The JSE has a track record in promoting governance, sustainability and Environmental, Social, and Governance (ESG) disclosure, evidenced by initiatives such as incorporating the King Codes in its listing requirements, being a member and past chair of the World Federation of Exchanges’ Sustainability Working Group.
ESG policies, have their origins in the world of sustainable and responsible investing. The policies and guidelines were developed to address various concerns related to the impact of businesses and organisations on society and the environment, as well as their overall governance and ethical behaviour. Hereby a brief overview of the origins of ESG policies:
1.Early Ethical Investing: The roots of ESG policies can be traced from the early 20th century when certain religious groups and individuals began to avoid investing in industries or companies that conflicted with their ethical or moral beliefs. The Muslim community does not invest in alcohol or tobacco industries. This laid the foundation for ethical investing, which later evolved into the broader ESG framework.
Socially Responsible Investing (SRI): In the 1960s and 1970s, the concept of socially responsible investing gained momentum. Investors started considering not just financial returns but also the social and environmental impacts of their investments. This movement led to the development of screening criteria to exclude investments in industries like tobacco, weapons and the then apartheid-era South Africa, it now extends to many countries to whom arms sales are not permitted.
Environmental Concerns: In the 1970s and 1980s, growing awareness of environmental issues, such as pollution and climate change, contributed to the development of the “E” in ESG. Investors began to look at a company’s environmental practices, including its impact on air and water quality, resource use and carbon emissions. A leading country in this regard is New Zealand. New Zealand has implemented various policies and regulations to address pesticide use and its environmental impact.
2. Governance Focus: Governance, gained prominence in the late 20th century, due to corporate scandals like Enron and WorldCom. The scandals highlighted the importance of strong corporate governance, including factors like board diversity, executive compensation and transparency in financial reporting. In South Africa, great strides in this regard were made by the King reports. The release of the King III report on September 1, 2009 represented a significant milestone in the evolution of corporate governance in South Africa and brought with it significant opportunities for organisations that embrace its principles.
Globalisation and Reporting Standards: The globalisation of financial markets and the need for standardised reporting led to the development of various ESG frameworks and reporting guidelines. Organisations like the Global Reporting Initiative and the UN Principles for Responsible Investment played significant roles in promoting ESG reporting and integration into investment practices.
Regulatory and Investor Pressure: Regulatory bodies in various countries began to recognise the importance of ESG factors in financial markets. They introduced regulations that required companies to disclose ESG-related information. Additionally, institutional investors and asset managers started incorporating ESG considerations into their investment strategies, putting pressure on companies to improve their performance.
Mainstream Adoption: ESG investing gradually moved from niche to mainstream as more investors and companies realised the financial and reputational benefits of ESG integration. Today, many large corporations have dedicated policies and reporting mechanisms in place, and ESG considerations are a standard part of investment decision-making.
3. More attention is being paid to the impact of environmental risk on financial institutions’ lending policies. Large institutions are facing pressure from external stakeholders to better manage their exposures and some regulators are introducing stress testing for environmental risks. Financial institutions are experiencing increasing scrutiny when lending to businesses that face challenges adapting to stricter environmental requirements, including industries such as oil and gas and airlines. The assessment of environmental risks is a major component of Morningstar’s analysis for the property and casualty insurance business. This includes the impact of insured catastrophes on an insurance company’s financial strength, as well as considerations regarding claims predictability, frequency, and severity.
In the financial industry, social risk factors can potentially affect a financial institution’s customer and employee base, as well as an institution’s financial strength. Customers, regulators and the market could view firms with failings in managing data privacy and security extremely negatively. In several cases, financial institutions have paid substantial redress to customers with respect to product mis-selling. In general, financial institutions with retail-oriented operations face scrutiny from regulators to manage social risk factors fairly and can face fines and penalties for failure to do so. The recent trend and threats by banks to close client’s bank accounts are ongoing and the banks may find a backlash from their client base as retail clients disagree with the fairness treatment of selected clients.
Weak corporate governance, as well as inadequate business ethics, can have a detrimental impact on a financial institution, potentially resulting in fines, impaired financial performance, or even the withdrawal of an operating license. An institution’s corporate governance framework includes the ownership structure, as well as the clarity of the institution’s strategy and its execution; the track record and competence of the board and senior management; the organisational structure, reporting lines, and board committees; relationships with regulators; and organisational checks and balances.
4. The tables below illustrate two of South Africa’s listed entities and reference their respective ratings to the global ratings done by Morningstar
5. The JSE’s Sustainability Segment makes it easier to list and trade sustainability related instruments and provides a platform for companies and other institutions to raise funds for activities directed at sustainable development as we transition to a sustainable economy. The JSE claims the following benefits to clients to adhere to guidelines:
Benefits include the following: Enhances a company’s visibility and profile. Demonstrates commitment and contribution to a sustainable economy. Diversifies funding instruments. Provides potential for improved pricing. Allows access to deep pools of capital. Appeals to a diverse investor base with increased market demand for these instruments. Offers a highly regulated and secure trading environment. Allows a company to match the capital raised to their sustainability aligned mandate.
* Kruger is an Independent Analyst