In this issue:
- ESG-Financial Performance Link Explored – The right question about performance may be how much does the evidence support a positive link
- Saudi Arabia’s Budget Gets a Buffer – The new Saudi budget is notable for all its cuts but the addition of a Budgetary Support Provision will help reassure (future) external creditors
4th January 2016
We would like to wish all of our readers a Happy New Year! The first Finance Forward of the new year continues two themes we believe will be very important in the coming year for the MENASEA region: the impact of low oil prices and the potential for responsible finance to be a catalyst to more sustainable economic development. Finally, we hope you will participate in our survey which will be used in the Finance Forward Middle East Insurance Outlook Report 2016, to be released in February 2016 at the Middle East Insurance Forum.
Research confirmed: ESG is positive or neutral for financial performance
Many of the questions surrounding the inclusion of non-financial factors like the environment, social and governance considerations in financial analysis relate to whether it hurts performance. According to comprehensive new research, this is the wrong question to ask about ESG. Instead, the question should be about how much can it help.
A meta-analysis conducted by Gunnar Friede, Timo Busch and Alexander Bassen on over 2,0000 studies, likely the most comprehensive study ever conducted, finds overwhelming evidence that the data across 40 years of studying the impact of ESG finds at worst, no impact on overall performance and likely suggests a positive relationship. In addition, the impact has remained consistent across the 40-year time period suggesting it is likely to continue to hold in the future.
The top-line findings that more than 90% of studies have found a positive or neutral impact (with more than half of them finding a positive impact) is notable on its own, but other details in the research are equally important because it can demonstrate some wider lessons from the existing base of knowledge on ESG.
As one would expect, the performance in developed country equity markets (where a much greater volume of ESG activity has occurred) generally shows lower rates of outperformance, than emerging markets and assets classes where ESG is less common. However, in contrast to what the efficient market hypothesis would indicate, there is a consistent share of studies across multiple decades that identify a benefit from incorporating ESG factors. One of the findings from the meta-analysis that can explain this is a significant impact between ‘portfolio studies’ and ‘non-portfolio studies’, with the latter showing much higher rates of outperformance where ESG is integrated. The portfolio studies (those looking at funds rather than companies) focus on returns after the cost of fees are included which, on aggregate, may be enough to eat up enough gains to muddy the results.
The authors also highlight the role that focusing on aggregate performance could create: it could suffer from potentially contradictory impacts from positively screened versus negatively screened funds as well as the after fee impacts. A finding that performance is not negatively affected, even net of fees, could support the retail market development but has a much greater potential to boost institutional adoption where fees represent a lower drag than for the investment market on aggregate.
One positive outcome from the analysis is that even where sustainability screening is most common (developed market equities), there is a wide volume of research supporting a positive relationship between ESG and financial performance. In newer markets (such as emerging markets) and newer asset classes (including fixed income, real estate and infrastructure) where ESG offers a greater informational advantage, there is an even more significant opportunity for financial institutions and asset owners.
The Responsible Finance Summit will bring together key stakeholders from the traditional responsible and Islamic finance sectors to build connections to support rapid growth and increase the measurable impact of the industry. It will be held from 30-31 March 2016 and is hosted by Bank Negara Malaysia, organized by the RFI Foundation and co-organized by Middle East Global Advisors. Visit www.rf-summit.com for more information for follow the Summit on Twitter at @RFIFoundation or #RFS2016.
Saudi budget builds in an added buffer to reassure financial markets
For many years, Saudi budgets acted as only imperfect estimates of the eventual fiscal performance but the tighter control over spending needed with lower oil prices has made the budgets more reflective of the eventual spending. A new budget item for 2016—a Budget Support Provision—leaves room for higher spending should it be necessary to offset budget pressures caused by continued low oil prices, expenditure overruns or lower revenue caused by slower non-oil growth.
In a way, the Budget Support Provision can be thought of as a way to signal expected overspending relative to budgeted amounts. This is needed because during recent years (particularly from 2010-2014), government spending was dramatically higher than budgeted (between 29% and 44% according to Global Research). With high oil prices, this did not have a significant financial impact on the economy because SAMA reserves were continuing to grow between $5 – 10 billion per month.
However, as the surpluses shift to deficit, the financial sector and future external creditors (if an international bond or sukuk is issued, as expected) are likely to be much more reliant on budget figures that reflect likely spending. Some of this change has already taken place with expenditure in 2015 coming in at a relatively modest 13% over budget as a result of changes in public administration that have been implemented since King Salman’s accession.
The addition of a Budgetary Support Provision (BSP) equal to 22% of planned spending goes some way to building in protection against shocks that could widen the deficit beyond what is expected. It follows recommendations from the IMF during the most recent Article IV consultation where the IMF recommended budgeting “within a medium-term fiscal framework that clearly establishes the authorities’ policy intentions […] and delinks expenditures from short-term volatility in oil revenues while ensuring that spending adjusts to longer-term price trends”.
The reason that the BSP is important in the context of Saudi financial markets is two-fold. On the domestic financial sector, the ongoing issuance program of SR 20 billion ($5.3 billion) per month is drawing down available liquidity from the banking system. The loan to deposit ratio for the banking system as a whole is at a six-year high of 83.7%. Growth in financing to the private sector has shrunk from an annual growth rate of close to 15% to just 5% year-on-year in October 2015. That means banks will have to more carefully manage their asset growth to preserve their own liquidity against unexpected government withdrawals or increased bond issuance.
The other reason that a buffer is important is to reassure potential future external creditors about the country’s public finances, which was cited by Standard & Poor’s in their credit rating downgrade of Saudi Arabia at the end of October. The move, with which the Saudi Ministry of Finance “strongly disagreed”, represents at minimum concern over the visibility of public finance in the Kingdom.
The inclusion of a BSP in the budget at least provides some acknowledgement about the concerns of international creditors-to-be. Higher deficits besides what is budgeted for could be covered from reserves held at the Saudi Arabian Monetary Authority but that would raise uncertainty with international creditors. By incorporating a (possibly higher than needed) buffer, it could soothe international investors’ concerns and ease the debut offering.
The budgetary concerns in Saudi Arabia will continue over coming years as spending will adjust with much more of a lag compared to revenues which have already fallen significantly in response to oil price changes. However, management of these deficits and the way in which the Saudi Ministry of Finance introduces greater transparency in communication of public finances is showing signs of improving. This will support a more orderly transition towards lower government spending should oil prices remain at their current low levels.
Middle East Global Advisors is looking for insights from the insurance and takaful industry and hopes you will complete a short survey to guide an outlook for the insurance industry in the Middle East. Your views will be included in the Finance Forward Middle East Insurance Outlook Report 2016, one of the highlights of the industry’s regional gathering in February, 2016. You can share your views in our survey here.