Summary Report: Why are ESG Metrics Critical?

Background

A January 2021 media report in the UAE states, â€œEnvironmental, social and governance standards are at the heart of investment strategies of sovereign wealth funds in the UAE as they look to deploy tens of billions of dollars at home, across the broader Middle East and North Africa region and elsewhere in the world.â€[1]

Morningstar Inc is a US-based global financial services firmâ€™s Global Sustainable Fund Flows report, showed that in the first four months of 2020, sustainability-themed funds attracted inflows of US$45.6 billion from investors globally. The report also showed that ESG investments were more resilient during the initial stage of the COVID-19 crisis with more than 70% of sustainability-related funds across all asset classes performed better than their traditional counterparts.[2]

As investors are sending a clear message, they are also pushing for ESG to be a regulation imperative. So far, worldwide governments are nudging and hoping that the private sector will see the value of ESG and report voluntarily.

Examples of ESG-related Regulations being initiated over the last few years[3]:

UAE	2019 2021	Dubai Financial Market issues ESG Reporting Guide for corporates looking to enhance ESG reporting. Securities and Commodities Authority (SCA) requires listed companies to disclose sustainability reporting.
Europe	2020	EU Taxonomy Regulation â€“ enables firms and investors to identify environmentally sustainable activities (facilitates the effective functioning of the Disclosure Regulation).
UK	2017	2017: LSE Guide to ESG reporting published â€“ CoE requirement.
China	2017	China Securities Regulatory Commission (CSRC) requires companies discharging key pollutants to disclose relevant environment information in their annual and interim reports. Shenzhen Stock Exchange & Shanghai Stock Exchange provide voluntary guidelines for ESG reporting.
Japan	2015	Tokyo Stock Exchange issues Corporate Governance Code which requires listed companies to disclose information on ESG matters.
India	2018	Bombay Stock Exchange published Guidance Document containing a comprehensive set of voluntary ESG reporting recommendations.

At a recent event in the Middle East, Future Investment Initiative (FII), CEO Richard Attias noted, â€œAlthough ESG has proven its worth, much remains to be done to ensure we use it to its full potential. The low level of inclusion and participation of emerging markets in the development of ESG frameworks is counterproductive to global sustainability.â€[4]

Henry A. Fernandez, chairman and CEO of MSCI, US, said: â€œWe have to look at ESG not only as a threat but also as a significant opportunity. Many companies in emerging markets will come out as major winners and will attract more capital in developed markets.â€[5]

A recent MSCI survey[6] of 200 leading global investors found the following:

77% intend to increase ESG investments in the future.
31% consider climate change to be the most significant consideration from an ESG perspective.
36% want to increase the social impact element as part of their investment consideration.

The Capital Club Dubai hosted a high-level roundtable moderated by Laudy Lahdo, CEO of C3 (under Chatham House Rule), to discuss some significant questions about why ESG metrics are so critical today.

Question: The driver of value for corporates has shifted from an emphasis on tangible assets to intangible assets. Is ESG a precursor for impact investment and what role does FX play in decision making?

ESG is going to become the norm in a few years. In fact, it will drive value. There is mounting evidence that being a strong ESG-minded company does not come at the expense of performance. A recent HBS research tested the hypothesis that companies with ESG strategies outperform the non-ESG companies. It studied the market sell-off of 3000 companies globally, representing US$59 trillion market capitalisation, between February â€“ March 2020.[7] The results revealed that companies with better ESG characteristics demonstrated less draw down than the other companies. Another interesting finding in 2020 was that on the MSCI index, the ESG version of that index outperformed the standardised version by 1.6%.[8]

Â Question: Are companies incorporating ESG scores into their corporate strategies and investor communications in this region? And how do they strategise for ESG?

Many exchanges are driving disclosures around ESG, and businesses need to understand that it is no longer about just being a good corporate citizen but also about securing investments. The example of one private energy company is worth noting, as it pushed for a coal exit in 2015, even while it was very profitable. Though a difficult decision at the time, today its portfolio has more value when compared with other energy companies.
A decade ago, sustainability related issues was handled by a CSR department, and perceived as good to have non-financial indicators. However, the impact of emissions, especially for the energy sector has now become important, and ESG strategies are required throughout the organisation. In fact, one private energy company has the ambitious goal of reaching zero net emissions by 2045. Its investment committee decided that it will not bid in any coal assets business, and though this was considered by many as an â€˜anti-business/anti-profitâ€™ strategic decision, today others have joined this thinking and only four bidders are in this sector from traditionally 15 competitors.
Communication is vital and companies should publicly state their ESG targets, to be held accountable as well as to motivate internally. It needs to start at the top, with the board of directors, who must mandate to achieve ESG targets as a central priority, not only in the core business, but in every aspect of who you are as a company, embedding it in the services, productsâ€™ supply chain, reporting, compliance, investment products, etc.
In listed companies, the top 10 shareholders in most companies tend to be asset managers or managers of sovereign wealth funds. And the new breed of investors who value ESG are using their voting rights and seat at the annual general meetings to push for a range of issues such as gender and ethnic diversity, executive pay, carbon emissions and environmental topics, etc. Interestingly, some investors who previously excluded companies that did not meet the ESG criteria, now tend to stay invested and engage with the companies to help bring change.

Question: What datasets, metrics and standardised frameworks should be used for ESG reporting?

There is a flurry of data frameworks available that view ESG metrics in different ways, and a lack of standardisation is partly the reason why the ESG agenda has not progressed as fast as it could. The Sustainability Accounting Standards Board (SASB) is a non-profit organization, founded in 2011 by Jean Rogers to develop sustainability accounting standards and this framework is getting a lot of attention now, and many agree that this might become a global gold standard. With the existing complexity and lack of consistency in reporting and methodologies of frameworks used across the world it makes it very difficult for investors to compare and decide.
Creating regional criteria will create more challenges making it impossible to have comparable data points and so the strong recommendation is for all countries to aim for global standards, with the need to distinguish between different industries.
Without standardized reporting, you cannot compare the ESG position between institutions, and therefore cannot distinguish between them or make informed investment decisions based on their ESG performance. Therefore, standardization is key, without standardization there is no comparability, and without comparability, there is no accountability.
A lack of proper ESG data is impacting investment into the region. The mandates of all major investment managers globally require some sort of ESG evaluation before an investment decision can be made. Some companies are very thorough and have a company policy that every investment decision needs to be passed through an ESG board, and others are less extreme, but there is an ESG evaluation process in most major firms these days.

Question: How can we move the needle in the UAE and nudge companies towards ESG strategies and reporting?

This is still a global issue and not just a regional challenge. Both, global reporting standards and regulations are needed to accelerate real change long term. At present, ESG reporting is still voluntary and without proper regulations companies will not think long-term. The EU is leading and this year it will enforce companies to disclose on ESG investment products. The world will follow.
There is a genuine lack of awareness in companies on the benefits of engaging, disclosing, and reporting on ESG strategies. It is only recently that listed companies have realised that investment can be realised from capital markets through ESG scores.
There is awareness of the need for greater FDI in the region and as more companies are listed here, opening to foreign investments, the pressure to align to international standards will increase. The public sector is acutely aware of this, and ESCA regulations are the first steps towards compliance, however, they are not progressing as quickly as they could.
Even in family offices, the investment landscape has changed with the next generation and the conversations and funds are moving towards the ESG space. Social impact is especially important for family offices, including the fintech space which focuses on the underserved in society.

Question: How do we drive ESG in the SME ecosystem?

Smaller companies, who are suppliers of products and services to the larger corporates where ESG strategies are embedded, will need to step up to also meet the standards or could be removed as supplier of choice. It is challenging for a SME to meet the needs of different clients who might each look at the frameworks differently, with unique priorities. It is quite disorienting to manage this, and for them SASB seems tough to implement. It is easier for smaller companies to put one or more of the 17 SDGs in place.

Question: How do we increase the supply and demand of women in leadership in this region?

The International Labour Organisation reports that the participation of women in the workforce in the GCC is 27% (the global average is 49%).[9] However, the more important statistic is that more than 60% of graduates in the GCC are women[10] and here is the significant imbalance â€“ half the graduate women do not make it into the workforce.
Recently, Saudi Arabiaâ€™s leadership has understood the impact of these numbers and have unlocked this core of talent and women are in jobs in all sectors. And this is not just perception or marketing. They are on boards, in senior management, in all professions and across many sectors, and bringing the much needed change at a much faster pace than anywhere else.
A private international energy company, with a presence in the MENA region, has an ambitious target to have 50% female managers by 2030.[11] Considering they are at 7% in the MENA region and 24% globally,[12] this is a big jump, but one they feel is long overdue, especially with more girls graduating with STEM degrees. One way of raising the profile of women is with a HR policy that when considering new recruits, 30% of CVs should be from women.[13] The company also plans to move from 31 gigawatt of renewables today and to 80 gigawatts of renewables by 2030.[14] This will attract younger women who believe in this agenda and vision. They have a strong policy in place, including strong awareness campaigns for both men and women on the gender issue.
Another important support that companies can provide for women is to instil a good womenâ€™s network for their career progression; and help women (when their kids are older) with placements abroad to obtain international exposure.
Finally, it is important from an HR perspective that all aspects of the hiring process are disclosed like gender, ethnicity, executive pay, etc. This data can then be evaluated for gaps and turned into targets, which are made publicly available. Every manager in the organisation has visibility and a plan in place to be aligned to the leadershipâ€™s vision.

Question: What are some recommendations for policy change in the region?

The regulators in this region are very consultative in nature and do engage with companies. The UAE currently has two key priorities â€“ finance and gender, and Saudi Arabia is following the same issues.
The ESCA decision for one woman on the board is a start but is not enough and much more needs to be done regarding gender equity in this region throughout the corporate career path.
To consider using global standards for measuring ESG rather than regional ones.
To bring more ESG regulations in all sectors to drive change.
To continue to lead by example.
For companies to be intentional about strategizing for female talent in the region.
For companies not to be over reliant on existing board networks when replacing board members. The recruitment agencies need to widen their circles for hiring high level people that include women.
Organisations like the 30% Club can be a source for identifying the right female talent for senior management and board positions.
There is supply and demand in the region for recruiting women, and with help from the different organisations and the authorities, we can connect the dots.
Alongside regulations, financial incentives for specific targets would be useful. For example, pilot studies for Hydrogen to replace traditional energy. Similarly, incentives for gender equity and diversity inclusion would be beneficial.
There is a need for a range of tool kits for consistent reporting across the board in all sectors, to provide the right comparisons. Developing these toolkits would be the next step, because without this support many companies will be left out.
There needs to be an awareness of ESG-greenwashing, and the authorities need to have a â€˜watch-dogâ€™ system in place to evaluate, reward or penalise.

Concluding Thoughts

As the ESG dialogue develops further, there is a serious concern about ESG greenwashing. For instance, three of the largest 12 ESG funds with combined assets under management of US$85bn still have exposure to oil & gas groups such as ExxonMobil, Chevon and ConocoPhillips, who are some of the largest producers of carbon gases in the world. Northern Trust World Custom ESG Equity index fund has more than 50 investments in oil and gas groups totalling US$213m, according to Morningstar, more than any other of the large ESG funds analysed in our data set by number of oil & gas investments.[15]

The pandemic has shown up many vulnerabilities in society and the environment, amplifying the need to reinforce ESG values. And the next generation, as producers, consumers, investors, and decision-makers are going to drive the change. A 2019 survey by Morgan Stanleyâ€™s Institute for Sustainable Investing found that 95% of millennials are reinforcing the idea that sustainable investing will be the new normal in the near future.[16]

[1] https://www.thenationalnews.com/business/economy/esg-forms-the-core-of-uae-s-sovereign-funds-investment-strategy-1.1150424

[2] https://www.ft.com/content/8e9f8204-83bf-4217-bc9e-d89396279c5b

[3] Feb 2021 Report by Dubai Sustainable Finance Working Group: Sustainable Investing Guide

[4] https://www.arabnews.com/node/1843741/business-economy

[5] https://www.arabnews.com/node/1843741/business-economy

[6] Global investors accelerate ESG investments in response to pandemic, according to MSCI survey; interconnected risks present challenges

[7] Social-Impact Efforts That Create Real Value (hbr.org)

[8] Performance of ESG equity indices versus traditional equity indices (hkex.com.hk)

[9] wcms_446101.pdf (ilo.org); The gender gap in employment: What’s holding women back? – InfoStories (ilo.org)

[10] Womenâ€™s Education in the GCC â€” The Road Ahead | Middle East Institute (mei.edu)

[11] Finding from the Roundtable discussion at Capital Club Dubai

[12] Ibid.