ESG TOPICS

ISSUES, strategies and frameworks

This section contains a deep dive on ESG topics and investment strategies.

It considers the context of Responsible Investing in terms of the real-world outcomes and impacts.

Global and South African ESG topics are discussed together with national and international frameworks and guidance on corporate reporting and disclosure.

Key ESG topics globally and in South Africa

Introduction

The types of ESG issues that are relevant to investors can vary widely across countries, industries and companies. This section provides short articles of ESG issues that are commonly encountered in RI implementation around the world and in South Africa.

The term “ESG factor” is used here to mean material and relevant investment risks and opportunities for asset owners over the short, medium and/or long-term, and, for the purpose of this tool and in line with the interpretation of Regulation 28 and the FSCA Guidance Note, ESG factors are considered as financial factors.

A prudent investor should integrate these factors into their investment and risk management process.

How to identify and prioritise material ESG topics:

In order to do establish what ESG topics are most relevant to the pension fund, trustees should explore views on megatrends (at the macro / national level), including those of environmental and social nature that are influencing the future investment environment and real economy impacts (impacts at sector and business level), to determine how their institution can best generate returns.

Relevant questions to explore while reviewing this section include:

  • What are the key ESG risks and opportunities in South Africa? Are there ESG-related issues of particular interest to our members? How do these impact the asset classes / sectors / businesses in our investment portfolio?
  • How do we ensure we monetise future financial returns by participating in megatrends?
  • How do we integrate externalities into our investment return framework?
  • Are ESG factors assessed as part of the financial return or separately?
  • How will the ESG performance of investments impact our financial models and company valuations?
 

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Global ESG Topics

The most commonly used global sustainability framework is the United Nation-led Sustainable Development Goals (SDGs) which were adopted in 2015 as part of the 2030 Agenda and

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Climate change impacts and adaptation

Climate change is possibly the largest threat to economic and social development worldwide, as increased global emissions and changes to weather patterns threatens the availability

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Job creation and SME development

Job creation is a critical concern in South Africa, given its persistently high unemployment rate. South Africa has one of the highest rates of unemployment

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Skills shortages

A large gap exists between the demand for and supply of skilled workers in South Africa. Despite high levels of unemployment, private sector job vacancies

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HIV/AIDS

HIV/AIDS threatens the labour productivity of Southern African economies. With HIV prevalence rates among the highest in the world, the impact of this epidemic on

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Financial inclusion

The South African financial sector is expected to play an active role in directing savings towards investments of national priority. The Financial Sector Charter, established

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Technology and innovation

Responsible investment predicates the need to eliminate ‘information asymmetry’ from investments for improving anti-fraud and anti-corruption efforts. The challenge from an investment monitoring perspective at

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Corruption

Technology and Innovation for Leveraging Better Governance Article by: Mr. Nilesh Moodley, ESG Manager, Government Employees Pension Fund Pensions as a form of social security

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ESG Strategies

Introduction

This section provides an overview of the different RI styles that can apply to Listed Equity, Fixed Income and Alternative Investments including Private Equity, Property and Infrastructure.

Responsible Investment (RI) and ESG integration are used as umbrella terms that encompass a range of investment styles and strategies that take into account ESG issues and that can be applied to all asset classes across the whole portfolio.

Neither Regulation 28, the FSCA Guidance Note, nor CRISA are prescriptive about the precise styles or techniques that should be used by pension funds, this is up to the pension funds to decide in line with their investment beliefs, strategy and policy, see Section 1 on Developing a Policy 

The main RI techniques for portfolio construction and ownership decision-making are:

  • Screening (both negative and positive)
  • Integration
  • Active Ownership (shareholder engagement and proxy voting)
Trustees are not expected to become experts in the detail, but must know enough to be able to make decisions, ask questions and hold service providers to account. When starting out with RI it is important to first ensure that the basic ESG risk management and engagement frameworks have been implemented across all the major asset classes in the pension fund’s portfolio. Pension funds need to look critically at each asset class and evaluate what is possible given liquidity, risk, returns and influence. For example:
  • Robust and efficient risk management and engagement, starting with listed equities, with phased implementation across all asset classes, is likely to represent the overall most impactful starting point of the ESG integration journey by South African pension funds.
  • In South Africa, the best exposure to assets that are socially inclusive, low carbon and resource efficient, i.e. the “Green Economy” may be in the Unlisted Markets (Private Equity and Infrastructure). Here pension funds also have board seats and potential to exert control.
For a proposed phased and strategic implementation in asset allocation strategy see the Sample Action Plan in Section 2 of this tool. These different approaches are not mutually exclusive and are often used in various combinations and overlays as illustrated below.

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Negative screening

Negative screening involves the exclusion of certain holdings from the investment universe based on ethical or ESG criteria or factors.  The screening decision is based

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Positive screening

Simple positive screening: Whereas negative screening is designed to remove companies or other assets from the investable universe on an exception basis (by excluding ‘worst

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ESG integration

“ESG integration” is a term that is often used quite loosely, or as in this tool, as a general umbrella term interchangeable with Sustainable and

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RI in the context of Developmental Investment

RI can include very specific, narrowly focused strategies and products that specifically target investment-grade opportunities to finance projects and companies that involve developmental objectives. Developmental

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Application of ESG Strategies Across Asset Classes

The different ESG strategies are not mutually exclusive and are often used in various combinations and overlays.  The matrix below provides a general indication of the suitability of each of these techniques to the different asset classes that pension funds will typically need to consider.

ESG techniques suitability for different asset classes

RI in passive equity strategies

Some investors have the mis-conception that because a manager cannot make active investment decisions in passive strategies, ESG factors cannot be integrated in passive investments

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Fixed income

Sovereign debt instruments: Internationally, RI practices to sovereign debt has evolved over the past few years and all the major international credit rating agencies now

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Private equity

RI good practice in the emerging market private equity asset class is well developed as a result of the long-standing influence of international financial institutions

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Property

RI good practice in property and real estate (also referred to as ‘Responsible Property Investment’ (RPI) or, at the asset level, ‘Green Building Design’ has

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Infrastructure Investment

Although infrastructure is not a separate asset class under the South African Investment Policy Guidelines, infrastructure investment by pension funds has been an area of

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National and International Frameworks

Introduction

A range of existing standards and norms promotes good corporate practice from South African companies including the Broad-Based Socio-Economic Empowerment Charter for the South African Mining Industry (2004), the Amendment of the Broad-Based Socio-Economic Empowerment Charter for the South African Mining and Minerals Industry (2010), the Financial Sector Charter (2003), and the DTI Codes of Good Practice (2007). This guide does not provide detail into these familiar codes.

Instead, focus is drawn to key national and international initiatives and standards related to RI, or promoting responsible business practices, that a responsible investor may wish to consider when determining the composition of their investment portfolios.

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ESG Ratings and Indices

There has been an exponential increase in ratings and indices that investment service providers offer to aid investors in assessing ESG performance. The JSE currently

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