How the Middle East can fund its green transition

Money matters – and we need a lot of it to address climate change.

The challenge is not whether we have the technologies to solve climate change – we mostly do. Energy efficiency solutions, renewables, electric vehicles and climate-smart agriculture are all well-understood and relatively easy to deploy.

The question is how to mobilise the $4tn per year needed to reach net zero, or the $7tn required annually to achieve the United Nation’s Sustainable Development Goals (SDGs), which include both
environmental and social objectives. In the Arab world, about $230bn per year is needed to achieve the SDGs. Most of this investment will come from the private sector. But governments in the Middle East have big levers they can pull to mobilise this finance and channel it towards sustainability projects.

Financial markets are also innovating to unlock it.

ALL EYES ON THE MIDDLE EAST
The next two UN climate change conferences will be held in Egypt (COP27 in November) and the UAE (COP28 in 2023), bringing the Middle East’s climate credentials under intense global scrutiny. The annual summit’s focus has shifted from simply setting carbon reduction targets to actually implementing them. Governments must show how their pledges are translating into actions that unlock green investments. The recent study I co-authored, Financing a Green Transition in the Middle East, published by the Mohammed bin Rashid School of Government and funded by HSBC, looks at 14 tools to accelerate green finance in Bahrain, Egypt, Iraq, Kuwait, Oman, Qatar, Saudi Arabia and the UAE.

These include enablers that shape the investment environment, like green taxonomies, financing strategies, and disclosures around climate and nature risks. They also include specific instruments
that de-risk investments and “crowd in” private sector finance, like guarantees, loans and green bonds, or sukuk. Three opportunities stand out: harnessing high public spending, leveraging huge sovereign wealth funds, and capitalising on the strength and ubiquity of state-owned enterprises.

SPECIAL OPPORTUNITIES FOR THE MIDDLE EAST
The first capitalises on the countries’ high government spending as a percentage of GDP, averaging 20 per cent versus a global average of 17 per cent, and reaching a high of 28 per cent in Saudi Arabia.

This gives governments an outsized opportunity to directly shape the sustainability marketplace by greening public procurement. Green procurement creates demand at scale for sustainable products and services, which boosts their availability and lowers their price, making them more accessible to businesses. Governments can also multiply their influence by requiring private sector partners to
apply sustainability criteria to their supply chains.

The second is size and scope of sovereign wealth funds. Of the eight countries studied, seven have sovereign wealth funds worth a total of over $3tn, and Iraq has plans to create one. Sovereign wealth funds like the UAE’s ADIA, Saudi Arabia’s Public Investment Fund, the Kuwait Investment Authority and Qatar Investment Authority have a mandate to deliver both financial and social returns on investment.

Governments across the region can set investment criteria to ensure this huge capital endowment is used to finance a green transition whilst deprioritising investments that exacerbate climate change.

The third is the prominence of state-owned enterprises. They represent both a big chunk of the countries’ economies and an outsized proportion of their national greenhouse gas emissions. Governments that own oil and gas companies, heavy industries and airlines can instruct these companies to invest in energy efficiency, low carbon fuels and innovation.

HELPING POLLUTERS ALONG THE JOURNEY
It’s not easy or cheap, however, to transform a high emissions business. Such companies cannot simply be let out of the conversation or told to shut down to achieve national climate change targets. They need to be part of the solution. And they need investment to finance their transition to a low carbon future. “Sustainability-linked” loans and bonds are relatively new instruments that help companies raise money at a lower interest, providing they set and achieve meaningful sustainability targets.

They differ from sustainability loans and bonds (without the “linked”) because the capital can be used for anything, so long as the company achieves its targets. Missing the targets results in a penalty.

Sustainability-linked loans and bonds are becoming hugely popular, increasing in value by three and ten times respectively year-on-year, to nearly $800bn in 2021. They even surpassed the $522bn green bond market in 2021. But sustainability-linked instruments come with risks. “Meaningful” targets may not be science-based. Having ‘sustainability’ in the name could lead to greenwashing.

“Linked” instruments do not guarantee additionality, i.e., that sustainability improvements would not have happened otherwise. To be effective, four things should change. Sustainability should be disaggregated into its constituent parts, with a special focus on greenhouse gas emissions. Meaningful climate targets should align with the Paris Agreement and be scrutinised by credible entities such as the Science-Based Targets Initiative. Penalties for missing the target should be high and therefore motivating. To avoid greenwashing, governments should develop harmonised guidance to govern this new asset class, just as the Green Taxonomy guides investments in the EU.

SEIZE THE OPPORTUNITY
Climate change is both an existential threat and the “greatest commercial opportunity of our time”, said former Bank of England Governor Mark Carney. Blackrock’s CEO Larry Fink agrees, while warning that countries and companies that do not invest in the opportunity “risk being let behind [and] risk losing jobs, even as other places gain them”.

At a time when trillions of dollars are needed to tackle climate change, government action and innovative financial tools will prove vital. The Middle East can use its special position to seize the
opportunity and invest in a sustainable transition, creating jobs and ensuring continued prosperity in the future low carbon global economy

Jeffrey Beyer is the managing director of Zest Associates, a UAE-based sustainability consultancy