Sustainable & Responsible Investing have become hot topics in the investment industry as well as business in general. There are lots of concepts being used (sometimes incorrectly) which can be quite confusing. We attempt to summarise the different issues and principles in this article.
Environmental, Social and Governance (‘ESG’)
Sustainability challenges faced by many investors range from the effects of the recent financial crisis, which left most pension schemes underfunded and government debts in developed markets at unsustainable levels, to socio-economic challenges and climate change which threatens our own existence as human society. ESG describes the three main areas of concern that have developed as the central factors in measuring the sustainability and ethical impact of an investment in a company or business. ESG is the catch-all term for the criteria used in what has become known as Socially Responsible Investing.
ESG can be broken up into 3 broad categories:
- Environmental: This includes the topics of Sustainability, Ecosystems, Climate Change and Fossil Fuels vs Renewable Energy.
- Social: Socio-economic impact, Diversity, Human Rights, Consumer Protection, Animal and human welfare can be categorised here.
- Governance: Management structures, employee relations and ethics are included in this category. The King reports cover corporate governance.
United Nations Principles for Responsible Investment (‘UNPRI’)
Every trader has limits on the maximum size allowed for each The United Nations-backed Principles for Responsible Investment Initiative (‘UNPRI’) is a network of international investors working together to put the six Principles for Responsible Investment into practice.
In 2005 the United Nations Secretary-General invited a group of the world’s largest institutional investors to join a process in developing the Principles for Responsible Investment. Individuals representing 20 institutional investors from 12 countries agreed to participate in the Investor Group. The process, conducted between April 2005 and January 2006 involved deliberations in a series of all-day long discussions and debate. The Principles for Responsible Investment emerged as a result of these meetings.
The Principles were devised by the investment community. They reflect the view that environmental, social and corporate governance (‘ESG’) issues can affect the performance of investment portfolios and therefore must be given appropriate consideration by investors if they are to fulfil their fiduciary duty.
In 1992 the King Committee on Corporate Governance was formed in South Africa, and, in line with international thinking, considered corporate governance from a South African perspective.
The result was the King Report 1994, which marked the institutionalisation of corporate governance in South Africa. It aimed to promote corporate governance in South Africa and established recommended standards of conduct for boards and directors of listed companies, banks, and certain state-owned enterprises, with an emphasis on the need for companies to become a responsible part of the societies in which they operate. King I advocated an integrated approach to good governance, taking into account stakeholder interests and encouraging the practice of good financial, social, ethical and environmental practice.
In 2002 the second King Report on Corporate Governance was published. King II had a chapter dedicated to integrated sustainability reporting. The concept of reporting on economic, social and environmental performance (the so-called “triple bottom line”) is thus not new. However, there is growing global and local attention to sustainability issues.
The revised Report on Governance Principles for South Africa (King III) was released on 1 September 2009, with an effective date of 1 March 2010. King III requires the statutory financial information and sustainability information to be integrated in the “integrated report”. An integrated report should be prepared annually. The integrated report should have sufficient information to record how the company has positively and negatively affected the economic life of the community in which it operated during the year under review. The report should also contain forward-looking information on how the board believes it can enhance the positive aspects and negate the negative aspects that affect the economic life of the community in which it operates, in the future.
Although voluntary, the Johannesburg Securities Exchange has requested listed companies to comply with the King Report recommendations or to explain their level of non-compliance.
Code for Responsible Investing in South Africa (‘CRISA’)
The investor community has the ability to influence and encourage the companies in which it invests to apply sound governance principles and to care for the environment in which it operates.
The Code for Responsible Investing in South Africa (‘CRISA’) was finalised in July 2011 and the effective date for reporting on the application of CRISA was 1 February 2012. With the introduction of the CRISA, South Africa became the second country after the United Kingdom to formally encourage institutional investors to integrate ESG issues into the investment process.
CRISA applies to:
- Institutional investors as asset owners, for example, pension funds and insurance companies.
- Service providers of institutional investors, for example, investment managers and consultants.
Read together, King III and CRISA provide a framework that relates to the function of all role players in the overall governance system.
To date, it has been widely accepted by different industry bodies. The Institute of Directors in Southern Africa, the Principal Officers Association, the Association for Savings and Investment South Africa (Asisa), the Financial Services Board (FSB) and the Johannesburg Stock Exchange have all made public declarations of acceptance of the Code.
King III requires ESG issues to be reported in the Annual Financial Statements of all companies. The companies need to report how they positively and negatively affected the economic life of the community in which they operated during the year under review.
UNPRI is 6 principles devised by the investment community in order to incorporate ESG into their investment process. The importance of ESG issues is recognised by top pension funds and investors, who want to reduce both risk and generate sustainable financial returns. There is a growing body of expert opinion and evidence that well governed companies produce more reliable returns and put in better environmental performance than poorly governed companies. Signatories become part of a community aimed at empowering them to incorporate ESG.
Similar to UNPRI, CRISA is aimed at the investment community and is based on the belief that the investment community has the ability to influence and encourage the companies in which it invests to apply sound governance principles and to care for the environment in which it operates.