Globally, ESG investments are expected to reach $53-trillion (R957-trillion), according to estimates by Bloomberg, which could be close to half of the world’s institutional assets. There are many positive implications of this shift, but there is also a significant negative one: it could make it hard for SA to attract international investment.
SA is an outlier on some global environmental, social and governance (ESG) measures. Climate change is now the most prominent issue in the global ESG conversation, and SA has the unique feature of being an emerging market with developed market levels of carbon emissions. It is the world’s 32nd biggest economy but the 15th biggest carbon emitter. It also scores poorly on several governance indicators such as corruption perceptions indices, and components of the World Bank’s Worldwide Governance Indicators, though it also scores well on others such as freedom of the press.
Social measures such as inequality also count against it. In practice, investors use indicators like these to create screening models that either downweight or eliminate investments that score poorly. The practice is already diverting capital away from SA, as investors either downweigh or rule out investment in SA debt or equity. This trend will likely intensify as ESG becomes more universal in investment practice.
This presents a unique challenge for SA. On the one hand it needs to attract very large amounts of investment to finance the transition of the economy, particularly in how it produces electricity. That alone will require investment of up to R14-trillion (R252.8-trillion) by 2050. But on the other, global investors are increasingly shunning it in the name of ESG.
This national picture reflects at the level of companies. Many have weak emissions profiles and score low on sustainability given their reliance on coal-based power and the economy’s bias towards extractive industry. But, again, companies also need to finance the transition of their activities, requiring significant additional capital investment.
The result is perverse. One of the aspirations for ESG is that it helps to allocate investment towards improved environmental and social outcomes, measured against global aspirations like the UN Sustainable Development Goals. But to achieve that, governments and companies need access to funding to invest in the infrastructure that will transition energy systems to reduce carbon emissions and reorient production to more sustainable outcomes.
The ESG approach that screens out or downweighs investments is mostly an outside-in exercise that scans the market for threats to profitability without necessarily changing how those profits are derived. Also, at the same time that it diverts investment from emerging markets, it often enables continued investment in companies domiciled in developed jurisdictions that score highly on the secondary indicators that feed into ESG ratings despite not being truly “sustainable”.
Continued investment in companies that worsen social conflict (for example through arms sales or labour abuses) or that damage the natural environment (for example through fracking, deep-sea mining, or fossil fuel exploitation) will eventually destroy the base from which all profits are made. The costs of escalating social inequalities in some parts of the world and of the climate change crisis are already being felt by businesses and investors.
For example, increasingly severe and more frequent natural disasters damage physical assets and harm the workforce, damaging productivity. The same can be said of riots and protests. As social and climate instability intensifies, the stability of the financial markets and the ability to generate dependable returns deteriorates as well.
Taking an inside-out view that accounts for the effects of business and investment on society could be useful. We might call this approach an “ESG output” orientation, where investment is seen as a tool to actively drive transformative and tangible, measurable change for people and the planet, rather than passively screening out investment opportunities based on incomplete and historical secondary data. It is concerned with the additionality of investments.
This is about whether an investor enables the achievement of some positive environmental or social outcome that would not be possible, or that would be unlikely, without her investment. SA presents a clear opportunity for additionality: by directing capital to finance transition and wider development, ESG investment can actively reduce emissions and improve social outcomes. Additionality can actively reduce negative climate and social effects by proactively investing in and thus being a stimulus for change, rather than merely screening out investments that are linked to negative practices.
However, this is complicated in practice. How do we measure ESG outputs, additionality, transition and change, in clear, consistent ways that are not prohibitively resource-intensive? Most ESG tools are backward-looking in that they rate companies on historic data. ESG additionality, however, is forward looking: it requires assessing the impact that an investment will make on future ESG performance. This requires estimates and forecasts that have not been part of most ESG strategies in the past.
It is clearly in the national interest to advance thinking on additionality. To do that, Business Day has partnered with Sanlam and Intellidex to launch a research and thought leadership project called the ESG Barometer. With the barometer, we will assess approaches and practices relating to ESG additionality among SA’s biggest companies, through a survey of listed companies. The survey findings will be used to identify case studies to explore particularly interesting phenomena in greater depth.
Together, the survey findings and case studies will help us to create a typology of practice, and ways that ESG additionality can be factored into investment decisions. The intention is to highlight to investors how additionality can be far more impactful in their ESG strategies and therefore why it is appropriate to allocate capital to SA.
Investor relations and sustainability officers at listed companies are invited to an information session to explore the project in more depth on 8 November at the JSE in Sandton. For details, please visit: