in achieving these goals?

This is an unfinished task and an emerging research area that requires further attention.

 

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