How GCC investment firms can adapt to capture new opportunities

The pressure on investors to make real progress on Environmental, Social, and Governance (ESG) issues has rapidly escalated. Private equity firms, principal investors, and Sovereign Wealth Funds (SWF) with a full ownership governance model, multi-year investment horizon, and relative freedom from the short-term pressures, is well placed to lead this sustainable finance revolution.

The challenge for the region’s governments, the business community, and civil society is to translate climate concern into action. Currently, the GCC countries recycle, reuse, or recover a small fraction of the plastic and metal waste that they produce, much less than the global average of 32 per cent.

Electric vehicles are scarce and there is good reason to believe that more people would embrace sustainable lifestyles if the public and private sectors made them more accessible through financial incentives, public-awareness initiatives, investments in green infrastructure, and a wider choice of affordable eco-friendly goods and services. This would not only enable the GCC nations to advance their green agendas but also create important new growth opportunities in sectors as diverse as tourism, consumer goods, transportation, real estate, and education.

While there is no one-size-fits-all sustainability playbook, several strategic options can be considered to capture value through sustainability, and these provide a menu of potential moves for firms mapping their paths ahead:

· Transforming sustainability laggards: Buying and transforming assets with lagging sustainability performance across environmental and social factors, by deploying a well-developed toolkit and sustainability-focused strategies and capabilities

· Shifting the whole portfolio: Continuous improvement of sustainability performance for the full portfolio year-over-year, through the wider deployment of levers, potentially leveraging a shared playbook

· Sustainability-as-a-service: Investing in companies that provide data, consulting, engineering, and other transformation services to companies making the sustainable journey

· Investing in sustainability leaders: Investing in companies with leading sustainability performance

Across these strategic options, private equity firms, principal investors, and SWFs have a set of key drivers to focus on to fully integrate and leverage these strategies mentioned above:

Invest in capabilities and culture
The gap in capabilities is one of the primary barriers to action for private equity firms, principal investors, and SWFs today. Installing champions with the right multi-stakeholder experience to straddle both the traditional investment and the sustainability worlds can be a vital first step in building institutional capabilities. However, operational responsibility cannot be isolated under these champions alone; it must be intentionally shifted within the organisational culture, creating a sense of ownership for sustainability imperatives at all levels.

Focus on a long-term plan
Developing capabilities and driving a cultural change to develop value proofs will take time and likely involve false starts along the way. To stay the course, firms must take advantage of the greater time horizon flexibility in private markets and optimise for the long-term outcome, not just quick wins – for example, by embracing experimentation.

Communicate the plan, along with measurable milestones along the way
Given the lengthy time horizon required to see results at the asset and portfolio levels, communicating the long-term plan and progress towards it to all stakeholders is vital to securing and maintaining buy-in. Communicating progress requires both standardised metrics (to enable comparisons) and customised reporting (to accommodate the unique aspects of each investment), and asset-level transparency, given that portfolios turn over approximately every five years.

Don’t just divest, transform
Divestment and sector rotation offer quick wins for a single investor, but they do not remove sustainability laggards from the global mix. As these assets continue to operate, the systemic risks they engender will ultimately affect returns across the market. Larger investors who are essentially universal owners and may have long-term obligations cannot divest their way out of these systemic risks. Sustainability challenges need to be addressed head-on by deploying capital to transform these grey assets.

Collaborate to address key barriers
Addressing measurement challenges and establishing the right incentives cannot be accomplished in isolation. Investment firms in the region must continue to collaborate to set standards and policies. The current momentum and relative maturity of measures to combat climate change can provide a testing ground for action on these ecosystem challenges, providing templates for system-wide collaboration across a broader set of sustainability topics.

Current national pledges under the Paris Agreement are insufficient to limit warming to 1.5°C with no or limited overshoot and would require an abrupt acceleration of mitigation efforts after 2030 to likely limit warming to 2°C.

The transition to a net-zero world on a wide range of closely intertwined drivers and constraints, including policies and technologies where notable advances over the past decade have opened up new and large-scale opportunities for deep decarbonisation. Private equity firms, principal investors, and SWFs in the region need to respond to rapidly evolving societal goals and expectations on sustainability. This presents not only financial, reputational, and regulatory risks to be navigated, but also prospects for long-term value creation.

They must take action to seize this opportunity.

Antoine Samaha is a partner at Boston Consulting Group (BCG)