Climate control

While it is understandable for them to be distracted by the global pandemic, institutional investors – pension funds included – must realise that ESG factors are more important than ever before

Climate control

Just when it seemed that SA’s investment community was seriously incorporating climate risk and sustainability in its decision-making processes, COVID-19 hit the world. The ensuing crisis has diverted attention away from environmental, social and governance (ESG) issues.

Yet the year started so promisingly. In January 2020, the world’s largest asset manager, BlackRock, joined Climate Action 100+, a global investor initiative to engage with the largest corporate greenhouse-gas emitters. This is a big deal, because BlackRock, with approximately $7 trillion under management, exerts huge influence over asset managers worldwide and over the companies in which it invests.

As such, BlackRock chief executive Larry Fink’s annual letter to CEOs is relevant for investors and big business across the globe, including SA. ‘Climate risk is investment risk,’ he writes in this year’s letter. ‘I believe we are on the edge of a fundamental reshaping of finance.’ He explains that his firm is moving sustainability to the centre of its investment approach. The new strategy includes increasing the number of sustainable funds, being more transparent about engagement with investee companies and being disposed to voting ‘against management and board directors when companies are not making sufficient progress on sustainability–related disclosures and the business practices and plans underlying them’.

This targeted focus on sustainability – climate risk in particular – comes at a time of growing pressure from clients, shareholders and climate activists.

In a similar vein, Standard Bank shareholders in SA voted for better disclosure of carbon-intensive projects at their AGM in May 2019. The bank made headlines as the country’s first company to table a shareholder resolution related to climate risk. FirstRand followed suit in November 2019 and pledged to publish a ‘full roadmap for climate risk disclosure’ towards the end of 2020.

Together with Nedbank (which in 2010 emerged as Africa’s first carbon-neutral financial institution), the two banks withdrew from funding two proposed coal-fired independent power producer projects in Mpumalanga and Limpopo.

‘Have we finally reached a tipping point, where the world’s most powerful economic actors understand the extent of the climate and ecological challenges facing humanity, and are determined to take the action needed to address them?’ asked Just Share, a non-profit shareholder activism and responsible investment organisation.

That was in January 2020, shortly before COVID-19 reached SA where it unleashed economic and human hardship that pushed ESG issues to the back of the investment agenda. However, Tracey Davies, director of Just Share, warns institutional investors, companies and government against using the pandemic as an excuse to scale back climate action.

‘COVID-19 may have stopped many things, but climate change is not one of them,’ she says. ‘The risks posed by climate change are unaltered by the coronavirus, and its impacts will be even more devastating in a world where the resilience and resources of hundreds of millions of people have been drained by lockdowns, social-distancing requirements and ill health. So it’s as important – if not more so now – for institutional investors to be focusing on the disclosure and management of climate risk.’

Jon Duncan, head of responsible investment at Old Mutual Investment Group, agrees. ‘I don’t think there is any good reason for institutional investors to take their eyes off the ball regarding long-term ESG issues. In many respects, COVID-19 shows us how acutely we are all connected to each other and our environment.

‘We know that the main issues in South Africa are social in nature – poverty, inequality and unemployment. The focus on these issues will not change. However, we shouldn’t forget that climate risk is an amplifier of these social risks,’ he says. ‘Based on our analysis, the ESG indices we track are holding up well, which further strengthens our conviction that considering ESG as a part of investment and ownership practice is additive to our ability to deliver appropriately risk-adjusted returns for our clients.’

Financial institutions and asset managers have been described as ‘climate actors’ because their choice of investments can either boost – or delay – the transition to a low-carbon economy. ‘Pension fund boards, for example, can impact on what type of investments are chosen for a fund and, therefore, if the investment policy statement is structured in such a way that companies or investments that promote climate change are given preference, then they can play a big role,’ says Liezel Alsemgeest, acting director of Free State University’s School of Financial Planning Law.

‘However, while their core aim is to look after their members’ interests, “doing good” in general and showing investment growth is always the best option. Seeing that attitudes are changing quite a bit about issues such as climate change, it would also send a clear message to non-environmental companies to pull up their socks and get with the programme if large investors start influencing investments based on the environment.’

And there are indeed opportunities for investors: the World Bank’s International Finance Corporation estimates that there will be $23 trillion worth of climate-smart investment opportunities in emerging markets until 2030. Pension funds are particularly well positioned to lead in responsible investing. Their scale gives them leverage to demand high ESG standards from the companies in which they invest. It’s in their interest to invest in companies that don’t contribute to a scenario where their members retire into a world ravaged by climate catastrophe and social instability.

SA’s Government Employees Pension Fund alone is in charge of more than 1.2 million active members, with investments of more than R1.8 trillion that are managed by the Public Investment Company. In addition, the JSE sees a massive number of institutional investors investing for retirement purposes on behalf of employer-sponsored pension funds, life-insurance policyholders and unit holders of unit trusts.

Being entrusted with the life savings of millions of people, it’s important for asset managers and pension fund boards to understand how exposed their portfolios are to environmental risk (which includes climate change, global warming and extreme weather such as drought, flood, wildfire and heatwaves – events that are already occurring in Southern Africa and may become more common in the future).

‘The core purpose of pension fund boards is, according to Regulation 28 of the Pension Fund Act, to “give consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social or governance character”,’ says Alsemgeest. ‘The most important word to note in that sentence is “sustainable”. Pension boards have a fiduciary duty to look after the best interest of their members and it’s obviously important to focus their investment interest on assets that will be sustainable in the long term.’

The Financial Sector Conduct Authority was on the cusp of making its ESG directive for pension funds mandatory in SA, but in June 2019 announced that the directive would remain only a ‘guidance’ note. This was met with disappointment by those who had hoped for stronger regulations in order to significantly improve the ESG reporting and practices of retirement funds

David Geral, head of the banking and financial services regulatory department at Bowmans law firm, says that while regulation doesn’t compel ESG investing in SA, it does oblige funds to consider ESG criteria when making investments. In a recent opinion piece, he writes that ‘SA retirement fund regulation goes much further in encouraging ESG investing than jurisdictions such as the US, [where] funds must approach investments from a purely financial perspective that emphasises maximum returns’.

Obviously the single-minded US focus on financial metrics is short-sighted, as a more integrated approach to ESG investing (as practised by Norway and other northern European countries, for example) is more sustainable in the long term – not only from a planet and people point of view but also in terms of profit.

‘There is a myth among investors that ESG investments offer inferior performance and sacrificed returns when taking ESG matters into consideration,’ says Duncan. ‘However, ESG investments have repeatedly demonstrated that capital employed sustainably can not only meet but often outperform investors’ return expectations.’

For retail investors, ESG investing can be as simple as opening a bank account where some of the bank’s income is diverted to green initiatives, says Sonia du Plessis, a certified financial planner at Brenthurst Wealth Management. She adds that other options include ETFs, unit trusts, bonds and property developments that meet ESG criteria, but cautions that not all ESG investments have the same impact. ‘One unit trust may screen only for environmental factors but does so across entire industries. Another may support shareholder resolutions in the shares within their portfolio that push ESG compliance and reporting.’

It is important to know where exactly our money and especially our retirement funds are going. Collectively, our investment choices of today influence how resilient SA will be tomorrow.

By Silke Colquhoun
Image: Gallo/Getty Images