The term “ESG ratings” refers to a broad spectrum of rating products in sustainable finance, including ESG scorings and ESG rankings. ESG factors considered in an ESG rating may include: 1) climate or other environmental topics; 2) impacts on society, as well as employees, customers, suppliers and specific community or indigenous groups, and 3) assessment of entity governance structures and systems, both formal and informal.
According to S&P in its ‘Corporate ratings criteria’, when referring to the credit rating process, it states that ‘The rating process benefits from the unique perspective of credibility gained by extensive evaluation of management plans and financial forecasts over many years.’ A similar thing could be said for the benefits of ESG ratings. Though ESG ratings are currently mostly voluntary and deemed ‘non-credit products’ according to PRI, an ESG rating also involves extensive evaluation of management around ESG factors, this evaluation can offer insights to improve any business, especially from a risk & opportunity perspective. PwC highlights several broad benefits of harnessing ESG Ratings:
| Key Benefits of ESG Ratings | How |
|---|---|
| Improved risk management | Reducing the likelihood of adverse impacts on their reputation, finance, and statutory obligations. |
| More stakeholder engagement | Building trust and loyalty by their shareholders and attract investment and customers to whom sustainability is a matter of priority. |
| Better reputation | Positive ESG evaluation can help distinguish the company from its competitors and attract positive media coverage and acknowledgement of sustainability indexes. |
| Improved financial performance | Robust ESG procedures are more able to perform risk management, attract investment, and fulfil the requirements of investors who are increasingly focused on sustainability. |
| Compliance with legal regulations | By adhering to these regulations, companies can avoid legal risks and reputational risks and thus they can prove their sustainability commitment. |
One of the biggest challenges when it comes to ESG ratings, regards the issue of ‘incomplete and inconsistent’ data. A 2023 poll by BNP Paribas of 420 investors, found that 71% viewed ‘inconsistent and incomplete’ data as the biggest barrier to ESG investing. This is underscored by the PRI that states the ‘Definition, transparency, and public availability’ of ESG ratings products, vary between providers, creating confusion among many market participants. These problems are magnified in the MENA region due to the lack of a unified ESG Taxonomy, warns the World Bank.
These challenges create a big issue for the region in tackling climate change and remaining fiscally stable. According to ‘Arabian Gulf Business Insight’, the Middle East may suffer from depressed credit ratings due to ESG factors if it doesn’t ‘reduce its exposure to climate risks, improve public policy on social issues, and strengthen governance standards’. This challenge is underlined by the findings of the 2023 Middle East Report, which highlighted the top three challenges in progressing an ESG strategy as: Lack of internal skills/expertise, lack of funding, and external issues (such as political uncertainty). These factors are clearly linked as without internal skills, companies cannot make ESG progress, while a lack of funding may erode motivation to make progress or invest in ESG at all. This is borne out by Bain & Company’s research that finds ‘The prioritization of sustainability among CEOs has dropped amid challenges’.
The findings of the PWC report are backed up by Vijay Bains, Chief Sustainability Officer and Group Head of ESG, at Emirates NBD, who acknowledges that while the ‘UAE banking sector’s role is very important in the country’s target to meet net zero by 2050’, the lack of a mature ESG landscape is creating conflicts of interest, with banks self-assessing their clients for ESG risk. Accurate, independent measurement of ESG risk, is therefore crucial to support the legitimacy of sustainability-linked loans and bonds, by avoiding conflicts of interest, and to support green finance more broadly in the region. In some jurisdictions such as the UK government now ‘rates the raters’, by issuing new regulations to combat bad practices and conflicts of interest, giving investors further assurance. Unfortunately, these kinds of assurances are not fail safe, nor common, and so it’s up to the investor to do their own due diligence.
As far back as 2011 the Middle East region saw the launch of the ‘Middle East and North Africa (MENA) Environment, Social and Governance (ESG) Index’. In 2024, the demand for the rating of ESG performance to inform ESG-linked capital, is growing exponentially. This can be seen by the popularity of certified ‘Green Sukuk’ bonds, offered by the Climate Bonds Initiative. Sukak Bonds alone are projected to cross $50 billion within the next two years. Overall, the Middle East Issued $16.7 Billion in Sustainable Bonds from January to September 2024. One such example is that of MUFG EMEA and Qatar-based Doha Bank which closed their first green repurchase scheme in the Middle East and North Africa (MENA) region, marking the first green repo scheme for both institutions that utilises green bonds as the underlying collateral.
Though there are real challenges to the mainstreaming of ESG ratings, the continued growth of Sustainable Finance provides a huge opportunity for ESG leaders (and aspiring leaders) to leverage ratings to attract public and private investment. RSM consulting recently affirmed that ‘ESG-focused products are the most important factors driving wealth management growth across the MENA region’. Take the 2021 MSCI ESG rating upgrade for First Abu Dhabi Bank FAB from A to AA. The upgrade was based on FAB’s improved management practices related to mitigating environmental risks in its lending business, spurring further investment. Sarah Pirzada Usmani is Managing Director, Head of Loan Capital Markets & Sustainable Finance for First Abu Dhabi Bank (FAB), and recently noted that ‘Sustainable commitments can greatly improve quality of life in the MENA region and beyond, impacting health, water and food, economies, and livelihoods overall’. This is driven by investors in the region ‘keen to channel financing towards ESG-compliant institutions and in support of green assets’. This can all be enabled by harnessing ESG ratings.
In the Middle East guidance related to ESG disclosure and ratings is primarily led by each country’s stock exchange, with all exchanges in the region also being members of the UN’s Sustainable Stock Exchanges (SSE) Initiative (SEE). Regional progress includes the creation of 29 ESG disclosure standards and metrics by the Gulf Cooperation Council (GCC) Exchanges Committee, chaired by the Saudi Stock Exchange, to unify ESG reporting in the region. The new standards include categories across greenhouse gas (GHG) emissions, energy usage, water usage, gender pay, employee turnover, gender diversity, and data privacy. According to the SEE, these standards also align with the two most popular ESG reporting frameworks in the region: GRI and SASB.
While the UAE is yet to develop a mature ESG ratings ecosystem, ESG risk is an active focus for the UAE government, and the region generally, particularly post COP28. As a Partner Exchange member of the Sustainable Stock Exchanges (SSE) initiative, the Dubai Financial Market (DFM) developed its own ESG stock index in 2020, to align with the UAE Sustainability Strategic Plan 2025, which aims for the UAE to be a leading sustainable financial market by 2025. This work included DFM’s development of 32 ESG disclosure metrics and indicators, for listed companies, the Abu Dhabi Global Market’s (“ADGM”) new ESG disclosures Framework, and The Dubai Sustainable Finance Working Group’s Self-Assessment Tool. This tool can help companies get started on measuring, managing, and mitigating ESG risk, aiding disclosures in alignment with the United Nations’ Sustainable Development Goals (SDGs) and the standards of the Global Reporting Initiative. Furthermore, the UAE’s Sustainable Finance Working Group has also created its excellent ‘Principles for the effective management of climate-related financial risks, which should help improve climate-related disclosures, positively impacting overall ESG ratings.
A recent benchmark study by Instinctif Partners, found that ESG performance for publicly listed companies in the MENA region is behind those of other regions. Despite this, Diana Estupinan, Chief Client Officer and ESG Advisor at Instinctif Partners states that ‘Qualitative feedback from investors showcased in our analysis indicates a paradigm shift in the importance of ESG.’ The study also states that the UAE is leading the way in the MENA region when it comes to this, with an average investor score of 39.5%. While ESG continues to grow in importance as a catalyst for investment decisions by institutional investors, Diana Estupinan rightly advises that ‘MENA issuers have a valuable window to adapt robust frameworks. By understanding where the ESG performance gaps are and addressing them, ESG leaders can harness ratings for accelerated success.
