The State of Responsible Investment in South Africa

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1 The State of Responsible Investment in South Africa Findings from a recent survey with South African institutional investors By Gloudi van der Ahee (Department of Accounting, Stellenbosch University) and Jess Schulschenk (Climate Change & Sustainability Services: Ernst & Young) South Africa is internationally recognised for best practice in corporate governance principles and practice with many countries looking to the King Codes for guidance. With integrated reporting a key recommendation of King III, South Africa has a history of corporate sustainability reporting that has contributed to the country being recognised for the strength of its corporate reporting on key environmental, social and governance (ESG) issues. An international study by Eccles and Serafeim 1 in 12 found that South Africa has a high degree of integrated reporting by companies but very little interest by investors in non-financial performance metrics. The emerging field of responsible investment is a critical component to realising effective corporate governance. Responsible investment is broadly defined as the active consideration of ESG issues into investment decision-making and ownership on the basis of their financial materiality 2. In a recent interview with Philip Armstrong, head of the Global Corporate Governance Forum and convener of the King Committee for the second King Report, he expressed concern that without interest from the institutional investors in ESG issues, there is ultimately little to hold companies to account for performing on key ESG issues. This is supported by research by Blackburne 3 in 12 which found that companies respond more to investors than to regulators. Whilst the United Nations Principles for Responsible Investment (PRI) have sought to raise awareness of and commitment to responsible investment internationally, the Code for Responsible Investing in South Africa (CRISA) is the voluntary code that sets out the governance duties of South African institutional investors in relation to the overall governance system. CRISA was released in July 11 with the backing of major industry bodies including ASISA, POA, IoDSA, SAICA and the JSE. Research Findings We undertook a survey in 12 with South African institutional investors (by contacting both POA and ASISA members) to investigate the extent to which ESG issues have an impact on their decision making, and thereby the degree to which they practice responsible investment. The findings of the study reveal that there has been significant growth in awareness and support for the practice of responsible investment since previous research in 7. Over ninety percent of the respondents were aware of CRISA and PRI (in comparison with only a third of the respondents in a 7 study who were aware of the PRI), and 7 percent were found to endorse and / or subscribe to CRISA and PRI. The institutional investors surveyed felt that companies are motivated to report on ESG performance predominantly from a corporate reputation perspective, followed by compliance and risk management as the key drivers.

2 Reputation Compliance Risk management Capital Growth Figure 1: Motivations for companies to report on ESG issues Over 8 percent of institutional investors indicated that they do consider ESG issues in their investment decision making and more than half indicated that these issues ultimately influence their investment decisions. Responsible corporate citizenship was cited as the most important motivator for such considerations, followed by a commitment to CRISA and increased financial returns. These findings suggest that the responsibility element of responsible investment is critical but that CRISA has played a crucial role in driving the development of responsible investment and that there is increasing appreciation for the long term sustainability of responsibly managed investments. Client demand has increased significantly since the 7 study on responsible investment. 19

3 Personal Client demand Regulation PRI CRISA Return Citizenship Figure 2: Motivations for institutional investors to consider ESG issues The greatest trends influencing investment decision making was found to be corruption followed by employment equality and resource depletion Climate change Resource depletion Employment inequality Poverty Corruption Figure 3: Trends influencing the landscape of companies Whilst all three ESG components are considered important, governance ranked as the most important issue under consideration with all institutional investors considering it to be critical or important.

4 Environment Social Governance Figure 4: Level of importance of the ESG components The lack of sufficient ESG measurement tools is considered the greatest barrier to considering ESG issues in investment decision making. The available benchmarks which are considered 69 percent, 68 percent and 59 percent of the time were BEE scores, non-financial information in integrated report and the JSE SRI Index respectively. Table 1 indicates the extent to which the respondents believe that adequate measurement tools for the three components of ESG issues are available to serve as a basis for their investment decision making. ESG component Yes No Environmental issues Social issues Governance issues Table 1: Availability of measurement tools for the ESG components Industries were also found to play an influencing role on the relative importance of ESG issues. Table 2 summarises the influence of industries on the consideration of ESG issues. ESG components Investment sectors Financial Industrial Resources Environmental issues Social issues Governance issues Table 2: Influence of industries on consideration of ESG issues Furthermore, on average 6 percent indicated that they are willing to pay a premium for sound ESG performance. Of those who indicated that they were prepared to pay a premium, this premium was found to be an average of 14 percent for companies with lower perceived risks in terms of ESG issues, ceteris paribus. 21

5 The State of Responsible Investment in South Africa Performance of ESG components 3.4 Sound environmental performance 22.7 Mean Sound social performance 13 Sound governance performance 17 Client Regulation PRI CRISA Return Citizenship demand Table 3: Premium willing to pay for sound performance of ESG components The majority of respondents (7 percent) valued independent assurance of the disclosure on ESG issues by an external party. Key enablers identified by investors included short courses for providing guidelines and benchmarks for mainstreaming ESG issues. Collaboration with civil society was considered less important. The way forward Other 25 Benchmarks 32 Collaboration 7 Courses 36 The findings from this study provide valuable insights into the extent to which South African institutional investors, who count among a company s most important stakeholders, consider ESG issues in their investment decision making. Support for and practice of responsible investment appears to be a growing trend and a critical component in the development landscape of corporate governance. CRISA is shown to have played an important role in these developments, as has growing client interest and, perhaps most importantly, the increasing appreciation for sustainable value creation. The calls for training programmes to improve adoption of principles and guidelines, supported by benchmarks that provide meaningful ESG measurement tools are important areas of improvement going forward. Figure 5: Enablers for considering ESG issues Robert G. Eccles and George Serafeim, Leading and Lagging Countries in Contributing to a Sustainable Society, Working Knowledge, May 23, 11, hbswk.hbs.edu/item/6716.html 1 UNEP FI. 7. The state of responsible investment: B lackburne, A. 12. The long term matters, and sustainable investment holds the key to prosperity: 22