Explore the role of Know Your Finance (KYF) in Saudi Arabia's evolving economic landscape. Learn...
ESG success relies on robust KYC practices to mitigate risks like corruption, environmental crimes, and human rights abuses. For Saudi businesses, strong KYC ensures ethical operations, safeguards reputations, and supports compliance with global standards, making it a crucial investment for sustainable growth and alignment with today’s accountability-focused business landscape.
What do ESG and KYC (known as KYF in Saudi Arabia) have in common?
Clue: it’s more than being a three-letter acronym.
In fact, effective ESG (environmental, social and governance) strategies and programmes to reduce a firm’s negative impact on the environment and its human citizens are impossible without robust KYC (Know Your Customer) – due diligence to understand exactly who a firm is doing business with, what their interests are, and who ultimately benefits from the business relationship.
Understanding, for example, that a client is a PEP (politically exposed person) in a natural resource-rich country where there are high recognised levels of corruption, doesn’t just increase a firm’s risk of corruption and bribery from a financial crime and AML (anti-money laundering) perspective, it significantly challenges its ESG impact. In countries with generous gold or coltan reserves or dense forest regions, like the Democratic Republic of the Congo or Brazil, and Saudi Arabia’s oil reserves for instance, environmental crime is vastly enabled and facilitated by corrupt officials. These environmental crimes include illegal mining and illegal deforestation, which devastate the landscape, wreak havoc with biodiversity, release greenhouse gases into the atmosphere, pollute water sources and leach toxic chemicals into the surrounding ecosystem – none of which is good for a firm’s environmental footprint.
What’s more, they overlap extensively with human rights abuses and violence towards environmental defenders and Indigenous Peoples and local communities and are often undertaken by victims of human trafficking – all of which reflect poorly on a firm’s social footprint – not to mention serious organised criminal activity, terrorist or conflict financing, fraud and drug trafficking (which increases its exposure to financial crime and associated money laundering activity). Saudi businesses that hold relationships with third parties in countries where this sort of activity takes place can find themselves exposed to these risks by association (for example, through investments or client or supplier relationships).
Indeed, although ESG is a vital component of doing business ethically it also makes sense for purely commercial and financial reasons: ESG can confer a distinct competitive advantage to firms in a world where reputational damage (such as social media posts or negative press) can lose a company a hefty slice of its customer or shareholder base and send its share value plummeting.
Investors and clients may perceive controversial ESG incidents or reports as indicative of a lack of ethics or poor management, and the legal and regulatory consequences of such incidents can also be expensive (in terms of fines, reparative PR and necessary subsequent investment in governance and controls to protect against repeat incidents) as well as time-consuming to resolve.
In particular, MSHT (modern slavery and human trafficking) has gained increasing media attention over the past few years, especially in relation to KYC (or lack thereof) and how due diligence should relate to all third parties that a firm is doing business with, whether that’s in its supply chain or as a client.
The well-known case of Boohoo illustrates the reputational and pecuniary risks of breaching social and ethical standards when it comes to forced and exploitative labour. In July 2020, a report by The Sunday Times alleged that workers at Boohoo’s supplier factories in the UK were being paid less than minimum wage and working in hazardous conditions.
Subsequent investigation also revealed that Boohoo’s purported supplier, Jaswal Fashions, had ceased trading two years previously and was no longer one of Boohoo’s declared suppliers; instead, an entirely separate and unidentifiable company was leasing and operating on Jaswal’s former factory premises, with Jaswal signage. Boohoo stated that it was “trying to establish the identity of this company” and to “review our relationship with any suppliers who have sub-contracted work to the manufacturer in question”. The case clearly demonstrates the importance of KYC and of actively monitoring existing partners rather than simply evaluating potential new third-party relationships, as well as the extent to which a situation can combust when this practice is neglected. This global case underscores the importance of KYC and third-party monitoring, a lesson equally critical for Saudi firms managing complex supply chains.
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clients, suppliers, and third-parties for related risk exposure.
Indeed, one study of over 10,000 ESG-related controversial incidents found a negative effect on stock performance (specifically, a decline in valuation ranging from -2% to -5% after six months). Another found that two-thirds of the time, shares underperformed the broader market by an average of 12% (on the MSCI World Index) over the two years following a controversial ESG incident, lagging behind their regional sector by 4%.
Conclusion
In a world where firms increasingly publish ESG reports (or at least have a dedicated section in their annual reports) and where ESG-related due diligence is ever more common, firms who don’t consider ESG - or do so in a sloppy fashion, without shoring it up with robust KYC processes – risk their investor and customer bases, their reputations and their financial performance. Surely it’s better to invest in adequate KYC?
