When it comes to Environmental, Social and Governance (ESG), MENA stock exchanges are becoming key promoters, says Deloitte Middle East’s Franck Van Dellen Ramon.
Our world faces several global challenges: COVID-19, climate change, transitioning from a linear economy (use and throw) to a circular one (where material consumption cycles are closed to promote the reduction of waste, and the reutilisation and recycling of materials), increasing inequality, balancing economic needs with societal needs etc.
In this context, regulators, investors, consumers, and citizens are increasingly demanding companies to not only be good stewards of capital but also of natural and social capital and to have the necessary governance mechanisms in place to support this goal.
Environmental, Social and Governance (ESG) refer to the three central areas for any organisation to evaluate its impact and contribution to ‘Sustainable Development’, which is defined as the “development that meets the needs of the present without compromising the ability of future generations to meet their own needs”.
ESG journey often starts with annual report
ESG might seem to be a new topic in the international agenda, but the concept of sustainable development is certainly not, as it was already defined in the United Nations’ 1987 Brundtland Report.
Therefore, ESG is the framework that should help organisations drive and materialise long- term business strategies that are both financially sustainable and able to deliver positive impacts to their stakeholders.
Many organisations, however, have started their journey into the integration of ESG only from a reporting perspective, including both non-financial qualitative and quantitative data in their annual reports or constructing standalone documents to provide data on their performance around specific ESG topics.
Embedding sustainability in strategy
This approach is generally perceived as a compliance mechanism driven by the need to respond to ESG reporting requirements issued by particular stakeholders (e.g. regulators and/ or investors).
In those markets where ESG integration is more mature, reporting is conceived as a mechanism to reflect the outcomes of an organisation that has embedded sustainability considerations in its business strategy and the way it operates and delivers quantifiable positive social and environmental impacts on its stakeholders.
This approach is followed by organisations that have defined clear ESG ambitions and commitments linked to their business strategies.
ESG – a panopoly of E, S and G topics
ESG is perceived as an element to ensure long-term financial sustainability and respond to the needs and expectations of all their stakeholders (including groups such as employees, local communities or society in general).
Each of the components of ESG encompasses a diverse panoply of specific topics where organisations need to focus their ambitions and efforts, as a way to ensure the successful fulfilment of their ESG strategies as well as to respond to the needs and expectations expressed by their stakeholders, while maximising their contribution to the local, national and global sustainable development agendas.
- Environmental topics include those elements contributing to the positive and negative impacts on the environment associated with any organisation’s operations (e.g. greenhouse gas protocol (GHG) emissions, climate change, water and/ or waste management, and biodiversity conservation, among others).
- Social topics refer to how an organisation manages its employee’s development and labour practices, and its contribution to improving the life quality of the local community where it operates (including topics such as talent development and upskilling, employee well-being, talent retention, health and safety, or support to local communities).
- Last but not least, governance topics include all those priorities that any organisation should oversee, manage, and monitor to appropriately ensure good working and functioning, as well as the long-term financial stability of its businesses (including topics such as bribery, anti-corruption, ethics leadership or risk management).
Historically, ESG topics chosen for viability
Organisations use the concept of ‘materiality’ to select those priorities on which to focus both their business strategies and disclosures. The concept of materiality has evolved throughout time.
Historically, organisations identified material ESG topics as those environmental, social, and governance topics which had the greatest potential to affect their operations and financial viability.
The identification of these topics involved different processes and analyses, including benchmark reviews against peers, assessment of market trends, as well as engagement with key internal and external stakeholders for the organisation.
A new approach to ESG performance
Recently, this approach is evolving from an exclusive inward perspective, focused on identifying ESG risks that can affect the organisation’s operations, to including the assessment of potential opportunities associated with better ESG performance, as well as an outward review of how the organisation’s value influences its key stakeholders.
Under this new approach (‘double materiality’1), identifying ‘material topics’ requires an organisation to also understand the impact of its operations (and that of its whole value chain) on the preservation of the environment and the development of social wellbeing on its key stakeholders.
The application of this new approach requires organisations to integrate additional assessment tools to value the (positive or negative) environmental and social impact delivered by its operations on key stakeholders, as well as greater efforts to capture the impact throughout its whole business value chain (including up to tier 3 suppliers and impacts both upstream and downstream).
ESG being integrated into performance assessment
There is no doubt that ESG is getting traction at a global level. Many countries have signed up to different international agreements and commitments to support the development of different components under the umbrella of ESG (such as the Paris Agreement, the United Nations Sustainability Development Goals and/ or the United Nations Global Compact).
Stakeholders are increasingly integrating ESG criteria as part of their assessment of any organisation’s performance.
Therefore, they increasingly expect organisations to drive the sustainability agenda forward, as significant users of natural resources, employers of scale and the source of much technological innovation and therefore, with the potential of delivering a significant impact on each of the components of the ESG agenda.
Organisations urged to demonstrate ESG commitment
If organisations do not recognise the importance of their role in supporting sustainable development, the stakeholder might act. In more ESG-mature markets, stakeholders increasingly make their demands known and the weight of their decisions has more influence.
Therefore organisations are urged to demonstrate commitment, prove performance, increase communication, and increase transparency around ESG.
According to the results of the Deloitte CXO Sustainability Report, compiled from more than 2,000 C-suite executives across 21 countries, 97 percent of companies had already felt negative impacts from climate change and eight out of 10 CXOs2 had been personally impacted by climate events in 2021 and were feeling the pressure to act from their stakeholders.
MENA countries, decarbonisation and net zero targets
In this context, it is important to highlight that ESG has proven to drive positive impacts in those organisations integrating considerations in the way they operate, such as:
- Increased attractiveness to investors, as institutional investors are increasingly screening companies based upon ESG performance data and excluding those with low performance (therefore, there is clearly a positive impact for those companies who score higher and may be included in the sustainability indices and ESG rating agencies3 (such as CDP, Dow Jones Sustainability, or MSCI ESG Index, among others)).
- Return on ESG performing investments, as sustainable assets have proven to be profitable products while providing an additional capacity to manage and mitigate non-financial risks likely to have a financial impact.4
- Lower cost of capital and less volatile earnings than those with low or zero ESG scores5.
- Allowing companies to respond to current and future non-financial disclosure requirements.
- Increased ability to attract and retain the best talent, boost employee motivation, as well as promoting brand recognition and brand loyalty.
The MENA region is also taking part in this journey into sustainability. Many countries in the region have integrated different commitments toward the integration of sustainable development in their economies6.
Furthermore, some of them (the UAE, Saudi Arabia and Bahrain) have recently committed to decarbonisation and Net Zero targets, which provides further evidence of the importance of this topic in the future economic development of these countries.
Demand for ESG integration in Middle East
This change in the paradigm is also translating into a greater demand from companies for advice and support to integrate ESG/ sustainability considerations in their business strategies and the way they operate.
In this context, Deloitte Middle East has perceived a transition in the role of ESG in the market, migrating from an initial more philanthropic-focused approach (linked to the concept of Corporate Social Responsibility or CSR) to a proper integration of decision-making elements, policies and procedures, governance, metrics and actions.
The integration of ESG/ sustainability considerations in the regional market is being additionally backed up by an increasing demand from regulators for companies to be more transparent regarding their ESG performance.
MENA stock exchanges key promoters of ESG
Particularly, stock exchanges have become key promoters of ESG reporting in the region, including:
- Most countries in the region, such as the UAE (Dubai Financial Market and Abu Dhabi Stock Exchange or ADX), Qatar (Qatar Stock Exchange), Saudi Arabia (Tadawul), Bahrain (Bahrain Boursa), Kuwait (Boursa Kuwait), Jordan (Amman Stock Exchange), and Egypt (Financial Regulatory Authority), have issued voluntary reporting guidelines to help listed companies construct their specific disclosures.
- Furthermore, the UAE, Jordan and Egypt have issued mandatory sustainability reporting requirements for listed companies to disclose, either in a standalone report (UAE) or as part of their annual reports (Egypt), specific non-financial information that needs to be constructed in accordance with certain internationally acknowledged standards (particularly Global Reporting Initiative or GRI and the Task Force on Climate-Related Financial Disclosures or TCFD).
As a result, many companies in the MENA region are already mandated to communicate their ESG performance and progress while many others are expected to start reporting, which will serve as a catalyser for many organisations to initiate internal discussions about the role of ESG in their operations and its current performance, as well as to be aligned with the current and future market trends and practices in terms of reporting.
In this context, 2022 is turning out to be an exciting year for the development of sustainability reporting.
ESG is not just a regulator mandate
Many jurisdictions (such as Europe and the US) are already moving toward mandatory sustainability-related disclosures7, and great effort is being put to create a series of sustainability reporting standards to serve as a baseline of consistent and comparable information for capital markets8 to support companies to fulfil these requirements.
Furthermore, large institutional investors are putting a clear emphasis on the importance of sustainability disclosures, and many other users, from regulators to rating agencies, shareholders, suppliers, and consumers to civil society are all looking at companies’ published data and expecting the same level of information as the one provided in the financial numbers9.
However, ESG reporting should not be considered just a mandate from the regulator, a way to please investors/ shareholders, or merely a compliance duty to be fulfilled by any organisation.
ESG reporting reflections ambition and actions
Along with listed companies, many private companies in the MENA region are also starting to construct their ESG disclosures as a way to be ahead of the curve and prepare for potential regulation coming in the future, as well as to benefit from the opportunities associated with those companies considered as ESG performers.
As mentioned in the beginning, ESG reporting reflects the ambition, commitments and actions performed by any organisation contributing to the local, national, and global sustainable development agenda.
Furthermore, ESG is a means to ensure the long-term financial stability of an organisation and should be linked to an appropriate strategy, roadmap, governance structure and specific initiatives in place.
Companies cannot become ESG front-runners overnight
If done otherwise, companies might face significant risks associated to greenwashing10 and green hushing11. Therefore, companies should proactively adopt an ESG strategy that is aligned to their business mandate and philosophy but is also capable of demonstrating real performance and commitment to their stakeholders.
ESG is a journey: companies are not expected to become front-runners overnight but to show real and ongoing commitment throughout time; demonstrate alignment to their material ESG topics raised from within the business and their corresponding stakeholders, and report performance, measured through SMART (Specific, Measurable, Achievable, Realistic and Timely) targets, while ensuring regular communication based on trustworthy and reliable information.
Franck Van Dellen Ramon is a senior manager in the Deloitte Middle East Sustainability Reporting & Assurance team and provides both advisory and assurance services in the areas of sustainability, and climate change for public and private clients. He is a speaker for Aurora50’s Pathway20 accelerator, for women board directors seeking their first independent board role.
1 In 2019, the European Commission formally described for the first time the concept of ‘double materiality’ within the framework of the European Union’s Sustainable Finance Disclosure Regulation (SFDR). As per this approach, when identifying material topics, an organisation needs to consider not only the risks to its operations but its adverse impacts on both the planet and society.
2 CXO is a term to refer to any corporate executive including the terms Chief and Officer in their job title (includes all C-suite type of individuals).
3 Sustainability indices are instruments used to evaluate the performance of an organisation in specific environmental, social, and governance areas. ESG rating agencies are organisations that rate an organisation’s ESG performance based on their ESG policies, systems, and measures, gathering information from multiple sources.
4 “In the first half of 2020 alone, the assets under Principles for Responsible Investment (PRI) signatories grew 20% to more than US$100 trillion”; “The COVID-19 pandemic has focused investors on the vulnerability and resilience of the financial system and intensified the discussions around sustainability”. CFA Institute. Future of Sustainability in Investment Management: from ideas to reality. 2020. Source: https://www.cfainstitute.org/- /media/documents/survey/future-of-sustainability.ashx
5 Comparing Risk and Performance for Absolute and Relative ESG Scores. MSCI. 2020. Source: https://www.msci.com/documents/10199/a645d4ff-b83e-426a-4636-e6fb81bbc599
6 The UAE, Saudi Arabia, Bahrain, Qatar, Oman, Jordan, and Egypt have signed – the Paris Agreement on Climate Change, and the United Nations Sustainable Development Goals – SDGs.
7 Europe is developing its proposal for a Corporate Sustainability Reporting Directive (CSRD), a new EU reporting standard by 2023, while in the US, the SEC has issued proposals for registrants to disclose climate-related disclosures and metrics.
8 The International Sustainability Standards Board (ISSB) is currently developing the IFRS Sustainability Disclosure Standards to be adopted by regulators, stock exchanges, and companies globally, while the European Financial Reporting Advisory Group (EFRAG) is also working on sustainability reporting standards to help companies in the fulfilment of the CSRD.
9 More information around the current global move to ESG reporting can be consulted in the following Deloitte publication: Forging ahead | Deloitte Middle East | ME PoV issue 37.
10 “Greenwashing” is an umbrella term that includes different definitions such as “behaviour or activities that make people believe that a company is doing more to protect the environment than it really is’ (Cambridge Dictionary. Source: https://dictionary.cambridge.org/es/diccionario/ingles/greenwashing) or “activity (for example by corporate lobby groups) of giving a positive public image to practices that are environmentally unsound” (Oxford Dictionary. Source: https://www.oxfordreference.com/view/10.1093/oi/authority.20110803095906807).
11 “Green hushing” is a term that refers to “when businesses silence their sustainability efforts due to a fear of backlash, or because they know they’re not perfect in certain areas”. “Greenwashing vs Green Hushing”. 2021. Melda Simon. Founder of Little Fires consultancy and UK Lead for the Unstereotype Alliance, UN Women (https://www.linkedin.com/pulse/greenwashing-versus-green-hushing-melda-simon-she-her-hers-/).