The ESG metamorphosis is just beginning

If you are tired of being served up an almost daily dose of environmental, social and governance (ESG) news and opinion, then this writer has bad news for you: there will be plenty more ESG-focused content winging its way to an inbox or newsletter you have access to. And despite billions of dollars in institutional and retail investment already flowing to environmentally and socially focused funds, the global asset management industry is still in the first stages of what will become a multi-year ESG metamorphosis.

Disclosure and reporting burden to grow, exponentially

The South African regulators are upping the ante insofar as ESG disclosure and reporting for financial services firms. As proof, consider two media releases produced by law firm Webber Wentzel over the past weeks. In the first, the firm draws attention to a new ESG disclosure framework that is being proposed for local financial services companies. “The South African Reserve Bank (SARB) will shortly issue a draft sketching an ESG disclosure framework for the financial services organisations that it supervises,” writes Dawid de Villiers, Partner at Webber Wentzel. This framework, he opines, is aimed at appeasing the growing cohort that wants businesses to align with ESG ideals. 

“Recent floods in South Africa and droughts, heatwaves and wildfires in the northern hemisphere have highlighted the impact of climate change and the need for governments and corporates to pay closer attention to environmental considerations in their decision-making,” De Villiers writes. At this stage there is little clarity on how the country’s financial sector regulatory framework will evolve to address environmental and social concerns. However, a recent presentation by SARB Deputy Governor, Kuben Naidoo, to an event hosted by the South African Sustainable Finance Initiative (SASFI), throws some light on the matter. 

In that presentation, Naidoo made it clear that both the Prudential Authority (PA) and SARB had a duty to support a resilient financial services sector. His message, according to De Villiers, was that the SARB would “address the challenges and opportunities posed by ESG by creating an appropriate regulatory framework so that financial and other resources could be channelled in the right direction”. Our thanks to Webber Wenzel for their summary of the Deputy Governor’s address, which we have reproduced under the following bullet points. The SARB is: 

• Engaging with domestic banks on their risk modelling to develop a better understanding of banks’ approaches to ESG risks.
• Working on a common ESG taxonomy to ensure consistency across the financial services sector.
• Actively involved with National Treasury’s launch of the South African Green Finance Taxonomy.
• Focussing on ESG disclosures that are based on trust and simplicity, starting with the soon-to-be-released draft consultation document on an ESG disclosure framework for financial services institutions. 

Setting aside the carrot-or-stick approach

“This, the SARB hopes, will allow it to collect comparable data that will enable better quantification and enable it to begin building ESG stress-testing models at a macro level,” writes De Villiers. “In acknowledging ESG influences on financial services sector regulation, the SARB will not rely on the credit risk rating (Pillar II) tools available under the current prudential regulatory framework to incentivise banks to fund projects that are aligned with ESG objectives or disincentivise banks from being involved in projects that do not support ESG ideals”. So, for the time being at least, there will be no carrot-or-stick approach to get financial institutions to improve their environmental and social exposures. However, in committing to “create a transparent regulatory framework that supports ESG initiatives” the central bank has given a clear indicator of its intentions. 

“Ultimately, while acknowledging that there are clear risks, Naidoo said he was optimistic that ESG investments would create significant opportunities that could allow South Africa to take full advantage of its core strengths to serve as a conduit for ESG investments throughout the African continent,” writes De Villiers. Of course, under the twin peaks financial sector regulatory framework, local firms need to keep an eye on the Financial Sector Conduct Authority (FSCA) too. In its second media release covering the broad ESG theme, Webber Wentzel says that the FSCA is taking a number of steps to encourage pension funds to invest in green and other ESG-focused opportunities. 

How regulation 28 facilitates ESG

During the aforementioned SASFI event, Olano Makhubela, Divisional Executive: Retirement Funds Supervision at the FSCA, commented that regulation 28, in force since 2011, is designed to promote responsible investing of pension fund assets. The regulation is based on a sustainable, long-term, risk-aligned and liability-driven investment philosophy and establishes a solid foundation for sustainable, ESG-aligned investment by pension funds. Government has long had its eye on the ZAR4 trillion in the domestic pension fund industry to support infrastructure projects with high social value, though they stopped short of achieving this goal through prescribed assets. Ironically, today’s ESG frenzy means that pension fund trustees and fund members are more likely to entertain investments into impactful and sustainable projects. 

In Guidance Note 1 of 2019, the FSCA offered guidance on its expectations of pension funds insofar as ESG reporting and disclosure. And in 2021, the FSCA, in partnership with the IFC, released the Sustainable Finance Practices in South African Retirement Funds Survey brief, which provided an overview of the progress on sustainable investing by South African retirement funds, as well as identifying barriers and opportunities to unlock the significant potential for green investment. Announcing this survey, the FSCA wrote: “South African retirement funds, despite various known constraints and challenges, are well-positioned to take advantage of new trends in sustainable investing”. 

Future of ‘clean and green’ pension investments

More recently, amendments to regulation 28 were welcomed as introducing infrastructure as a distinct and separate new asset class into which pension funds may invest. “In future, the FSCA is likely to include ESG considerations in the toolkit that it produces to guide pension fund trustees in their decision-making; it will issue guidance notes as opposed to directives, allowing it to develop and fine-tune its approach through learning from and engaging with the industry,” concludes De Villiers. “This approach is aligned with and supported by the efforts of the JSE Limited as is highlighted by their recent publication of the JSE ESG Guide on Reporting and Disclosure”. Set your ‘How to fill in the Omni CBR Report’ brochure aside, dear reader, and brace for the flood of ESG disclosure and reporting requirements that surely await you. 

Writer’s thoughts:
Considering your pension fund’s environmental, social and governance (ESG) footprint is great, provided this focus does not detract from long-term returns. Are you concerned that pension fund trustees could back infrastructure projects on the basis that they satisfy ESG requirements, thus failing to ensure that the fund assets and returns match fund members’ liabilities? Please comment below, interact with us on Twitter at @fanews_online or email us your thoughts [email protected].

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