Geospatial ESG investing
In a week when the UK’s opposition leader Keir Starmer accused PM Boris Johnson of lacking an energy strategy and of “going cap in hand from dictator to dictator” – a charge also levelled at the Biden administration over its entreaties to Iran and Venezuela – the ESG credentials of Western supply chains – from fossil fuels to fertilizer – are under the microscope as never before.
Cynics will argue – and not without justification – that these efforts by the UK and the US prove that ESG is less of a concern in the world of international politics when oil prices are above USD100/b. And that Johnson and Biden were much more inclined to call out the Saudi regime for human rights abuses when oil prices were below USD50/b.
But for potential investors, operating in autocracies – whether Russia, Saudi Arabia or China – comes with a premium – and that price is now increasing, observes our Human Rights Analyst, Sofia Nazalya.
This was the case even prior to the Russia-Ukraine crisis. Underpinned by mandatory ESG reporting and human rights due diligence, the cost of doing business in EMs (and DMs alike) is set to intensify, whether that stems from reputational, legal, operational or geopolitical factors.
According to David Wille, our Principal Markets Analyst, the unprecedented scale and speed of investor and corporate divestment from Russia underscores the need for EM asset managers to urgently reappraise their approaches to ESG integration.
In the last two years, an outburst of civil unrest and a spiraling humanitarian crisis in Myanmar prompted a similar mass exit of energy majors, and significant disruptions to the global garment supply chain. And in China, US legislation targeting the use of Uyghur forced labour, alongside international condemnation of human rights violations, threaten to drive businesses from Xinjiang.
Taking stock of the exposure to poorly-performing countries across all areas of ESG should now be paramount, not only to protect longer-term portfolio value as macro headwinds on the asset class increase, but also to align with the expectations of clients and regulators, Wille emphasises.
The Ukraine conflict does not fundamentally rewrite the business playbook, but it does strengthen the argument for adopting a more holistic ESG lens. Plenty of countries with weak democratic governance attract billions of dollars of international investment, but companies will increasingly require a wider understanding of risk.
International investment in autocratic countries – of which there are many – inevitably will be more closely scrutinised. Among other factors, identifying red flags relating to human rights and governance risks - and doing this sooner rather than later - will be key to mitigating loss, Nazalya observes.
Certainly, Saudi Arabia’s ESG profile will only become a bigger concern over the coming years. The execution of 81 Saudi and foreign nationals on 12 March has focused renewed attention on the country’s performance.
Almost six years into Vision 2030 there is little evidence that Saudi Arabia is paying more than lip service to ESG principles, comments our MENA Principal Torbjorn Soltvedt. Our new Sovereign ESG Ratings model shows that the gap between ambition and reality is still wide.
Although the kingdom’s headline performance has improved incrementally over the last five years, led by a policy focus on the E, drilling down into the three pillars reveals that an improved governance performance has come at the cost of stronger repression, as well as a much more centralised hold on power by MBL; while the Kingdom’s much-vaunted new social freedoms (including for women) have been countered by a lower tolerance of dissent.
As such, Saudi’s overall Sovereign ESG rating remains low at just ‘2’ in 2022-Q1 (on a 15-notch scale of 1- to 5+). Not only is this in the bottom 20%-40% of our sovereign universe of 198 countries, and below the MENA average; this headline rating also comes with close to 20 red flags attached, referencing 17 extreme risk index scores across the E, S and G pillars.
Overall, the kingdom has not kept pace with the growing focus on ESG criteria in global equity and bond markets, and among foreign companies considering direct investments in Saudi Arabia.
As a result, foreign companies and investors have been slow to buy into Crown Prince Mohammad bin Salman’s Vision 2030 programme. Foreign direct investment (FDI) is likely to have fallen below 1% of GDP in 2021, far short of the 5.7% target set in 2017. If MBS is to get anywhere near his USD100 billion annual FDI target by 2030, the pace of ESG reform will have to pick up.
Without international investors, there can be no Vision 2030. For MBS, increased foreign investment is not just an economic goal; it is also intended to be a vehicle for change. Without faster change on the ESG front, MBS risks being caught in a ‘Catch-22’. While he needs foreign investment to make Vision 2030 work, investors want to see evidence of greater change before committing.