October 7, 2019 / Analysis

ESG on the rise in the Middle East

By Mark Battersby, Fund Selector Middle East

Long running global study has found ESG adoption is rapidly gaining traction among sovereign investors and central banks

ESG on the rise in the Middle East

Two thirds of sovereign wealth funds in the Middle East have implemented a top down ESG approach, according to the 2019 Invesco Global Sovereign Asset Management Study.

The survey of 139 individual sovereign investors and central bank reserve managers showed nearly two thirds (60%) of sovereigns now incorporate a top-down ESG policy – up from 46% in 2017.

ESG implementation remains most prevalent among Sovereigns in the West (76%) but it is now also common in the Middle East (67%) and Asia (59%) following an increase in adoption.

It is also increasingly a preoccupation of central banks, with 20% now incorporating a policy, up from 11% in 2017.

Fixed income on the ESG radar

While equities have been the starting point for ESG implementation, the study found that of those sovereign wealth funds that incorporated ESG at the asset class level, 65% are now applying ESG considerations into their fixed income portfolios.

The findings highlight a marked evolution in terms of both uptake and sophistication of ESG policies.

In 2017, the study highlighted the ESG polarisation between sovereigns, with supporters moving to further embed and integrate ESG in investment processes while non-supporters waited for evidence on investment implications.

Two years on, ESG for many is now front of mind, with supporters becoming more focused in their approach, adding dedicated teams and deepening the integration of ESG into their investment processes.

The absence of quality ESG data remains a key issue, with 52% of sovereigns citing quality data and ratings as the main challenge in incorporating ESG.

This issue is compounded when extending ESG principles to fixed income, for example the difficulties applying an engagement approach as a debtholder when many issuers are governments.

Green bonds and shift to the environment

Green bonds are seen as an easier way of taking ESG considerations into fixed income by both sovereigns and central banks.

Nearly one third (28%) of Central Banks and nearly half (45%) of sovereigns are currently invested in green bonds. However green bonds have their own problems, in particular lack of supply and liquidity which inhibit large exposures.

The 2019 study highlights the shift in focus toward “E” environment initiatives. Asset owners have, in the past, focused on “G” governance factors such as board composition and the ability to flag controversies. These are now relatively easier to measure and monitor.

But sovereigns are now looking to environmental concerns, with “climate change/carbon emissions” the single most important ESG issue.

Sovereigns are approaching environmental factors with an increased level of sophistication compared to 2017. The perceived increased frequency of physical climate risks such as hurricanes, heatwaves, earthquakes, and wildfires has precipitated some to pinpoint the risks of such events to assets such as infrastructure.

These risks are now also being considered for assets located in emerging markets, which until recently was considered near impossible by many given a lack of information and transparency.

This leaves social factors as the main remaining barrier requiring definition and measurement. While some ESG leaders think of ‘S’ as the risk of loss of social licence, for most sovereigns’ social factors have yet to become a practicable means of evaluating risk/return.

Alex Millar, head of EMEA institutional distribution sales, Invesco, said: “ESG policies continue to gain traction among sovereign investors and central banks. The fact that over half of all sovereign managers now incorporate official ESG policies reflects advancements in investors’ understanding of how to derive value from their application.

“As the adoption of such policies in the construction of portfolios continues to develop, we expect to see application spread across asset classes. This year’s study shows this process is already beginning to take place, with sophisticated adopters moving beyond equities into fixed income, and even, in some cases, real estate and infrastructure.

“Another striking trend is the dominance of environmental concerns over governance and social. While there are many contributing factors to this rise, it is a clear and heartening signal that governments and investors are beginning to take environmental concerns – and particularly climate change – very seriously.

This is Invesco’s seventh sovereign asset management study. In 2019 it conducted interviews with 139 funds: 68 sovereign investors and 71 central banks.

The 2019 sovereign sample is split into three core segmentation parameters (sovereign investor segment, region and size of assets under management). The 2019 central banks sample is broken down by developed vs emerging market.