Only two Middle East-based banks were founding signatories to the UN’s Principles for Responsible Banking – and both were Egyptian. The country’s government was among the first to introduce a sustainable development strategy in the wake of the Paris Agreement, while the sovereign was an early issuer of green bonds. Playing host to COP27 last November was the icing on the cake.
Hosting the UN climate conference has clearly focussed the minds of Egypt’s policymakers and industry executives. The Central Bank of Egypt (CBE) introduced guiding principles for sustainable finance in July 2020, which covered a broad range of topics, including capacity building, stakeholder involvement and climate risk management. These guiding principles lasted just 18 months until November last year, when – three days before the start of COP27 – the central bank issued binding regulations with specific requirements and timelines.
Speaking to bank executives in Cairo, there is a clear suggestion that the new regulations are as aggressive as they are progressive.
“This is no elevator pitch,” says one. “It is a broad mandate banks have to follow, and there will be monitoring.”
The regulations’ breadth reflects the fact that sustainability is a comprehensive issue: banks are being asked to bolster their green portfolios, introduce sustainable finance products and assess environmental risk across projects. Lenders need to put in place new policies and procedures; create and staff new sustainable finance departments; and prepare and publish annual sustainability reports.
The timeline for tackling these new requirements is not overly generous. Sustainability reporting has to start from 2024 at the latest. Creating departments and policies and demonstrating proof of progress have deadlines that fall in 2023.
This might seem onerous, particularly as banks are still in the process of clarifying some aspects of the rules with the regulator. But a change in mindset over the last few years means that Egyptian lenders are not at a standing start. Several banks have made great headway in pushing sustainability to the fore.
A shift in mindset
Unsurprisingly, it is the largest and more sophisticated banks that find themselves best placed to respond and adapt to the new framework.
Commercial International Bank (CIB) – the country’s largest private-sector lender – was a founding member of the UN’s Net-Zero Banking Alliance (NZBA) and is the only Egyptian bank to have issued a green bond.
You cannot approach green bonds as a standalone product. It requires cross-functional system transformation to be effectively implemented
Broadening the use of green capital market products will be crucial to growing the share of renewables in Egypt’s fossil fuel-dominated energy sector, and in attracting a new cohort of green investors. But stepping into green finance also necessitated a fundamental change to day-to-day business for CIB.
“You cannot approach green bonds as a standalone product,” says Dalia Abdel Kader, chief sustainability officer at CIB. “It requires cross-functional system transformation to be effectively implemented."
The bank’s board has made it clear that a sustainable finance strategy is part and parcel of the firm’s corporate strategy.
The lender has also introduced a highly structured approach to integrating sustainability across its operations. This involves addressing everything from governance and capacity building to education and communication. Departments now have key performance indicators based on both environmental, social and governance (ESG) outcomes and financial performance.
"It is a challenging journey," says Abdel Kader. "CIB is still in that process, but we've caught up to international standards in record time."
HSBC Egypt is similarly well advanced on its sustainability journey.
As a global bank – and another member of the NZBA – many of the new regulatory requirements are relatively straightforward. HSBC Egypt already has a dedicated ESG specialist on its risk team, for instance.
In other areas, the lender will focus on making sure that its existing sustainability procedures match the CBE’s new requirements and fill in any gaps.
Todd Wilcox, chief executive at HSBC Egypt, says one priority on the sustainability front is large infrastructure projects of the sort that fall under the government’s Nexus of Water, Food and Energy (NWFE) programme. HSBC Egypt is one of the partners for the programme, alongside the Glasgow Financial Alliance for Net Zero (GFanz) coalition and several multilateral development banks.
“We’re well placed to support this because many of the parties engaged are our clients,” says Wilcox. “These are the kind of projects that will fall under the Central Bank of Egypt’s sustainability regulations, which we’ll be reporting on from the start.”
From July this year, banks will need an independent environmental consultant to review risks for any large corporate project. Lenders then have to take into account the environmental review outcome when making credit decisions.
Some of the banks have excelled in building up risk assessment – knowing what is coming, what kind of risk they are entering into and managing and reporting on those risks
Questions remain about which industry will provide a pool of certified independent environmental consultants, but the focus on reporting across infrastructure endeavours is clear.
For much of the 2010s, executives trying to build banks’ capacity to assess climate risk struggled to make headway. Bankers in Egypt – as in many other countries – found the idea of imposing social and environmental requirements on their operations needlessly arduous. But much has changed.
Hashem Abd El Hakim, head of financial institutions for Egypt at the European Bank for Reconstruction and Development (EBRD), says that when he left Egypt in 2015 there was little interest in ESG risks.
“When I came back in 2019, I noticed a huge change,” he says. "Now banks are actively looking for support from the [development financial institutions] to make sure they have the appropriate platforms for assessing ESG risk and providing a better risk-management approach for clients.”
As to what drove the change in mindset, industry executives say the impact of climate change and unsustainable economic activity has become increasingly apparent to both the government and the banking sector.
Egypt has weathered flooding and droughts for thousands of years. But modern water scarcity is a far more fundamental threat. The country’s population rose from 27 million in 1960 to over 100 million by 2020.
There’s a step change occurring here, and firms are putting capital to work in order to prepare for the future
Climate change has increased the frequency of hot dry years. Available water per person is just 560 cubic metres each year – far below the UN’s 1,000 cubic metre definition of water scarcity. Air pollution has been a serious issue for decades, particularly in large cities such as Cairo. Health ministry estimates suggest up to two million people each year have to seek treatment for respiratory problems linked to air quality.
The EBRD has been working with Egyptian banks for several years to improve risk assessment. There is obviously variation across the sector, but several lenders have brought themselves up to international standards remarkably quickly.
“Some of the banks have excelled in building up their capacities to assess such risks – knowing what is coming, what kind of risk they are entering into and managing and reporting on those risks,” says Abd El Hakim.
In sectors where a bank lacks expertise, entities like the EBRD and IFC are there to offer support. Not all lenders have developed comprehensive risk-assessment systems, but with guidelines turning into binding regulations things will improve.
“I think you’ll see huge development in banks' approach to ESG risks following the new central bank regulations in November and following the COP27 event in Egypt, which stressed the need for all stakeholders to act immediately,” Abd El Hakim says. “Now the regulator is really making sure lenders have proper social and environmental risk management in place and promoting the concept of climate finance.”
Taking transition seriously
Better risk management is essential, particularly in light of the government's green infrastructure ambitions. Blessed with sunshine and strong wind, the government is aiming to have renewable energy supply account for 42% of power capacity by 2035. During COP27, the European Commission agreed to provide up to €35 million for Egypt’s Energy Wealth Initiative.
This endeavour aims to shut down 5,000 megawatts of existing and inefficient gas-based power generation capacity and support investment in 10,000MW of new renewable capacity.
As part of a separate memorandum of understanding, Egypt and the European Commission agreed to deepen their collaboration on renewable hydrogen.
With some exceptions, most commercial banks are relative newcomers to green energy financing, but the regulatory push means conditions are ripe for a rapid expansion.
“Banks are trying to lower their financed emissions and act as a champion for the energy transition by substituting traditional energy projects with renewable and green ones,” says Suzan Hamdy, chief financial inclusion, sustainability and business development officer at Banque Misr.
If this green and sustainability lending does become a large part of these banks’ loan books, I think that is going to take a long time
At present, Egypt’s oil and gas sector – which accounted for 24% of GDP in 2020 – continues to cast a long shadow on lending books.
“The oil and gas industry acquires a large share of the lending portfolios in Egyptian banks,” says Hamdy, noting that it is the second largest sector in her firm’s portfolio.
Oil and gas will continue to be the lifeblood of the Egyptian economy for some time yet, but there is scope for big efficiency improvements. Egyptian entities signed a host of agreements on the sidelines of COP27 aimed to accelerate sustainability and decarbonization efforts across the Egyptian sector.
The Bechtel-led consortium Coalition for Decarbonization and Egyptian Liquefied Natural Gas (ELNG) will together assess implementation of a zero-flaring system at gas terminals. Egyptian Natural Gas Holding Company (Egas) and Shell Egypt will create a framework to manage emissions. Egyptian General Petroleum Corporation, Egas and TotalEnergies will study options to decarbonize the local petroleum industry.
Hamdy at Misr notes that the ministry of petroleum and mineral resources is working on 16 projects with more than a dozen companies, which would enable the oil and gas sector to recover 25 million cubic feet of gas per day and offset 584,000 tons of CO2 emissions.
“Oil and gas companies are trying to make up for their negative impact on the climate via corporate social responsibility and sustainable development projects,” she says. “And on the other hand, banks are keen on financing projects within the sector that would cut emissions.”
Some of these initiatives are early stage, but the direction of change is important.
The CBE regulations do not prevent banks lending to the oil and gas sector. But lenders increasingly want clients to have a coordinated pathway for emissions reduction.
“The transition to net zero is of key importance to HSBC’s strategy,” says Wilcox. “At the core of our net-zero ambition is a commitment to support our customers in their transition journeys, and we've had ongoing discussions with clients, including in the energy sector, that have projects underway to ask: what is your transition plan?”.
The business case
A second priority for HSBC is small and medium-sized enterprises, which account for over 90% of Egyptian firms and where market forces are driving clients towards sustainability faster than expected.
Wilcox points to an Alexandrian garment manufacturer shifting to green production in order to keep supplying European fashion houses.
“There’s a step change occurring here, and firms are putting capital to work in order to prepare for the future,” he says. “We’re determined to become the bank of choice for our clients embracing those projects.”
Exporters often have a stronger motivation than more domestically oriented firms to get serious on sustainability, but even local businesses are keen to see where they can make improvements.
Fintechs may have expertise in developing digital platforms or technologies that can help traditional banks better assess and manage environmental, social, and governance risks
The market has come a long way from the days when lenders were reluctant to raise the issue of environmental risks for fear of turning away a client.
"Conventionally, bankers are concerned that the client might opt to go to a competitor who is less demanding on ESG criteria," says Abdel Kader.
But CIB puts great emphasis on demonstrating the business case for sustainability to its clients.
The bank has its own 'sustaining SMEs' lending initiative and a 'sustaining sectors' programme tailored to different industries.
"We started educating clients and potential clients on the business case with walk-through audits and demonstrating that sustainability is the only guarantee to sustain profitability and growth in a dynamic landscape," says Abdel Kader. “I always guard against discounted rates as an incentive – clients need to see ESG as a business booster and understand that they can monetise the environmental and social improvements and make a good profit.”
The social and governance components of ESG will also influence how banks approach lending. In many cases, boosting lending in ways that promote social improvement and reward sound governance requires making sure “the market comes together”, as one banker puts it.
The EBRD’s Women in Business programme, for instance, supports female Egyptian entrepreneurs setting up their own companies.
Development lenders can help ensure women-led companies build the right governance structure and business plans, allowing them to connect with Egyptian lenders eager for bankable projects to improve their ESG portfolios.
Governance also comes into play when looking at how banks interact with their country’s booming fintech industry, which is hungry for both collaboration and credit.
Imane Adel, executive vice-president of strategy at payment solution provider Paymob, sees plenty of potential for fintechs and traditional banks to work together to improve sustainability across the financial sector.
One option is to collaborate on developing innovative financial products and services that incorporate sustainability considerations.
“For example, fintechs may have expertise in developing digital platforms or technologies that can help traditional banks better assess and manage environmental, social, and governance risks in their investment portfolios,” she says. “Traditional banks, on the other hand, may have the necessary regulatory expertise and relationships with regulators to help fintechs navigate the complex landscape of sustainability-related regulations.”
Many lenders are keen to both partner with and provide finance to fast-growing fintechs. But ESG considerations mean lenders have to be selective.
“We’ve been investing significant attention on the tech space – and there’s now huge growth across greentech and fintech,” says Wilcox at HSBC. “We want to attract those companies where sufficient governance processes are in place. We often tend to focus on those companies that have come through a good accelerator or venture capital route.”
A helping hand
Analysts and executives are expecting sustainable lending to increase relatively quickly from a low base following the new central bank instructions. But at present there is little sign of a sector-wide change.
“Banks are still building up their sustainable finance portfolios and the impact on the loan book probably won’t become visible to us for six months or so,” says Redmond Ramsdale, head of Middle East bank ratings at Fitch Ratings. “If this green and sustainability lending does become a large part of these banks’ loan books, I think that is going to take a long time.”
Emerging markets are not capable of progressing in this field on their own. Local and international development finance institutions are key players in overcoming this challenge
Particularly for smaller and less sophisticated lenders, most of the increase in green and sustainable lending is likely to be done through subsidised loan programmes provided by the central bank and international financial institutions.
“That is going to be the area that grows the fastest, because it is good-quality lending and beneficial for the risk profile,” says Ramsdale.
The CBE has launched a range of initiatives to promote the green economy. This includes funding commercial bank credit facilities for things like irrigation improvements and renewable energy. Funding is also available for programmes under the government’s strategy to increase the use of natural gas, which includes initiatives to convert bakeries, cars and fuel stations to natural gas. This again touches on the desire to utilise Egypt’s abundant natural gas resources while still being able to point to at least marginal gains in efficiency – if not actual decarbonization.
The EBRD’s Green Economy Financing Facility is another avenue available to Egyptian banks. The facility provides participating banks with €140 million to finance a range of projects within the green economy sphere – from wastewater and recycling to energy-efficient buildings and renewable power.
Arab African International Bank, Alexbank and QNB Alahli have all signed on to participate.
In addition to financing, the facility provides lenders with technical assistance on climate finance, which local lenders say is crucial to building expertise across the industry.
“Emerging markets are not capable of progressing in this field on their own,” says Hamdy. “Local and international development finance institutions are considered key players in overcoming this challenge.”
Enacting change
One hurdle on the road to proper risk assessment and disclosure is data, which is a challenge for banks and their clients.
“Mandatory ESG reporting requirements are coming in for banks and listed companies and non-bank financial services firms at the same time,” says Hamdy. “Companies will have to provide the CBE and the Financial Regulatory Authority with frequent updates on their progress, which will most probably require data digitization.”
Maria Bazhanova, senior director at Sustainable Fitch, says data is the biggest challenge for banks when it comes to ESG. The quality of lenders’ disclosures and the lending decisions they make are reliant on getting good quality data from clients. Similarly, there is a base level of standardization necessary to make comparisons.
Another challenge for the banking system will be “moving to a triple bottom line”, says Hamdy. Banks and organizations should commit to measuring their social and environmental impact in addition to their financial performance. This will require a culture shift across the financial industry.
“There’s still a long way to go,” says Abd El Hakim. “Putting a legal framework and guidelines in place is part of it. But a time will come when a bank has to decide whether to overlook aspects of environment or social risk in order to make a profit on a certain project. The entire firm has to be on board in order to make sure it makes the proper assessment.”
But the banking sector seems to recognize that a wholesale shift is needed, and industry bodies are doing their part to coordinate.
The Federation of Egyptian Banks (FEB) set up a sustainable finance committee in 2021, chaired by Abdel Kader at CIB. The federation has its own strategic action plan designed to help banks improve sustainability across governance, risk and product development.
“The FEB is planning on setting up induction programmes and capacity-building initiatives for all banks in cooperation with the Egyptian Banking Institute,” says Abdel Kader. “So you have the Central Bank of Egypt’s efforts being supported and amplified by the Federation of Egyptian banks and Egyptian Banking Institute – this is a very powerful trio through which to enact change.”