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Is the GCC ready for ESG investing?

Published: Updated:

Environmental, social, and governance (ESG) principles are gaining importance as investors become increasingly socially conscious.

Environmental criteria refer to how conscious an organization is about its environmental impact, whereas social criteria focus on the relationships between an organization and its stakeholders – whether employees, customers, or communities at large. Finally, governance principles are aimed at an organization’s leadership, shareholder rights, internal controls, and the actions of executives.

As a demonstration of investors’ interest in ESG principles, there are 1,905 signatories to the UN-supported Principles for Responsible Investment, representing some $80 trillion in assets under management. These signatories have pledged to adopt ESG considerations in their investment decisions. This is a trend that is highly likely to continue as investors increasingly look for firms that are ESG conscious.

Al Arabiya English recently sat with Nathalie Wallace, the global head of ESG Investing at State Street Global Advisors in Boston. “Some of our investors and clients are coming at ESG from a value angle. The trends have changed thanks to the emergence of better quality data, methodology, and academic research. We have seen that integrating ESG factors in investment processes and investment solutions can actually help deliver a more sustainable and long-term business,” said Wallace. “Other clients we have focus on ESG from an ethical standpoint, with a commitment to advocate values, such as not being harmful to the environment or society.”

Wallace notes that there has been significant data collection and academic research on the impact of ESG principles on companies and organizations. The research shows that companies that have implemented ESG criteria tend to lead to a lower volatility of returns, suggesting they are able to better deliver long-term sustainable growth and value to investors.

“You’ve also seen an improvement in the profitability of products that are more sustainable, simply through the process of making sure that their litigation costs or supply disruption costs related to sourcing raw material or supply from a region that might be resource-strapped, are reduced,” added Wallace. “There are studies that show that return equity is improved and cost of capital is reduced – again showing the advantage of implementing ESG.”

When looking at the MSCI Emerging Markets ESG Leaders Index return versus the conventional MSCI Emerging Markets Index, the former tends to outperform the latter significantly. From a performance perspective, therefore, the case for ESG investing seems strong. This is in addition to the credibility benefits and positive environmental-impact associated with investing in companies that have implemented ESG values.

What’s driving ESG?

There are three key drivers of greater ESG demand and success, according to Wallace. The first is greater access to information that allows for a higher quality level of self-reporting. Increasing levels of self-reporting is crucial for companies to know how they are performing.

Furthermore, higher levels of artificial intelligence technology implementation means that data providers are able to collect information and access it more accurately and faster than was previously possible.

Implementation of technology solutions has also widened the scope to compile this data and integrate it in a risk-effective way – the second driving force behind ESG implementation according to Wallace.

“We have been able to design precision indices which allow large passive investment into ESG companies. This sounds simple but it actually requires a large amount of technology in the backend to reproduce a product meeting ESG criteria. This is especially challenging, as the need to implement esoteric, or non-financial, indicators is challenging without the technology,” added Wallace.

Finally, use of analytics once a decision has been taken to integrate ESG has allowed organizations to deliver better long-term performance as well as improve industry transparency and credibility. Paired with greater reporting, analytics enable investors to make superior risk assessments. “Every step of this process would not have been possible five to six years ago – from reporting to systemic implementation of solutions,” said Wallace.

How does the rise in ESG affect the GCC?

Emerging markets generally have less information coverage than other markets. This has an impact on the efficacy of reporting in comparison to more developed markets. Reporting levels are a major milestone for achieving effective ESG implementation.

Wallace also pointed to the effect of large external institutional investors on the region. Earlier this year, Norway’s giant one trillion-dollar sovereign wealth fund (SWF) announced it would divest from fossil fuel investments worth $13 billion and take a step back from any companies which generate a high level of electricity from fossil fuel sources. This is one, admittedly major, example of institutional investors looking to improve their adherence to ESG principles – and this affects companies in the GCC.

“You see this capital influencing and having an impact on ESG in the way that companies are managed. It’s a big influencer in terms of ESG integration in companies and will drive implementation as companies look to remain attractive to investors,” said Wallace. “I’m confident that the demand for reporting will increase over time as there’s more international investors looking at GCC companies, which will drive increasing standards as capital owners look for this information.”

Schroders in its Global Investor Study 2018 noted that 86 percent of UAE investors have confirmed that investing sustainably has become more important to them over the past five years, demonstrating that this trend is here to stay.

GCC governments driving ESG

Initiatives such as Saudi Arabia’s national Vision 2030 are explicitly aimed at creating a more sustainable future not only from an environmental perspective but also through future cash flow generation – which, by extension, involves implementation of ESG principles.

“It seems obvious that governments in the region understand the potential of diversifying their economies and are looking to make sure that capital is relocated towards more sustainable economic trends,” said Wallace.

Furthermore, Wallace noted that the success of renewables and low-carbon technologies are increasing dramatically, with costs coming down that will have a long-term impact on the price of oil – a critical export for governments to currently balance their budgets.

Regional government initiatives are providing crucial top-down support for ESG principle adoption, enabling the GCC business ecosystem to adapt and transform towards a more sustainable future. “I think essentially all top-down and government-related initiatives help prepare the grounds for companies,” added Wallace.

Evidently, challenges remain in the GCC for full scale ESG adoption. However, with government strategies aiding companies to adapt, and investors increasing their focus on ESG, the future will surely see greater adoption. Companies that have already adopted ESG principles are more profitable, generate greater value for shareholders, and have more sustainable long-term prospects. GCC companies would do well to implement them sooner rather than later.