ESG straitjacket is too rigid for Middle East economies

Tejas Sandhu/SOPA Images/Sipa USA via Reuters

There appears to be a full-scale backlash underway against the overuse of environmental, social and governance (ESG) criteria in investment decisions. For people living in emerging markets, and in particular the hydrocarbon-rich Middle East, that is a good thing.

Stuart Kirk, an influential figure in the financial world as the former head of responsible investing at banking giant HSBC, delivered his latest broadside against ESG in a recent, thunderous Financial Times column.

The new-wave investment philosophy, he said, was riven with internal contradictions that could not be reconciled.

“No-one has a clue whether to punish the likes of ExxonMobil or reward it for committing to spend half a billion dollars a year on green energy research,” Kirk said.

Given that Kirk quit his job at HSBC for mocking the icons of ESG, and especially its environmental criteria, it’s no surprise that he is taking another stab at the “woke” investment industry.

But he is not alone. In the USA, where the whole school of thought began before finding fertile ground in Europe, some of the biggest ESG converts, like Blackrock, Vanguard and State Street, have found themselves the target of legal actions, mainly in states with Republican administrations, for failing to pay proper attention to the financial basics.

There have been big withdrawals of funds from ESG portfolios, to the extent that there was a net outflow of investment in “green” equity portfolios in the first half of 2023, reversing a multi-year trend.

If the high-water mark of ESG has been reached, it should at least free investors in the Middle East from the urge to go chasing the latest fad in global investing, which never made much sense for the region in the first place.

Take the three initials. E stands for environment, and of course the need to protect the planet and reverse climate damage should be a top priority for all investors, and all thinking human beings.

But the E strand has become virtually synonymous with the extreme “Just Stop Oil” faction.

In the USA and Europe, many investors will not invest in new hydrocarbon projects out of loyalty to their ESG principles, even when their governments are giving the green light to new developments and there is a crying need for energy supply.

How could investors in the Arabian Gulf ever imagine applying such a yardstick, when hydrocarbons are the beating heart of regional economies?

Move on to S. What began as an aspiration for socially responsible investment practices has morphed into a militant campaign for gender equality and sexual diversity – both of which are problematic in the context of regional societies.

Great progress has been made, for example in increasing the proportion of women in employment in GCC countries. But it is a long race, and will not be won by sprinting towards some female quota system devised in New York or Brussels.

G is for good governance, a worthy cause we should all endorse. But again, in the Middle East the dominant role played by governments in business, and traditional tax-light economic models, mean that reaching arbitrary western-designed standards is neither possible nor desirable.

It is not just in the Middle East where ESG standards are looking increasingly difficult to achieve. The whole of the “Global South” operates according to different economic, social and cultural structures than the progressive West.

Because of that, western ESG funds have largely stayed away from large-scale investments outside their own backyard.

The result is that the countries which most need investment – to help with their road to energy transition, or to give women more access to jobs, or to learn better standards of governance – are ignored by western institutions increasingly obsessed by virtue-signalling rather than rational investment criteria.

There have been several attempts to reconcile western ESG systems with emerging market realities; most recently the move to draft IFRS (International Financial Reporting Standards) guidelines on sustainability measures. The jury is out on whether any of these projects will deliver.

As Kirk said, perhaps the best course of action is for the global investment industry to wake up to the contradictions inherent within ESG principles, and start again from scratch to try to create an inclusive framework to take into account economic, financial and social realities around the world.

As things stand, it makes no sense at all to try to squeeze the rest of the world into the West’s ESG straitjacket.

Frank Kane is Editor-at-Large