Ann Crotty
Almost 20 years ago, when the first King code on corporate governance was released, there was much excitement about its potential to extend its focus from strictly financial to include broader issues that might affect the long-term sustainability of companies.
South Africa is on its third King code. In addition, JSE-listed companies are required to issue integrated reports each year that include details of how sustainability issues are addressed. The majority of local institutional investors have signed up to the UN’s Principles for Responsible Investment and recently the institutional investors have committed to implementing the Code for Responsible Investing in South Africa (Crisa).
In 2011 the National Treasury announced changes to regulation 28 of the Pension Fund Act that aimed to “ensure that the savings South Africans contribute towards their retirement is invested in a prudent manner that not only protects the retirement fund member, but is channelled in ways that achieve economic development and growth”.
But despite all of these initiatives, recommendations and regulations it appears that institutional investors in South Africa are continuing to focus on short-term financial returns and are paying little or no attention to environmental, social and governance (ESG) issues.
A report commissioned by the Crisa committee, which was released last week, suggests that institutional investors do not take ESG issues seriously and are generally not applying the Crisa principles.
These principles require institutional investors and their service providers to incorporate sustainability considerations, including ESG issues, into their investment analysis and activities.
The sections that appear to have caused most difficulty since the code was introduced in February 2012 relate to the disclosure of details of ESG engagements between investors and the investee companies and, in particular, the disclosure of how investors voted at shareholder meetings.
The report describes how one major institution argued that the low level of commitment to incorporating ESG issues was because environmental and social data provided by investee companies was inconsistent and difficult to evaluate and that the time and resources needed to take them into account did not generate short- or medium-term financial benefit.
“Environmental and social risks or opportunities are sometimes considered as too remote and not quantifiable enough, thus conflicting with short- to medium-term business returns requirements,” the report says.
If investors are not taking these ESG issues seriously and holding companies to account for them, there is a danger that the investee companies will not take them seriously.
However, David Couldridge, a senior analyst at Element Investment Managers, which together with the Public Investment Corporation, sets the benchmark for disclosure in this field, contends that companies are considerably ahead of investors when it comes to ESG issues and disclosure. “Most companies have realised that they must take ESG issues seriously if they want to retain their social licence to operate,” said Couldridge, noting that they often find it reduces costs.
He adds that South Africa is a world leader in terms of governance codes and recommendations but few investors are interrogating the application of these codes and recommendations by companies in which they are investing.
Couldridge, who is a member of the Crisa committee, says some investors have hesitated because they are unsure precisely what “responsible investing” means. They are also concerned that Crisa’s call for a collaborative approach may be tantamount to investors acting in concert and therefore contravene JSE regulations.
A definition of responsible investing has been developed and a guidance document produced to deal with concerns about “concert action”.
“The committee has now addressed all excuses so perhaps implementation of the code will pick up.”
Ansie Ramalho, the executive director of the Institute of Directors of Southern Africa, acknowledges that the report’s outcomes are “concerning” but believes the situation would improve if investors were put under pressure to improve their levels of disclosure.
She emphasises that the code is voluntary and is designed to ensure that investors, disclose information so that they can be held to account.
As the report states: “The public disclosure of these practices enables beneficiaries and other stakeholders to engage meaningfully with institutional investors and their service providers and hold them to account.”
Couldridge acknowledges that many pension fund members and ordinary savers are too daunted by the complexity of the issues to engage vigorously with their pension funds. Without pressure from their members, pension funds are likely to avoid vigorous engagement of their investment managers and service providers.
Couldridge, who acknowledges difficulties, suggests three simple questions to stimulate the appropriate form of engagement between a pension fund and an investment manager.
“Pension funds must ask anyone investing on their behalf what their investment philosophy and process are and ask for one or two examples of how sustainability is integrated into that process.
“They should also ask for one or two examples of companies with whom they have engaged and how this engagement reduced risk and added value.
“Finally, they should ask for one or two examples of how the investment manager used his proxy vote to add value or reduce risk,” he said.