Environmental, Social and Corporate Governance

32 min read

In a world of financial and environmental challenges, financial sustainability is essential in addressing the challenges of both the financial and environmental realms. It goes beyond short-term profit and incorporates social and environmental responsibilities into business practices.

The aim is to build a financial model

to build a strong and sustainable financial base for an individual or institution, which helps it adapt to financial challenges and achieve sustainable growth in the long term.

Striking a balance between financial needs and social well-being. This includes adopting sustainable practices such as renewable energy, waste management, and socially responsible engagement with the community.

Financial sustainability

Refers to the ability to maintain financial stability and planning in the medium to long term. It is related to managing financial resources in a way that ensures continuity of activity and the ability to achieve financial goals in the long term.

Achieving financial sustainability involves several important factors, including:

Good financial planning:

It includes setting financial goals and developing an effective financial strategy to achieve them.
This includes managing debt and investments appropriately and balancing income and expenses.

Financial diversification:

related to the distribution of financial resources among a variety of financial sources and assets.
This reduces potential financial risks and enhances financial stability.

Providing liquidity:

It relates to the ability to provide the financial liquidity necessary to meet current and future financial obligations.
Cash flows must be well organized and a portion of them allocated to financial reserves.

Maintaining a balance between return and risk:

An appropriate balance must be achieved between achieving returns on investments and reducing financial risks.
Potential investments should be carefully evaluated and informed financial decisions made.

Commitment to sustainable financial practices:

This relates to conducting business in a way that achieves a balance between economic, social and environmental dimensions.
Financial decisions must be environmentally and socially sustainable and take into account future impacts.

Fiscal Sustainability in Saudi Arabia

The Fiscal Sustainability Program was launched under the Vision 2030 plan in 2016 under the name “Achieving Fiscal Balance.” The program aims to build a balanced and strong financial system capable of adapting to all variables. The program works to implement key financial reforms to ensure long-term economic sustainability in the Kingdom and achieve public financial discipline.

The program has succeeded in achieving positive results, as the deficit in GDP was reduced from 15.8% in 2015 to 2.3% in 2021. This achievement contributed to strengthening the Kingdom’s financial position and enhancing its financial stability.

By achieving fiscal balance and implementing key financial reforms, the program seeks to enhance the Kingdom’s economic sustainability and maximize its ability to meet future financial challenges. The program works to promote sustainable economic growth, improve financial resource management, and enhance transparency and accountability in the financial system.

In short, the Fiscal Sustainability Program is an important part of Vision 2030, as it aims to achieve financial balance, enhance economic sustainability, and achieve financial stability for the Kingdom.

One of the ministries implementing financial sustainability is the Ministry of Human Resources and Social Development, where it has achieved In the fourth quarter of 2020

two initiatives from the Fiscal Balance Program were completed:

Citizen Account Initiative (transfers to beneficiaries).
And the financial compensation initiative for expatriates.

Chairman of the Program

His Excellency Mr Mohammed bin Abdullah Al-Jadaan

Minister of Finance and Member of the Council of Economic and Development Affairs:

“The Financial Sustainability Program achieves structural reforms in policies that support the development of public finances to reach a prosperous financial system that accelerates the growth of the national economy and keeps pace with modern changes.”

Responsible Investment

It is not uncommon in the world of finance to see a new trend in which the motives of making money and doing good are increasingly intertwined. This positive trend may explain the increase over the past decade in socially and environmentally responsible investing (also known as “environmental, social and corporate governance” (ESG) investing) – which aims to direct funds towards opportunities that have environmental, social or ethical dimensions that can be Verified and documented by an independent third party.

Responsible investing is a concept that refers to the practice of investing in a way that takes into account the social and environmental consequences of investment decisions. Responsible investing aims to achieve a balance between financial returns and a positive impact on society and the environment. And analyze investments based on environmental, social and governance (ESG) criteria.

Evaluation Criteria

Potential companies and projects for investment are evaluated based on their performance in these areas and a preference is given to investing in companies with sustainable and responsible practices.

Responsible investment strategies include avoiding investing in sectors that are harmful to the environment and society and preferring to invest in companies that promote sustainable development and social justice.

Environmental and social impact:

Responsible investing encourages investors to consider environmental and social impact and work to promote positive change in society.

Financial institutions can adopt responsible investment policies and include ESG criteria in their investment decisions.

Responsible investment reflects the orientation towards sustainable development and social and environmental responsibility in the investment sector and promotes long-term financial sustainability. Private sector investors see social and environmental stability as contributing to sustainable economic growth and overall sustainability. Investing in factors that improve social and environmental stability is a strategic and smart investment that supports long-term economic growth and sustainability.

The Principles of Responsible Investment

Refer to a set of guiding principles used by institutions and investors to guide their investment activities responsibly. One of the most prominent sets of principles for responsible investment is the United Nations-backed Principles for Responsible Investment (UNPRI).

The Principles for Responsible Investment supported by the United Nations consist of six main principles. They are as follows:

Integrate sustainability into investment decision-making: Investors pledge to take into account environmental, social and governance consequences in the process of analyzing and making investment decisions.
Transparency: Investors undertake to disclose the information necessary to evaluate how the principles of responsible investment are applied, including how they implement their commitments and the performance of responsible investment strategies.
Realistic responsibility: Investors pledge to be responsible for the impacts of their investments on society and the environment, and to strive to achieve a positive impact and avoid a negative impact.
Effective participation in the market: Investors pledge to contribute to the development of sustainable practices and standards in the investment market, and to work with companies and interested parties to enhance social and environmental responsibility.
Collaboration: Investors pledge to cooperate with others to promote sustainable practices and achieve positive change in the investment sector.
Report: Investors pledge to submit periodic reports on the performance of their responsible investments and their progress in achieving the principles of responsible investment.

This is just one set of responsible investment principles supported by the United Nations, and there are also other sets of guidelines used by financial institutions and investors in their responsible investment practices.

ESG (Environmental, Social, and Governance) practices:

It refers to a set of factors or criteria that investors use to evaluate companies based on their sustainability practices, social impact, and corporate governance

The "E" in ESG represents Environmental factors, which focus on a company's impact on the environment and its sustainability practices. This includes evaluating a company's carbon emissions, resource usage, waste management, and other environmental risks and initiatives.

The "S" stands for Social factors, which encompass a company's impact on society and its stakeholders. This includes assessing a company's approach to human rights, labor practices, diversity and inclusion, community relations, customer satisfaction, and data privacy and security.

Finally, the "G" represents Governance factors, which relate to how a company is managed and governed. These factors cover aspects such as board composition, executive compensation, shareholder rights, transparency, and ethics and compliance policies.

The ESG framework allows investors to understand a company's performance and impact beyond traditional financial metrics. By considering ESG factors, investors can assess a company's long-term sustainability, its ability to manage risks, and its potential for generating positive social and environmental outcomes.

Its relationship to Islamic finance:

ESG (Environmental, Social, and Governance) criteria and Islamic finance have more similarities than differences as they share a common goal of promoting ethical and sustainable practices. Islamic finance is a principles-based approach to investing, avoiding investments considered haram under Shariah law, while ESG criteria evaluate the sustainability and ethical impact of investments. There is an overlap between ESG principles and the principles of Islamic finance, with both taking into account environmental and social factors, as well as governance practices. Islamic finance institutions incorporate ESG principles into their investment and financing decisions, aligning with their shared principles. In summary, Islamic finance and ESG investing are complementary approaches, offering products that cater to both Muslim and non-Muslim investors, with strong practices and policies that mutually benefit each other.

Pros of ESG Investing:

Risk mitigation: ESG criteria can help investors avoid investing in companies that operate in a risky or unethical manner, reducing the potential for blowups and negative consequences like financial losses.
Social value: ESG investing aligns with investors' values and allows them to support companies that prioritize environmental sustainability, social responsibility, and good governance.
Corporate accountability: By considering ESG factors, investors can hold companies accountable for their actions, encouraging them to improve their practices and avoid damaging incidents like oil spills or emissions scandals.
Performance tracking: Investment firms are increasingly tracking their ESG performance, providing transparency and accountability through annual reports that review their ESG approaches and outcomes.
Driving real change: ESG investing can incentivise companies to drive positive change for the common good, pushing them to adopt sustainable and responsible practices.

Cons of ESG Investing:

Limited investment universe: ESG investors may not have access to the full range of stocks available in the market since they exclude industries like tobacco and defense. This limitation can potentially impact diversification and investment opportunities.
Potential lower returns: Industries avoided by many ESG investors, such as tobacco and defense, have historically produced above-average market returns. By excluding these industries, investors may sacrifice some potential returns in exchange for aligning their investments with their values.
Premium pricing: ESG-friendly investments often trade at a premium, making them relatively more expensive compared to traditional investment styles. This can impact overall portfolio performance and returns.
Tradeoff considerations: While many ESG investors are willing to accept lower returns to invest in companies aligned with ESG standards, factors like valuation and price remain important considerations for them. Balancing financial goals with ESG values can be a challenge.

Prominent Environmental, Social, and Corporate Governance Practices

Corporate governance revolves around how companies manage and steer their operations with consideration for their environmental and social impacts. Below are some of the primary issues encompassed by Environmental, Social, and Corporate Governance (ESG) practices.

Climate Change: Companies must shoulder the responsibility for carbon emissions and their climatic repercussions. They are required to devise strategies to reduce emissions and adapt their operations to changing climate conditions. Furthermore, insurance companies are assessed based on the physical risks posed by climate change to insured assets and individuals.
Resource Sustainability: Firms face challenges related to sustainable management of natural resources such as water, forests, and land, with an emphasis on conserving biodiversity and minimizing water and soil pollution.
Transparency and Disclosure: Corporations must maintain transparency regarding their environmental and social performance and furnish adequate information to investors and stakeholders for evaluating their performance in these contexts.
Supply Chains: Supply chains play a pivotal role in promoting ESG practices. Attention is needed to ensure labor rights, decent work, fair wages, reasonable working hours, and safe working conditions throughout the supply chain.

Prominent Websites for ESG Evaluation

MSCI ESG Research:

MSCI is a global company specializing in providing financial asset evaluation services from an ESG perspective. It offers ESG assessments for companies, funds, and financial assets. Specific criteria are applied to appraise corporate performance in environmental, social, and corporate governance aspects. MSCI provides data on financial sustainability and the influence of environmental and social factors on financial assets, facilitating informed decision-making for both investors and companies based on ESG criteria and business sustainability.

S&P Global ESG Scores:

S&P is a financial services company offering asset financial services and market assessments. They manage well-recognized financial indices, including the S&P 500. Recently, they have introduced ESG standards for evaluating corporate performance in environmental, social, and corporate governance areas. They also contribute to providing information about business sustainability.

Sustainalytics:

Sustainalytics is a global leader in ESG performance evaluation. It provides assessments and tailored reports for companies, investors, and financial institutions. Through the utilization of diverse standards and indicators to evaluate corporate performance in environmental, social, and corporate governance domains, they supply information on business sustainability and assist in comprehending corporate impact on the environment and society. Moreover, they offer reports to support companies in enhancing their ESG performance and development

These websites, using ESG standards, aid investors and companies in comprehending and assessing the environmental and societal impacts of companies, thereby facilitating sustainable and responsible financial decision-making.

Click the image to learn about ESG disclosure guidelines by the Saudi Exchange Market!

Resources:

Prepared by:

Shahad Alwahbi
Lubna Alharbi
Hanan Alshawi