Climate change as a central pillar of ESG
Today’s ethical consumers are extremely worried about climate change, especially after the deadly COVID-19 pandemic triggered an international energy crisis and caused an overall energy price cap. As a consequence of the current climate crisis, these consumers are reluctant to invest in companies associated with fossil fuels. Consequently, some progressive firms have decided to sell “environment friendly” products and focus on environmental, social, and corporate governance (ESG). Yet, it is clear that embracing ESG is about more than just including a note on the price tag saying the product is “100% sustainable.” It is important to identify what ESG actually is and to explore whether it is enough to combat the problem of corporate “greenwashing,” when companies exaggerate their green credentials for marketing purposes.
The term ESG was first used in a 2004 U.N. report entitled “Who Cares Wins: Connecting Financial Markets to a Changing World,” which 18 financial institutions (with a total of over $6 trillion in assets under management) from nine countries were invited by then U.N. Secretary-General Kofi Annan to participate in developing. According to the report, the main target of ESG is “to develop guidelines and recommendations on how to better integrate environmental, social and corporate governance issues in asset management, securities brokerage services and associated research functions.”
Accordingly, E stands for “Environment” priorities by highlighting issues of:
- Climate change and carbon emissions
- Air and water pollution
- Energy efficiency
- Waste management
- Water scarcity
S stands for “Social” consideration of people and relationships by highlighting issues of:
- Customer satisfaction
- Data protection and privacy
- Gender and diversity
- Employee engagement
- Community relations
- Human rights
- Labor standards
G stands for “Governance” standards for operating an organization by highlighting issues of:
- Board composition
- Audit committee structure
- Bribery and corruption
- Executive compensation
- Political contributions
- Whistleblower schemes
By enabling ESG to be aligned with the objectives of the Kyoto Protocol and the Paris Agreement, climate change has become its main catalyst. Relatedly, Christine Lagarde, the head of the European Central Bank (ECB), remarked, in a statement published by the ECB, “Within our mandate, we are taking further concrete steps to incorporate climate change into our monetary policy operations. And, as part of our evolving climate agenda, there will be more steps to align our activities with the goals of the Paris Agreement.”
How to tackle climate change through ESG management
In a 2013 Harvard Business Review article entitled “Accountants Will Save the World,” the CEO of the World Business Council for Sustainable Development, Peter Bakker, highlighted that by changing accounting rules, businesses can become engaged in solving “wicked” problems, such as water or energy price caps. Undoubtedly, this can be an effective approach to tackle climate change.
To cope with climate change, companies and investors should look to improve the availability and reliability of climate-related financial information to inform decision-making. Yet, it is difficult to achieve high performance on all three dimensions of ESG. Taking Tesla as an example, despite having made significant progress on climate action because of its electric vehicles (EVs), the company’s record on human rights and labor issues is not commendable. Recently, California’s Department of Fair Employment and Housing filed a lawsuit against Tesla for racial discrimination and harassment. As a result, the firm was removed from the S&P 500 ESG Index last year, raising questions about how an oil company like ExxonMobil has a better ESG record than a EV producer like Tesla. However, this perceived disparity is due to the ratings categories used. Sustainability institutes that rate companies’ ESG records do so by dividing them up into categories by type of business. As such, fossil fuel companies are rated in a different category from EV firms.
As governmental climate action laws, especially on climate neutrality by 2050, push companies and institutions towards incorporating ESG regulations, investors concerned about companies’ ESG records have poured billions of dollars into funds using the necessary criteria. For example, to attract green investments on ESG, the U.S. passed the Inflation Reduction Act, which provides $369 billion in subsidies for clean energy projects.
Global transition to renewables and ESG
In this era of global energy crisis, ESG investments through green bonds are shaping the energy transition. According to BloombergNEF’s “Energy Transition Investment Trends” report, 2021 witnessed total investment in the energy transition of $755 billion, up 27% from 2020. This marks a new record for global investment that is linked to rising climate ambition and policy action from countries around the world. To provide an example of how green bonds might help to support an energy transition project in accordance with the objectives of the Paris Agreement, solar and carbon capture project owners could apply for green loans for the purpose of promoting clean energy and reducing emissions. For example, French bank Société Générale, a long-time investor in energy projects, has set a target to invest $120 billion by 2023 in energy transition projects using a range of sustainable finance solutions, such as loans, bonds, and advisory.
The Middle East’s ESG agenda
The Middle East is particularly vulnerable to the effects of climate change as a result of its scarce water resources, high levels of aridity, and long coastlines threatened by rising sea levels. With an average annual per capita water availability of 977 cubic meters, the Middle East is the most fresh-water-scarce region in the world, and the available resources are expected to decrease even further, to 460 cubic meters per capita, by 2030. Therefore, sustainable investment is crucial and can be achieved through effective ESG policies.
When compared with Europe, where 50% of total assets have been invested by global leaders according to ESG principles, the Middle East is seen to be at an early stage of ESG adoption. Having the 2022 and 2023 U.N. Climate Change Conferences take place in the Middle East and North Africa provided some initial movement towards mainstreaming climate finance regulations in the region, where there is a lack of universal measures and standards for responsible ESG investing. The countries of the Gulf Cooperation Council (GCC) have emphasized a greater focus on improving the living standards and national well-being of their citizens. This is evident in how sustainability as a core principle is embedded in all of their national visions aligned with the U.N. Sustainable Development Goals (SDGs) — for example, Saudi Vision 2030, Oman Vision 2040, and Bahrain Economic Vision 2030. Based on these factors and according to a survey of CEOs across the Middle East conducted by consulting firm PwC, in 2023 46% of regional respondents said that they aim to increase their investments in ESG and sustainability initiatives over the next three years as part of their post-pandemic transformation planning.
Why do we need ESG in the Middle East?
As a major center for fossil-based energy production, the Middle East is key to global ESG developments. Even though the region’s reliance on oil poses a challenge on the path to reaching net zero by 2050, there are also huge opportunities to expand the use of solar energy. Most of the Middle East is located in the heart of the global sunbelt, and the GCC countries in particular have some of the highest sunlight exposures in the world. According to PwC, solar power plants in the region can expect 1,750 to 1,930 hours of full-load operation per year. As a result of high solar exposure, a solar-photovoltaic panel in the region can produce twice as much as it would in Germany or any climatically similar European country. With an eye to expanding solar production, in 2021, the Energy Transition Accelerator Financing (ETAF) Platform secured $400 million in anchor funding from Abu Dhabi Fund for Development to serve as a strategic partner for local solar companies.
To help build a green economy in the region, the financial system must be reoriented to meet the huge financing demands required to achieve the SDGs; the Arab world alone will need an additional $230 billion per year. This investment gap underscores the importance of changing the architecture of the financial system to mobilize both public and private sector finance towards sustainable investments. The growth in poverty caused by the COVID-19 pandemic and the accelerating impacts of climate change make the urgency of this change all too clear.
One of the most important issues vis-à-vis ESG is the environmental fiscal reforms needed to promote green investments in the Middle East. No country in the region offers sustainability incentives (e.g., tax credits, subsidies, or other business incentives) to encourage taxpayers to engage in behaviors and develop technologies that can positively impact the environment. For example, charging higher taxes for oil and gas companies and lower taxes for green companies, like solar energy firms, can be implemented by law.
Relatedly, the head of trade and working capital for the Middle East at Barclays, Sereen Ahmed, has stated that they’ve “recently started to see a real conscious effort and shift in focus towards ESG and sustainability in the region, and much of that is being led by the UAE.” An example of this effort is Saudi Arabia’s NEOM project, currently the biggest green investment in the region; as part of the project, the kingdom is building a $5 billion plant called Helios to produce green fuel for export while reducing the region’s dependence on petrodollars. This kind of investment can be a model for future ESG investments in the region that support net-zero targets more broadly.
ESG integration through net-zero 2050 targets
Through the ESG framework, we can look towards sustainably and ethically providing food, health, education, transport, and communication services for the world’s 8 billion people. Today, ESG is no longer just an elective option for greening economies by shifting away from oil-based dependency through net-zero 2050 targets. Its integration should take place at all levels given the abundance of data and ESG scoring mechanisms available.
Every sector, regardless of scale, should prioritize specific segments for responsible investing. While oil remains essential for many, sustainable energy should not be deprioritized. Rather, the solution is to pursue a gradual transition: a measured but steady shift through sustainable investments in renewable energy sources. Responsible investors are enabling this transition across major industries, thus presenting attractive growth opportunities. If they are applied globally and in an effective way, ESG regulations and tax subsidies can be a critical means of reaching that goal.
Dr. Elif Selin Calik is the author of “The Renaissance of Smart Energy" and the CEO of Women in Smart Energy UK (WSE-UK). She provides ESG consultancy services to SMEs, banks, and other institutions specializing in energy politics, renewable energy, and climate change resilience. Dr. Calik has been a U.N. Climate Change Observer since 2015.
Photo by Christopher Pike/Bloomberg via Getty Images
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