This post is a guest-authored commentary piece discussing the findings of  Diligent Institute and Corporate Board Member’s 2023 What Directors Think survey and report. This is the fourth blog in a series of global commentary pieces analyzing board and governance trends in the US compared to other regions. 

Until recently, Environmental, Social, and Governance (ESG) issues have been viewed by many companies in the Middle East and North Africa (MENA) region as a communication and compliance exercise. This has often resulted in stand-alone ESG initiatives and projects that were mainly driven by management, with the communication department taking the lead and collaborating with different functions within the company to collect and report on information. Unfortunately, this meant that boards in the MENA region spent very little time on sustainability and related issues. What Directors Think, a survey of US public company directors conducted in collaboration between Diligent Institute and Corporate Board Member, quite found the opposite. In that survey, 50% of respondents indicated that boards are spending too much time on ESG. Why do we see this disparity?

The lack of engagement of the boards in the MENA region in relation to sustainability could be attributed to a number of challenges. Other than being a fairly new topic in the region’s boardrooms, the broad and complex nature of sustainability and ESG overall as a concept and the multitude of topics and standards it encompasses made it difficult for boards to know where to start and how best to address ESG issues. The biggest challenges, however, are likely related to data and talent.

Sustainability reporting requires a significant amount of data and information, and while this can be difficult to gather, it is even more difficult to present and have directors interpret the data in a meaningful way outside the context of a sustainability strategy. The limited availability of specialized talent in the ESG area in the region does not help. Simply put, the governance around ESG is not there.  There are reasons, however, to believe that this has started to change. Here is how matters are changing and why the pace of change is expected to accelerate.

Advancements in ESG issue governance

The region is witnessing a noticeable increase in awareness regarding sustainability’s significance for companies and more importantly a shift in directors’ mindset. Previously, sustainability was believed to contradict the shareholders’ interest in short-term returns. The rise in stewardship has brought sustainability to the forefront of boards’ agenda. Regional board members are increasingly expressing the need for greater focus on ESG at the board level. The majority of directors are also acknowledging the benefits of incorporating sustainability as part of their ongoing professional development. 

In the MENA region, where competition to attract investors and get access to capital is intense, there is a growing recognition of the importance of ESG practices in differentiating businesses as responsible and attractive to investors. A number of global independent rating agencies are assessing listed companies, including the region’s companies, based on their ESG practices. The S&P Hawkamah ESG Index has been assessing a sample of about 150 listed companies across the region based on their public disclosures since 2007. The results have shown that companies with stronger ESG practices consistently outperformed their counterparts, implying a positive correlation between companies adopting ESG practices and their share price valuations.  

The business case for sustainability is widely recognized. Incorporating sustainable practices enhances a company’s reputation, reduces costs, increases efficiency, and minimizes risks, ultimately leading to the business’s long-term growth. Sustainable practices also have the potential to boost a company’s brand, and attracting and retaining loyal customers. In addition, sustainable practices enable companies to comply with regulatory requirements, anticipate market demands, and mitigate social and environmental risks. 

ESG practices have gradually gained traction due to the influence of regulations. Significant progress has been made in the realm of governance, as governments across various regions have introduced and updated governance codes for the private sector, state-owned companies, and governmental entities. Rather than a shortcoming of regulations, this development should be positively regarded as a means to establishing a strong foundation for driving improvements in the social and environmental domains. Notably, many of these codes now place ESG responsibilities within the purview of the boards. The recent unprecedented case against the Shell’s 11 board directors, holding them accountable for failing to approve an energy transition strategy that aligns with the Paris Agreement and breaching their legal duties, is expected to prompt board members worldwide to re-evaluate their priorities. 

There are early indications of a move towards standardization in the region, as exemplified by the GCC Exchange Committee’s publication of a unified set of ESG disclosure metrics this year. The 29 standards include 10 environmental, 10 social, and 9 governance metrics aligned with the World Federation of Exchanges and Sustainable Stock Exchanges Initiative, covering areas such as GHG emissions, energy and water usage, gender pay, employee turnover, gender diversity, data privacy, and ethics. 

Two primary catalysts have ignited the ESG momentum in the region. Firstly, the pandemic and related disruptions to the supply chain have had a global impact, including companies in the MENA region. Interestingly, the pandemic has highlighted the social aspect of ESG. A recent survey by Masdar indicated that 85% of 525 global executives considered the COVID-19 pandemic a wake-up call on sustainability, with many seeing it as a tipping point for investments in sustainability projects. 

However, it is the government’s recent impactful approach to ESG issues that is expected to accelerate the adoption of sustainability practices in the region and maintain its momentum. With net-zero commitments and national visions that prioritize sustainability, different countries have committed to and are working towards ambitious targets. Some countries have taken more significant steps than others, such as the United Arab Emirates and the Kingdom of Saudi Arabia, which are among the most visible on the world stage. The hosting of COP27 in Egypt in November 2022 and the upcoming COP28 in the United Arab Emirates in November 2023 will further increase the region’s prominence in the sustainability dialogue. Other countries are also participating in this change, albeit in a more phased approach. 

The UAE has also launched a series of initiatives as an indication of its commitment to develop sustainable projects tackling environmental and social issues and fostering a sustainable economy. Examples include the UAE environmental goals by 2050, UAE energy strategy 2050, circular economy policy, wiser consumption initiatives, UAE Net Zero 2050, national climate change plan of the UAE 2017 to 2050, UAE green agenda 2015 – 2030. The country has named 2023 “The Year of Sustainability.”

The shift towards sustainability will have an impact on companies at all levels, with the boards of directors playing a crucial role in driving this change. Companies owned by governments or sovereign funds are expected to lead the way, with others following suit. Some companies have already declared they were working towards supporting their countries’ national visions and ambitious targets. Concrete actions and plans will have to follow as companies will naturally start taking a more deliberate approach in their oversight of sustainability, with the goal of making a difference and future-proofing their businesses. 

Changes in board-level ESG oversight  

Initially, boards are likely to engage more closely with stakeholders on sustainability. This will include connecting with and listening to governments, investors, employees, customers, and communities, to better understand their concerns, expectations, and perspectives on ESG issues and ensure that the company’s ESG strategy is aligned.

Directors will also be focusing on the formulation of ESG strategies that align with companies’ values, goals, and purposes. This will be carried out at the board level or through an ESG or another designated committee. The fact that companies in the region are beginning to bring on Chief Sustainability Officers is a step in the right direction. 

Because sustainability risks can have a significant impact on a company’s operations, reputation, and financial performance, boards will consider identifying, managing, and integrating ESG-related risks, including climate change, human rights, data privacy, and supply chain issues into their companies’ overall risk management frameworks. More importantly, though, is for boards to consider ESG-related risks as part of their decision-making process. 

Sustainability oversight will also be part of the board’s monitoring of the business performance and corporate culture. Monitoring ESG performance means measuring and tracking progress towards ESG strategic goals and compliance with regulations. Few companies have taken the lead in including sustainability as part of the CEO and executive management team KPIs.  

Finally, boards are expected to dedicate time to monitoring how well ESG is integrated into the corporate culture. In some instances, boards may be looking at intentionally shaping the corporate culture and the employees’ behavior for a greater alignment with ESG strategic goals.