31 October 2023
ESG investing, which stands for environmental, social, and governance investing, has seen a rapid rise in popularity in recent years driven by investors' desire to align their financial goals with the well-being of society and the environment. This resulted in the cumulative capital raised by ESG-oriented funds between 2019 and 2022 to reach USD 270 billion. However, some concerns have emerged about whether investments in ESG-focused products are delivering the impact that was promised. This unease is reflected in fund flows, as ESG-focused equity funds experienced consecutive net outflows in the second half of 2022 and the first half of 2023. Before this, there had been only one instance of net outflows in a half-yearly period since 2013. Despite the slowdown in ESG investment growth, there is a growing interest in sustainable investing. Sustainable investing is a broader term that encompasses ESG investing, but it also includes other factors, such as impact investing and climate investing. Although there has been a slowdown in worldwide sustainable bond issuance, it is expected that green, social, sustainable, and sustainability-linked bond (GSSSB) issuance will reach between USD 900 billion to USD 1 trillion, accounting for 14% to 16% of the total issuance in 2023 (S&P Capital). Notably, sustainable bond issuance in the Middle East also surged, exceeding USD 15.4 billion in the first half of 2023, with governments prominently backing green bonds. For instance, three issuances from the Saudi Arabian Public Investment Fund (PIF) constituted 36% of the total issuances in the region during the same period. Although ESG and Sustainable investing might sound synonymous, they diverge in several areas.
Differences between ESG Investing and Sustainable Investing
Although the terms were interchangeably used, we are now seeing the emergence of a difference set of investment products that focus on sustainability and not just ESG. Next generation thematic funds are not merely taking ESG ratings into account and focusing more on the economic, social, and environmental value added by the company as criteria for consideration.
Green, social, sustainable, and sustainability-linked bond (GSSSB) issuance breakdown by type
On the Middle East front, there are not many opportunities that exist in the region for retail investors in ESG or sustainable-focused products despite retail investors’ increasing interest in them. For instance, according to the survey by Lombard Odier (a Switzerland-based private bank), 81% of high-net-worth investors (HNI) in the Middle East were looking to integrate ESG criteria into their portfolios. On the contrary, there are only two ESG-focused equity funds in the GCC region, namely HSBC Global Equity Climate Change Fund (in partnership with Saudi Alawwal British Bank) and GIB MENA ESG Equity Fund. Nevertheless, concerns surrounding climate change and the environmental ecosystem have amplified the emphasis on sustainable investment for both retail and institutional investors, as well as sovereign wealth funds (SWFs).
ESG and Green Sukuk Issuances in the GCC Region
Sustainable finance/investing, in the form of green bonds, ESG sukuk, and sustainability-linked loans has substantially increased over the past few years. According to Bloomberg's Capital Markets League Tables, in 2022, the total value of green and sustainable bond and sukuk issuances in the GCC amounted to USD 8.5 billion across 15 transactions, a significant increase from the USD 605 million raised through six deals in 2021. Saudi Arabia's Public Investment Fund (PIF) and the Abu Dhabi National Energy Company (TAQA) were the prominent issuers in 2022. The growth of sustainable finance instruments in GCC is also facilitated by the formulation of sustainable finance frameworks, with a primary emphasis on fostering sustainable investments, bolstering environmentally friendly projects, and promoting the growth of sustainable financial institutions, as per the Gulf Economic Update by the World Bank.
A fundamental critique of ESG-oriented investing revolves around the absence of transparency and uniformity. Typically, these funds rely on unregulated ESG ratings that tend to be highly subjective. For instance, it was discovered that bonds linked to Saudi Aramco, worth over USD 28 billion, indirectly received financing from investors with ESG mandates, owing to intricate financial structures (Bloomberg).
Nevertheless, a considerable number of investors in the Gulf region are anticipated to favour sustainable investing over a sole emphasis on higher returns from their investment vehicles. This inclination is rooted in the fact that sustainable investing closely resembles Sharia-compliant investing. Similar to sustainable investing, Sharia-compliant investing considers social values and upholds good governance principles.
The GCC nations have been transitioning towards cleaner energy through initiatives such as the Saudi Green Initiative and UAE Net Zero 2050. The COP28 (2023 United Nations Climate Change Conference), scheduled to take place in Dubai from 30th November to 12th December, is expected to raise awareness for ESG investing and attract new investors thereby eventually leading to the creation of newer products in the region. Likewise, governments around the world are increasingly supporting sustainable investing through policies and regulations. For instance, the European Union has introduced several regulations to promote sustainable investing, such as the Sustainable Finance Disclosure Regulation (SFDR) and the Taxonomy Regulation. According to S&P, nearly USD 3.5 trillion annually needs to be invested until 2050 to limit global warming. Nevertheless, ESG investing is still a constantly evolving concept that could find favour among investors if concerns about better transparency, and standardization are addressed, and ESG demonstrates that it could deliver an actual impact to society. However, the initiatives towards addressing climate change, the transition towards cleaner energy, and greater emphasis on sustainability in business practices collectively project an optimistic outlook for sustainable investing both globally and in the GCC.
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