With global environmental, social, and governance (ESG) assets on track to exceed $50 trillion by 2025, sustainability is top of mind around the world from asset management firms to corporate boardrooms and governments.
The Middle East is no exception, with major governments committed to net zero carbon targets and many companies rapidly improving their ESG disclosure practices and standards. The region has both the potential and a strong desire to contribute much more to the cause of sustainability, as some other regions are doing.
The uptake of ESG in the Middle East is being driven by many factors. Firstly, many governments are well aware that sustainability and green initiatives are essential not just for the environment and people’s wellbeing, but for economic growth. Secondly, regional as well as international investors are increasingly using ESG metrics within their investment decisions, to not only assess risks, but to identify real-world impacts of corporate operations and future investment opportunities.
Thirdly, regional consumers are demanding sustainability in the products and services that they buy. Recent reports show that sustainability factors affect Middle East consumers’ decisions more than their global peers (31 percent in the Middle East, compared with 18 percent globally).
From a listed or issuer company’s perspective, the three main pillars of sustainability are target setting, performance management, and reporting. Many companies in the Middle East are now embedding these in their corporate strategy and behaviour.
Regional stock exchanges have taken significant steps to improve reporting. Dubai Financial Market (DFM) published its Guide on Environmental, Social and Governance (ESG) Reporting in 2019, while the Bahrain Bourse published its ESG Reporting Guide in 2020 and the Saudi Exchange’s ESG Disclosure Guidelines was released in 2021. The UAE is the first country in the region to mandate formal reporting requirements for issuers, with the UAE Securities and Commodities Authority now requiring companies listed on the DFM and ADX to adhere to certain ESG disclosure norms and publish sustainability reports.
Mandatory reporting can be very helpful to both companies and investors, as it provides a clear framework for them to follow so that different entities can be compared with each other using the same metrics. One of the problems faced by the sustainability movement globally and in the region is fragmentation of standards, including a variety of non-government as well as government frameworks.
Whichever sustainability framework companies in the region use, before reporting they should follow a systematic approach with comprehensive internal ESG processes and strategy. They should then be able to meet investor expectations of third-party audits, follow-up meetings, and science-backed targets. Companies also need to understand the different frameworks used by asset managers including their screening mechanisms and sector and country-based exclusions, as well as engagement requirements.
The good news for some companies in the region is that for now many investors are overlooking low ESG scores and high CO2 emissions, and instead are keen to work with such companies to understand their sustainability journey and provide them with support.
Fortunately, there are clear moves globally towards standardisation of reporting. In the future, it seems likely that the International Sustainability Standards Board (ISSB) will become the global gatekeeper of ESG disclosures. The ISSB was established at the COP26 climate conference in 2021 and includes climate-specific disclosures as well as general sustainability.
Increasing standardisation and thus transparency will help allay a host of misgivings that investors often have about companies, ranging from supply-chain monitoring to accurate emissions reporting. Investors’ decision-making will improve and companies that deserve investment will be more likely to have it allocated to them, especially if they frequently tell their ESG story and demonstrate its progress to investors, both through the earnings cycle and one-on-one meetings.
Standardising ESG reporting and making it mandatory nonetheless does not come without limitations. Not all ESG metrics can be quantified and they may not directly translate into enhanced corporate earnings or performance. Also, current sustainability disclosures are often biased towards process and procedures, not towards actual performance.
Additionally, applying the same factors to companies in different regions and industries with varying business practices can be problematic, as companies have different business models, and different regions have different challenges that need to be considered when it comes to data quality, especially in emerging markets such as the GCC. All in all, the ESG approach should be unique to every company.
Many companies in the Middle East are increasingly considering a ‘triple bottom line’ approach as they expand their ESG commitment. This concept includes social and environmental impacts in addition to financial performance. It can be broken down into ‘profit, people, and the planet’.
While in western countries, ESG is mainly driven by the demands of asset managers, financial institutions and corporate decision-makers, in the Middle East it remains for the moment more driven by regulators. The balance in the region is changing however, as investors and companies themselves embrace sustainability more fully.