Adding ESG to the bottom line

ESG or Environmental, Social, and Corporate Governance has established itself with remarkable speed as one of the “hot topics” of our time. What many dismissed as a fringe phenomenon just years ago has now successfully become part of mainstream financial discourse.

Evidence continues to mount that observing the “triple bottom line” can serve as a competitive advantage at multiple levels. Indeed, the myopic focus on quarterly financial results was seen by many market participants as a contributing factor to the 2007-2008 global financial crisis.

While some criticize ESG as “greenwashing” and question its actual impact in delivering concrete changes in corporate behavior, the overall framework of the debate has clearly shifted.

ESG practices have landed most recently in the Gulf, along with the area’s rapidly growing policy focus on sustainability. In some ways this is nothing new. For instance, the rise of Islamic banking represented an attempt to place financial service provisions on a much more principles-based footing.

But the shift to ESG today is much broader, involving government-related entities, large businesses and financial institutions.

The list of new projects and initiatives is now growing longer by the week. In combination with ambitious government-endorsed green energy investment pipelines, Acwa Power and Masdar have leveraged partnerships to expand capacity in renewable generation.

Several green hydrogen initiatives are underway. Leading regional banks have established sustainable finance frameworks in Saudi Arabia, with Riyad Bank recently issuing its first green sukuk.

But much effort is still needed to popularize these initiatives across the corporate sector and among the broader public. While ESG is now on many people’s lips, it is new and often misunderstood.

Opinions differ as to the motivations behind the change. Some see it as a chance to jump on the bandwagon of global public opinion, whether out of perceived necessity or expediency. Others still equate it with corporate social responsibility — a nice thing to do, but ultimately a luxury.

One should not underestimate the transformative potential of ESG in the Gulf. It promises not only to drive more inclusive investment but also to accelerate the necessary process of economic diversification. Channeling capital into new activities will activate additional economic growth drivers through relatively untapped opportunities.

The structural need for improving capital allocation through new products, intermediaries and greater inclusion has been recognized for a long time, and will only grow in importance as governments retreat from some of their traditional activities.

Projects anchored in ESG can also draw capital to the Gulf as more global investors operate with ESG mandates. Conversely, investors would abandon projects they see as noncompliant.

Enhancing corporate governance is a chance to create better, more professionally run businesses.

Many sectors can expect to reap particular benefits from ESG. It can help future-proof the energy sector in the face of changing opinions about hydrocarbons. Initiatives such as the circular carbon economy are a case in point and already giving rise to multiple projects.

The ample spaces available for renewable energy on an exceptionally sunny peninsula can help harness renewable energy for emissions reduction and electricity exports. It can also help power new industries that can serve a global market, such as green hydrogen, given the challenges of de-carbonizing many economic activities.

The Gulf can be a global leader in this area and use it to develop local R&D capacity and innovation. A changing energy sector can drive diversification and innovation within manufacturing as well, thereby contributing to the growth and diversification of regional exports.

ESG also promises transformative potential in the area of infrastructure development and real estate, which have both been key investment themes for decades.

Aldar Properties recently announced a plan for an AED1.8 billion ($490 million) sustainable city. Resilient, smart and energy efficient buildings can not only contribute to more livable communities but also boost the value and competitive standing of these assets. The potential for innovation is obvious, as solutions developed for the extreme climatic conditions of the Gulf can also gain popularity elsewhere in a warming world.

Inclusive development remains an important strategic consideration. Entrepreneurship and SME development in the Gulf continues to suffer from acute capital constraints, even if some encouraging signs are emerging. Ultimately, this is a chance to create a more diverse and resilient economy that is capable of offering economic opportunities to more people.

ESG provides a compelling framework for the Gulf region to accelerate the process of change toward diversification, productivity, sustainability and inclusion. It promises exceptional opportunities for entrepreneurship but also for broadening the Gulf region’s competitive standing through new areas of excellence and expanding innovative capacity.

With its long-term perspective, it is a logical complement to the transformative economic visions of the regional economies.

• Jarmo Kotilaine is an economist and strategist focusing on the Gulf region. He writes on issues ranging from economic development to changes within the corporate sector.