FOCUS INCREASINGLY MOVING TOWARDS MEASURING IMPLEMENTATION OF STRATEGIES

While listed companies are working hard to improve ESG outcomes, the reality in South Africa with its struggling economy and high unemployment levels is that for many smaller companies, cutting costs is a priority. Their focus tends to be on community inclusiveness.

The inaugural Intellidex Environmental Social Governance (ESG) Barometer (South Africa) demonstrates impressive buy in to the concept with all but two of the JSE listed companies surveyed adopting ESG policies and strategies. Indications are, however, that South African companies may actually be lagging the leaders in some ESG reporting trends.

While the local focus is on the adoption of policies and strategies –implying an emphasis on financial risk rather than the impact these companies are having on the environment and social issues – the global investment focus is increasingly moving towards measuring the actual implementation of these strategies. There is also a strong drive abroad to achieve standardisation on ESG criteria with ESG ratings agencies using their unique methodologies that often don’t relate to each other.

“Imagine accounting, if we didn’t have a standard way of measuring accounting so anyone could label something as an asset or a liability on the basis of a whim,” says Brett Wallington, MD of Paragon Impact, which uses a digital tool and methodology to help companies around the world analyse their ESG performance. He says that shift is now beginning to happen. “If you are not doing ESG your social licence to operate is severely harmed, affecting your legitimacy regardless of whether you are a private or public company.”

Although there is as yet no regulatory requirement for JSE-listed companies to embrace ESG strategies, Laurie Hammond, senior associate at law firm Hogan Lovells, says there are several long-standing policies and laws in place which encourage good corporate governance.

One example is the 2008 amendment to the Companies Act which requires certain firms to have social and ethics committees to monitor good corporate citizenship, environment, health and public safety, consumer relationships and labour and employment. Others include the voluntary Responsible Investing in South Africa initiative to provide guidance to institutional investors in developing and implementing sustainable, responsible and longterm investment strategies; and the King IV Report on Corporate Governance for South Africa embracing voluntary principles and practices to be applied – and set out in sustainability reports – in order to substantiate claims of practising good governance.

Wallington, however, observes that some sustainability reports are increasingly becoming documents that have a marketing feel about them, “telling a great story while staying very quiet about the negatives”.

Hammond points out that E, S and G policies have been around South Africa for a long time but it is only recently that they have been bundled together under the ESG umbrella. Thanks to these historical initiatives, according to Wallington, South African companies are at the cutting edge of reporting.

“We are now experiencing a growing compliance requirement that is a director’s responsibility, so it is not just about competitive advantage but now it’s about regulation. “Furthermore, there is a strong drive – emanating primarily from Europe and Britain with bodies like the International Sustainability Standards Board – to consolidate all the different indicators into one system of reporting. And, on the corporate side, you have the new Corporate Sustainability Reporting Directive – new EU legislation requiring all large companies to publish regular reports on their environmental and social impact activities – probably being promulgated in mid2024.” Another is the Sustainable Finance Disclosure Regulation –a European regulation aimed at improving transparency in the market for sustainable investment products and preventing greenwashing.

Wallington says South Africa used to have some of the best integrated reports and the best coverage of Global Reporting Initiative (GRI) reporting for sustainability data. “However, we seem to have fallen behind. Europe is now taking over and pushing hard on the ESG regulatory agenda. Now we are probably going to have to watch and see what happens and then follow suit.”

Keeping pace with European trends is important for our international trade prospects but the reality is that locally, given South Africa’s challenged economy and other issues, many companies are just trying to survive and on the face of it adopting ESG policies and applying these strategies may seem to be a luxury they cannot afford.

“It’s very tough for organisations to apply ESG principles when their focus is just on turning a profit,” says Wallington. “The reality is that it is mostly the big guys with big capital behind them – like the Old Mutuals of this world and the banks that are the leaders in this space.”

But the dilemma that the survivalists face, he adds, is that ESG is going to become increasingly essential for any organisation aspiring to global competitiveness. “If you don’t get on the train you’re simply not going to qualify to do business with the large European and British companies,” he says.

Despite these challenges, Lullu Krugel, ESG platform lead for consultants PwC Africa, believes there has been something of a step change in terms of how companies have viewed ESG over the past few years, particularly the last year. “There is a realisation that ESG should be part of who we are; it’s not something that is outside, it should be a cornerstone of our strategy.” At the same time though, she says companies are feeling immense pressure from the local and global economic climate and they realise the plans that they have in place and the rate at which they are moving at the moment is not sufficient to meet what we will need in a couple of years’ time.”

It is probably for this reason, according to the ESG Barometer (which canvassed the views of 21 JSE top 40 companies accounting for over 20% of the Top 40 Index’s market capitalisation) that only two of those surveyed did not have defined ESG policies and strategies in place.

Of the two, the one company had not fully committed either way –possibly indicating that a dedicated ESG strategy was perceived as not being worth the hassle, or that it was not distinct enough from what the company might already be doing from a CSI perspective. In the other case, the company operated a decentralised business model, preventing the imposition of a top-down strategy – in this case individual units would need to develop their own plans.

One of the findings to emerge from the survey revealed that the main reason for most companies having an ESG policy was to achieve a positive impact on society and to attract investors.

But it is far more complex than that. Dr Tsakani Mthombeni, sustainable development executive at platinum group metals mining house Implats, says: “Obviously, a company like ours must satisfy and create value for all stakeholders, including investors, through returns, but we also have to satisfy society through our taxes paid to governments, our social projects delivered, our jobs created, the salaries we pay, the local economic development we stimulate by procuring goods and services from communities surrounding our operations, the supply chains and SMMEs we create, upskill and grow, the housing, schools, clinics, libraries and sports centres we build and support, the bursaries we provide and the skills development we provide to mine-host communities –employees through salaries, incentives, wellness benefits, skills development and support and customers through the responsibly mined, superior products we deliver.”

He says that for Implats, sustainability is the strategic pillar rather than a narrower focus on ESG. “ESG is a useful metric to show investors how you are doing – but our sustainability agenda is not driven by investor expectations of E, S and G.” And, like Implats, South African Breweries (SAB) which last year launched its formal ESG strategy sees ESG as integral to every aspect of the way the organisation runs its business rather than a separate component.

Barbara Copelovici, SAB’s communitie and entrepreneurship director, stresses that the ESG policy is not a separate entity, but a core of its business and part and parcel of the organisation’s overall policy.

She says ESG, as a concept and component part of the drive for a sustainable future, is in its infancy although the elements that contribute to it have been in place and implemented by the organisation over many years. The concepts are applied throughout its operations which include seven breweries, 51 depots and swing depots (depots that receive stock from more than one brewery) and 14 distribution points. “Because ESG is about sustainability it is about the future. We aim to achieve global targets and deadlines in terms of emissions and sustainability –our contribution to climate change. If we aren’t seen to be doing the right thing we will not hang onto our reputation for very long and that will damage or destroy our business.”

The business case for protecting an unsullied reputation is endorsed by Hogan Lovell’s Hammond: “Notwithstanding that principles of ESG have been around for some time, there is a lot of pressure from consumers engaging with companies, especially technology companies, for transparency on the ESG strategies and the corresponding progress of any statements, pledges and policies. Where companies are not transparent or are merely making ‘greenwashing’ statements, without actually adopting any principles from pledges or policies and making the necessary investment by companies, this is likely to influence consumers’ decisions to engage with such companies,” he maintains.

It could also result in formal penalties where misleading claims are made. Regulators across the world, he says, are increasingly concerned about “greenwashing”, where companies describe products or investments as “climate-neutral”, “eco-friendly” or “ESG-compliant”. These types of statements are found more and more frequently on products and in advertising campaigns and investment brochures. Globally, there have been a number of high profile cases and multimillion-dollar fines for companies that have misrepresented their green credentials.

In another finding, respondents told the Intellidex ESG barometer researchers that they believe the most relevant risks to their operations related to climate change, greenhouse gases, and the responsible use of water.

SAB’s Copelovici concurs, but says it is broader than that: “We have over recent years endured a series of extraordinary events, both natural and otherwise, ranging from extensive flooding to the coronavirus pandemic and even electricity load-shedding, all of which have a potentially negative impact on sustainability and ESG. In our case one of our production facilities was severely damaged by flooding and we realised that it was vital to include scenario planning and preparation for unpredictable events that could affect sustainability and ESG – in essence, risk mitigation.”

It also emerged from the barometer that since implementation, 71% of respondents believed their organisations’ reputations among the general public had improved compared with less than 30% who believed it was unchanged. The barometer also found that nearly 60% believed operational performance had improved since implementation of ESG while the balance felt that it had stayed the same and 71% of respondents claimed the cost of capital had improved since adopting ESG policies.

When it came to the expectations for financial returns on ESG projects, nearly 40% of companies believe their returns exceeded the cost of capital, just over 40% found it to be on a par and less than 5% achieved returns below the cost of capital.

While PWC’s Krugel agrees with the barometer that the main reason for most listed companies having an ESG policy relates primarily to achieving a positive impact in society and attracting investors, she says there is something of a dichotomy between the listed companies and other organisations. “Certainly with listed entities, one of their primary considerations is how do they use ESG as a differentiator from their competitors so they are seen as different and how will it benefit them if they need access to capital and attract investors.

“The big companies that do business with Europe, in particular, tell us that they realise that if they want to export to those markets they will be expected to meet certain requirements – like the carbon border adjustment tax introduced by the EU – and other similar legislation that is coming through, which means that the regulatory environment is of major concern to them.”

In contrast, “the smaller family businesses and larger unlisted organisations tell us that their ESG is focused on the big role that they play in the communities in which they operate. It is not formalised in the same way so the priorities are different to those of the listed entities.”

This view is endorsed by Philippa Rodseth, executive director of the Manufacturing Circle, a voluntary industry association for more than 50 generally larger manufacturing companies in different parts of the value chain. “Manufacturers must contend with the whole spectrum of ESG challenges from legal, through environmental and risk to regulatory, reputational challenges. ESG will not go away. It is clearly something that will become increasingly rather than decreasingly the important in terms of meeting the challenges of climate change and social challenges. And investment will have to keep pace with the demand for change.”

However, she adds the proviso that in terms of sustainability the biggest challenge currently is the lack of demand for manufactured products in a lacklustre economy. Because of this, areas of focus include cost-cutting issues and identifying demand-side opportunities for products and addressing many supply-side challenges.

A supply chain view is absolutely critical, not just from an export perspective but because it has to do with profitability and sustainability and the circular economy. This is an area where many manufacturers are focusing – where one manufacturing operation’s waste is the raw material for another’s production process.

“Manufacturers are at the rock face of ESG in that they use the raw materials to produce the products that are fed into the supply and value chains, and also interact with and have a direct impact on their communities – environmentally in terms of resources they use and any emissions that they might produce. They also have an impact socially in terms of the jobs they provide and wealth creation, along with other inputs into communities such as housing and education and recreation,” says Rodseth.

While the focus for many manufacturers may be primarily local and even parochial, sectors like motor manufacturing must blend this with a major eye on international perceptions of them and issues that affect them.

National Association of Automobile Manufacturers of South Africa CEO Michael Mabasa believes that the motor industry is at the forefront of ESG partly because transport, particularly road transport, is seen globally as one of the largest atmospheric greenhouse gas emitters. “The other aspect is that it is a global industry where we manufacture for the local and export market and many of the OEMs servicing the motor industry have centralised their environmental specific priorities at a global level because they involve global supply chains.” He points out that only 39% of the components used in the manufacturing process are actually sourced locally – the balance is imported. “It is, therefore, easier for them to then report globally in relation to their environmental footprints.”

At the same time, he adds, motor vehicle manufacturing is critical to the local economy, not just in terms of what happens on the production line, but also in terms of the materials, including raw materials, that are sourced and used right through the value chain, such as the steel used in the vehicles or the rubber, the plastics, the alloys and everything else that goes into the production process.

“It is obviously in our interest to ensure that we focus on building vehicles to a final product that is absolutely sensitive to environmental priorities. To achieve this we work with multiple sectors of the economy, whether mining or other manufacturing sectors, to ensure that as we set our own targets with regards to aspects such as carbon neutrality, we also work with those providing different services in a way that they help us to reduce our carbon footprint.”

Ultimately, however, it must be appreciated, as Hogan’s Hammond puts it: there is no one size fits all approach with ESG. What works in Europe or Brazil may not work in South Africa. The local context is key.

For example, in the US and European markets the main focus is on the E – environmental issues and the green economy. This focus on green opens companies up to a lot of funding and investment. In South Africa and other less industrialised countries, there needs to be more focus on investment on the S, though with environmental concerns increasing. South Africa has always been strong on corporate governance with the international standards set in the King reports on corporate governance driven locally by the Institute of Directors of Southern Africa.

For South Africa in particular, getting the balance right between the social and environmental will usually lead companies towards greener, more sustainable options.