The Impact of Sustainable Financing on the Performance of Sovereign Funds in UAE

The Impact of Sustainable Financing on the Performance of Sovereign Funds in UAE

The past few years have seen sovereign funds become an important factor in the world’s financial landscape. Sovereign wealth funds (SWF) refer to state-owned investment funds that invest in different asset classes like real estate and stocks to bring more value to a country’s investment funds (Sharma & Chandani, 2022). In most cases, SWFs are funded by excess revenue from selling a country’s natural resources like oil and gas. As one of the largest oil producers in the world, the United Arab Emirates (UAE) benefits from surplus revenue from the sale of its oil and gas. The presence of surplus revenue prompted the government to have several SWFs like the Abu Dhabi Investment Authority (ADIA), one of the world’s largest. A growing interest in responsible investing and sustainability has led to increasing interest in the impact of sustainable financing on the performance of sovereign funds in the UAE. Therefore the main aim of this literature review is to analyze how the performance of sovereign funds in the UAE is affected by sustainable financing.

Theoretical Basis and Background

According to Velayutham and Hasan (2021), SWFs refer to state-owned investment funds that control and invest a country’s surplus wealth that is mostly gotten from the sale of minerals like oil and gas. In most instances, SWFs are created by countries that have surplus revenues from their minerals and want to limit their dependence on single revenue streams. Therefore, SWFs are created to provide more alternative revenue streams for countries and provide a source for long-term savings and economic development. The UAE is one of the countries with the highest number of SWFs, mainly the Abu Dhabi Investment Authority (ADIA), the Investment Corporation of Dubai (ICD), and the Mubadala. The SWFs have played a significant role in the UAE’s economy by acting as an investment source for the country’s surplus revenues.

Figure 1: The graph shows sustainable investing activities by Mubadala. The sovereign fund invested $2.5 billion in Sky born technologies, $1.5 billion in Envirotainer and $0.6 billion in Canada Cartage (https://www.bloomberg.com/graphics/2023-middle-east-wealth-funds-with-more-money-than-uk-gdp-become-world-bankers/?leadSource=uverify%20wall).

Ćuzović (2019) defines sustainable financing as the financial investment that accounts for governance, social and environmental factors. Sustainable financing does not only focus on monetary transactions but also the impacts of such transactions on the environment and society. Sustainable financing focuses on investing in projects that positively impact the environment and society and can be achieved in many different ways, such as social impact bonds, green bonds, and sustainability-lined loans.

From the analysis of existing literature, it is evident that many different studies have investigated the relationship between sovereign funds in the UAE and sustainable financing. Research by Shamim and Munshi Naser (2021) sought to analyze how the performance of sovereign funds in the GCC region is impacted by sustainable financing. The study established that countries that invest their SWF in sustainable projects experience a positive impact on their financial performance. From the analysis of the study findings, it is evident that sovereign wealth finds in the UAE should increase their investment in sustainable projects to improve their performance.

Another study by Ayat (2023) investigated the sustainability practices adopted by sovereign funds in the UAE. The investigation established that the past three decades have seen the number of SWFs in the UAE increase their investments in sustainable projects like sustainable infrastructure and renewable energy. The study recommended increasing investments in sustainable projects to improve people’s lives in the UAE.

Through his study, Ayat (2023) also examined how sustainable financing affects the performance of sovereign wealth funds in the Middle East and North Africa (MENA). The study results indicate that sustainable financing by SWF positively impacts their financial performance (Ayat, 2023). The study also recommended that sovereign wealth funds invest in sustainable projects to improve performance.

Relationship between Sustainable Financing and Sovereign Funds in UAE

Understanding the relationship between sustainable financing and SWFs is critical in promoting sustainable development in the UAE. The UAE can use SWFs to encourage sustainable financing by investing in projects that positively impact the environment and people. As Garg and Shukla (2021) recommend, some major ways SWFs can promote sustainable investing are social impact, green, and sustainability-linked bonds.

Existing research indicates that sustainable financing positively impacts the financial performance of SWFs. In most instances, investing in sustainable projects provides lower risks and higher returns, improving the financial performance of SWFs. Sustainable financing positively impacts the financial performance of SWFs because it can attract more investors. Ayat (2023) observe that most investors are looking for investment opportunities that are sustainable and profitable. Investors are more likely to turn towards SWFs that have been proven to be sustainable hence helping the SWFs attract more investors.

Recommendation on the Best Sovereign Fund Model That Has Performance and Sustainable Financing in Place

From the analysis of previous studies, it is evident that the best sovereign fund approach that combines sustainable financing and financial performance is the one that offers sustainable financing instruments like green bonds, invests in sustainable projects, and accounts for ESG factors in its investment strategy. Using such a model may help SWFs in the UAE increase their financial performance, improve their reputation, and decrease the risk they are exposed to.

Sharma and Chandani (2022) also state that sovereign funds in the UAE should help the country reduce its reliance on oil and gas by diversifying its investors. Diversification reduces the risk of exposing sovereign funds to fluctuations in oil and gas prices on the global stage. Diversification further reduces the risk and allows sovereign funds to invest in sustainable projects that have proven to positively impact their financial performance. Sovereign funds in the UAE should therefore focus on investing in other sectors besides oil and gas, like real estate and healthcare, which offer the potential for growth in the UAE.

Challenges Associated With Sustainable Financing by Sovereign Funds in the UAE

Sovereign funds are critical in the diversification, economic development, and stabilization of countries with abundant resources like the UAE. Through sustainability financing, such countries have managed to get financial returns from their sovereign funds while positively impacting the environment and their people. Although sustainable financing has been critical in helping develop the UAE economy, they face several challenges that the country must address.

According to Velayutham and Hasan (2021), one of the main challenges of sovereign funds investing in sustainability metrics is the lack of clear and consistent reporting standards and metrics. It is difficult to compare how different investments across sectors perform due to the lack of a standardized approach. Although the Mubadala Investment Company manages to publish detailed sustainability reports, including reports about its ESG, many other funds in the UAE are yet to follow suit due to the lack of clear and consistent sustainability metrics and reporting standards.

Apart from the lack of clear metrics and reporting standards, the limited sustainable investment opportunities in the UAE are another significant challenge that should be addressed. From the analysis of the UAE, it is evident that most sustainable investments are made in the energy sector, where the government seeks to invest in renewable energy (Shamim & Munshi Naser, 2022). However, the sector alone cannot accommodate all the investment needs of sovereign funds; a perfect example is the Abu Dhabi Investment Authority (ADIA) which has invested significantly in renewable projects in the UAE and the UK (“Abu Dhabi Investment Authority (ADIA)” n.d.). ADIA has invested globally in UK’s Thames Water and other renewable energy projects. However, ADIA has failed to invest in other sustainable sectors like healthcare and education.

Another significant challenge SWFs face in the UAE is the lack of balance between sustainable and financial return goals. However, there is an increase in the need for sustainable investing many investment authorities in the UAE struggle to find the balance between sustainable investing and financial returns (Sharma & Chandani, 2022). Most sustainable ventures take significantly longer to provide financial returns, posing challenges for sovereign funds which are accountable to their public and government stakeholders.

Furthermore, the perception that sustainable investments are less profitable and costly than traditional investments is another significant challenge that sovereign funds should address in the UAE. Although most investors want to be part of sustainable projects, most believe they are expensive ventures and risky since they have not been tried and tested (Velayutham & Hasan, 2021). Changing people’s perceptions of the profitability of sustainable investments is a significant challenge sovereign funds face in the UAE. Velayutham and Hasan (2021) state that sustainable investments appear costly and risky due to high initial costs. However, investors should be informed that long-term benefits like reduced operational costs and improved reputation compensate for such challenges. For example, the Mubadala Investment Company invested in the UK’s offshore wind energy sector, which appeared costly and risky but has achieved a long-term stable return on its initial investments.

Despite the challenges of sustainable investing, sovereign funds in the UAE should devise ways to overcome these challenges to leverage the benefits of sustainable financing. Careful planning and collaboration can be used by sovereign funds to promote sustainable development in the UAE.

Sovereign Funds’ Performance in the UAE

Several existing studies exist on the performance of sovereign funds in the UAE, like the Investment Corporation of Dubai (ICD), the Abu Dhabi Investment Authority (ADIA), and Mubadala.

Figure 2: The figure shows the investment activities of sovereign funds in the UAE from 2018 to 2022 (https://www.thenationalnews.com/business/economy/2023/01/02/gulf-sovereign-wealth-funds-set-to-shine-more-than-ever-in-global-markets-in-2023/).

From the chart above, it is evident that investment activities of sovereign funds have increased over the years (Kamel, 2023). Sovereign funds in the UAE are constantly looking for newer investment opportunities mostly in sustainable projects like renewable energy.

An investigation by Ayat (2023) sought to identify and analyze the investment strategies used by sovereign wealth funds in the UAE like the Mubadala and the ADIA. The analysis revealed that the ADIA and Mubadala use diversification as their main investment strategy (“Mubadala,” n.d.). Through diversification, the two sovereign wealth funds have allocated significant portions of their portfolios to non-oil sectors like real estate and healthcare. The study further established that diversification had been an effective investment strategy for ADIA and Mubadala as it has helped them reduce risk and tap into several profitable sectors. The investigation further established that the funds had invested in sustainable projects like clean technology and renewable energy.

Figure 3: Sovereign wealth funds’ investments in 2022 in Billion dollars (https://www.bloomberg.com/graphics/2023-middle-east-wealth-funds-with-more-money-than-uk-gdp-become-world-bankers/?leadSource=uverify%20wall).

A Bloomberg report sought to ivestgate the investment activities of the top five Middle East state sovereign funds. Out of the five, the UAE managed to produce the two leading sovereign funds in terms of investments (Martin & Nair, 2023). According to the report, the top five sovereign investment funds invested more than $20 billion in 2022.

A study by Ćuzović (2018) sought to analyze the financial performance of ICD and ADIA. The study established that ADIA had performed better than ICD when it came to risk-adjusted returns in the past five years (“Investment Corporation of Abu Dhabi (ICD),” n.d.). The study further established that both funds had used diversification as their main investment strategy and focused on asset classes like real estate and private equity.

Garg and Shukla (2021) also sought to analyze how sovereign wealth funds promote sustainable development in the UAE. The study established that the UAE has successfully been using sovereign wealth funds to promote sustainable financing through approaches like establishing sustainable investment funds and issuing green bonds. The study also found out that all the major sovereign funds in the UAE are investing in sustainable projects like renewable energy to increase their returns.

The analysis shows that sovereign investment funds in the UAE have been actively promoting sustainable financing by investing in sustainable projects. Despite the active investment in sustainable projects, most of the investment is in the gas and oil sector, which raises queries about the extent to which sovereign funds in the UAE are dedicated to promoting sustainable development.

Key Performance Indicators (KPIs) For Measuring Sustainable Financing

Several KPIs can determine the success of sustainable financing initiatives in the UAE. Through the KPIs, sovereign funds in the UAE can analyze and assess their investment strategies and establish whether they promote sustainable financing. KPIs also help sovereign funds identify areas of weakness and work on them.

One main KPI for measuring sustainable financing in the UAE is carbon footprint reduction. Carbon footprint reduction measures the reduction of carbon emissions as a result of investing in sustainable projects and can be used to indicate the success of sustainable financing initiatives (Garg & Shukla, 2021). Some main carbon footprint reduction activities include measuring the amount of carbon reduced by sovereign funds by investing in energy efficiency infrastructure or renewable energy.

Environmental, social, and governance (ESG) integration is another KPI that can measure sustainable financing in the UAE. The effectiveness of ESG integration can be measured by looking at the number of investments that meet the ESG criteria (Garg & Shukla, 2021). Tracking the performance of sovereign funds and how they impact society, the environment, and governance is another way that can be used to measure the success of ESG integration.

According to Shamim and Munshi Naser (2022), Green bond issuance is another important KPI when measuring sustainable financing by sovereign funds in the UAE. The issuance of green bonds is an indicator of sovereign funds that are committed to sustainable financing. An effective way of tracking the success of sustainable financing strategies includes analyzing the number of green bonds issued and how they impact sustainable projects.

Finally, Shamim and Munshi Naser (2022) state that reporting and transparency are effective KPIs when measuring the effectiveness of sustainable financing in the UAE. Tracking the frequency and quality of sustainability reporting is one of the main ways sovereign funds in the UE can measure the effectiveness of their reporting. Sovereign funds that regularly issue sustainability reports are more likely to promote sustainability financing than those that do not provide sustainability reports. The level of stakeholder engagement and the integration of sustainability information in decision-making processes is another way sovereign funds measure their contribution towards sustainability investments.

From the analysis, it is evident that sustainable financing significantly improves sovereign funds’ performance in the UAE. Sovereign wealth funds in the UAE have effectively promoted sustainable projects through the issuance of sustainable financing instruments. The literature analysis further reveals that the best sovereign fund model that accommodates financial performance and sustainable financing invests in sustainable projects and issues sustainable financing instruments like sustainability-linked loans. Therefore, sovereign funds in the UAE should continue diversifying their investments and reduce their dependence on the oil and gas sectors to improve their financial performance and sustainability.

References

Abu Dhabi Investment Authority (ADIA) (n.d.). Investments. https://www.adia.ae/en/investments

Ayat, S. D. (2023). UAE Sovereign Achievements and Future Aspirations in Vision 2030. AAU Journal of Business and Law, 7(1)https://doi.org/10.51958/AAUJBL2023V7I1P2

Ćuzović, Ð. (2018). SOVEREIGN WEALTH FUNDS INVESTMENT STRATEGIES. Ekonomika, 64(4), 121-134. https://doi.org/10.5937/ekonomika1804119C

Garg, R., & Shukla, A. (2021). The impact and implications of SWFs: a systematic review of literature. Qualitative Research in Financial Markets, 13(5), 580-607. https://doi.org/10.1108/QRFM-08-2020-0171

Investment Corporation of Abu Dhabi (ICD) (n.d.). About ICD. https://icd.gov.ae/

Kamel, D. (2023 January 2). Gulf sovereign wealth funds set to shine more than ever in 2023.  The National News. https://www.thenationalnews.com/business/economy/2023/01/02/gulf-sovereign-wealth-funds-set-to-shine-more-than-ever-in-global-markets-in-2023/

Martin, M., & Nair, D. (2023 January 18). The new bankers to the world aren’t on Wall Street. Bloomberg. https://www.bloomberg.com/graphics/2023-middle-east-wealth-funds-with-more-money-than-uk-gdp-become-world-bankers/?leadSource=uverify%20wall

Mubadala (n.d.). Investing for the Nation. https://www.mubadala.com/

Shamim, A. S., & Munshi Naser, I. A. (2022). Sectoral diversification of UAE toward a knowledge-based economy. Review of Economics and Political Science, 7(3), 177-193. https://doi.org/10.1108/REPS-07-2021-0075

Sharma, J., & Chandani, A. (2022). Sovereign Wealth Fund and Economic Indicators: An Exploratory Study. Cardiometry, (24), 825-834. https://doi.org/10.18137/cardiometry.2022.21.825834

Velayutham, S., & Hasan, R. (2021). Sovereign wealth funds and corporate social responsibility: a comparison of Norway’s Government Pension Fund Global and Abu Dhabi Fund for Development. [Sovereign wealth funds and CSR] Public Administration and Policy, 24(2), 139-151. https://doi.org/10.1108/PAP-08-2020-0037