COVER STORY: Editorials: Edition: March / May 2020


A wildfire is lit

Climate change has sparked unprecedented stakeholder attention on ESG. Pension funds will burn or be burned.

The timebomb of environmental degradation has visibly exploded across the planet, not least in SA suddenly beset by droughts and floods at extremes and frequencies previously unseen. Add to this disastrous evidence of climate change such other life-changing threats as the plastics’ poisoning of the oceans, frequently demonstrated off Durban beaches, and the deepening scale of social inequalities, volatile in their fuel for populism, to identify core motivations that “responsible investment” must shift from the slow lane to the fast.

Retirement funds had better realise it because:

Their asset allocations demand a focus on longterm liabilities that shape the societal fabric for ultimate pensioners;

Their stewardship of fund assets entitles, in fact obliges, them to sway corporate behaviour in terms of environmental, social and governance (ESG) criteria;

They need to attract millennials reportedly less inspired by conventional calls to save (warnings for old age) than by a propensity to stimulate positive consequences for their communities (welcome “sustainable”, “ethical” and “impact” investment to the accumulating lexicon).

Around the world, movement in the tectonic plates gathers intensity. There’s the UN programme of Sustainable Development Goals, integrated in SA’s National Development Plan, for actions to protect the planet and address poverty. There are also fund managers, with trillions of dollars under administration, climbing aboard a theme which has moved from moralistic to mainstream.

US Business Roundtable

Notably too, last year the US Business Roundtable abandoned the concept of shareholder primacy for profits alone. Redefining the purpose of a corporation, nearly 200 chief executives of leading American companies signed a commitment to serve all stakeholders – customers, employees, suppliers and communities and shareholders – to “promote an economy that serves all”.

The roundtable is underpinned by the world’s largest asset managers. BlackRock, Vanguard and State Street intend to prioritise ESG risk as rigorously as they evaluate liquidity and credit risk; so much so that, on all three ESG pillars including an urgent preoccupation with climate change, investee companies will need to impress. There’s a spin of capitalism itself being reinvented. The promise sounds disquietingly familiar, perhaps a glossy splash of over records of malfeasance as if the 2008-09 financial crisis never happened. The newborns are to be treated with scepticism until monitored for implementation. But this time, through the various mutations over the years of corporate social responsibility variously applied, the mantra of “profits with purpose” should be taken seriously. That’s without thanks to a mea culpa on the part of recalcitrant corporates. Forced by stakeholder pressure for commitment to a future lacking double-speak and reputational trade-offs, principles of transparency and accountability will be tested for real meaning.

Harsh view Larry Fink, chief executive of BlackRock – the world’s largest asset manager with $7 trillion under administration – has warned that his firm will take a “harsh view” of companies that don’t provide hard data on the risks they face from climate change. By the end of this year he wants all companies to report on the risks and opportunities they face from global warming. His endorsements of industry-specific guidelines set out by the Sustainability Accounting Standards Board and the Task Force on Climate-Related Disclosures go beyond the firm’s plans to divest from companies that generate 25% of revenues from thermal coal. It will additionally increase the number of exchange-traded funds that invest sustainably. As competitive managers follow, many public companies will face mounting insistence from their biggest shareholders for disclosures that comply with these standards. Banks, globally connected into SA, might expect their lending policies to be similarly scrutinised.

Inevitably, there’ll be collisions between green and growth. Companies will still need to optimise earnings, for survival of themselves and the tax base, and they’d still be faced with retrenchment challenges when profits shrink.

Neither is there an escape from fossil fuels, to be around for years to come, nor from aviation pollution as emission reductions are offset by increases in jet travel which burgeoning middle classes can afford. Consumerism and environmentalism are uneasy bedfellows. Bluntly, nonetheless, behavioural redirection is evident from the millions of people mobilised internationally around climate change as a key element of now-broadened activism. In SA, it’s amongst myriad factors that the Financial Sector Conduct Authority attempts to address under Regulation 28 of the Pension Funds Act. It centres on the requirement that the boards of retirement funds “consider ESG factors before investing in an asset”. As such, compliance is a simple agenda item. Tick a few boxes and, hey presto, ESG has been considered. Switch from a few hedge funds to a couple of green or blue bonds, to promote wind farms or protect water sources, and bask in a job well done. Hardly is there an asset manager who won’t claim to have ESG embedded in its investment processes. Some take it more seriously than others, and some have deeper resources than others; just as some trustees have the wherewithal to query their asset managers and consultants, while others leave decisions to them.

Comfort zones

On top of this, practical effect requires that they apply their minds to measurement for compliance through the multi-faceted ESG matrix. One size cannot fit a coal miner as it would a food retailer, let alone down their respective supply chains. Comfort zones become more complex with the issue by the FSCA of a draft directive followed by a guidance note which set out “the FSCA’s expectations regarding certain disclosure and reporting requirements relating to sustainability”. Kobus Hanekom, principal officer of the mammoth Sanlam umbrella fund, is in a tizz. He points out that most defined-contribution funds participate in pooled portfolios, several umbrellas offering more than 40 pooled portfolios. Here the asset manager, not the trustee board, determines the strategy and prepares the mandate. To take ESG into account, research would have to be done and a report provided for consideration on the ESG status of each share in which the asset manager has invested.


Compared to the FSCA guidance, such reports would be the better solution for funds’ compliance. At a series of workshops, it was noted that many managers already do this research but don’t consistently report their findings in a formal way to clients. To require every board of trustees to do this kind of investigation, as the FSCA suggests, is impractical. They do not necessarily have the training or skills. Where they do, it would effectively duplicate the investigation already done by the asset manager. Peculiar is the admission that few asset managers formally report their findings. It would seemingly be a strong point for client sales. Equally peculiar is the implication that clients don’t insist. It speaks poorly of skills or awareness, or of a lazy inclination not to navigate through EGS’s variety of components.

For ESG to be jacked up, as integral to trustees’ financial duty, who’ll pay? At bottom is this vexed Reg 28, desperately in need of revision (TT Oct ’19-Jan ’20). Funds are generally heavily weighted into JSElisted equities, despite the top rankers being mainly offshore revenue earners with little need to bother about such SA sensitivities as job creation and black economic empowerment.

By contrast, they’re seriously underweight in the allowance for alternatives such as private equity. This is where the opportunities are greatest for SA entrepreneurship and excitement in the risk/reward relationship, as well as infrastructure development targeted on communal impacts. The imbalance is due, at least partly, to the theme of Reg 28 being stuck in the philosophy of a putative prudence. It’s more apparent than real, given JSE returns and delistings over recent years. John Oliphant of Third Way, who was instrumental in bringing the UN-backed Principles for Responsible Investment to SA when he served as principal executive officer of the giant Government Employees Pension Fund, makes a radical proposal. It’s that Reg 28, instead of being guided by risk avoidance, stimulates economic growth and job creation.

“There’s a misallocation of capital to the JSE’s top 40,” he contends. “Smaller companies are unlisted or ignored.” Following adoption of the UN PRI, he spearheaded establishment of the Code for Responsible Investment in SA. From being disappointingly supine, he suggests that it be injected with life as a non-profit company under a strong secretariat. To date the major signatories are asset managers rather than asset owners. A vitalised CRISA, as he sees it, could offer services more effectively and cheaply than the PRI. Amongst the services would be research to precede company meetings, for example to help inform proxy voting on the election of directors demonstrably supportive of ESG. Managers will be hard-pressed not to concur. Says Ndina Rabali of Lima Mbeu: “A pension fund’s ability to meet the obligations to its beneficiaries depends on the decisive role it can play as an owner of SA companies.” Less enthused on the practicalities is Andrew Crawford of Seshego Benefit Consulting: “The mountains of publicly-available literature present a case that’s conceptually powerful. But I don’t foresee that it will be readily adopted in SA.”

With the advent of member investment choice and the preponderance of defined-contribution retirement funds, few segregated portfolios remain. Decisionmaking is dominated by the handful of large asset managers, life offices and administrators. He adds: “In the absence of client demand and commercial incentive, they’ll probably prefer to trundle along with ESG optics and advocacy.” Merely ask Tracey Davies of non-profit Just Share, a rising star in the ESG firmament from her articulate presence at shareholder meetings. Her circulars to companies, requesting information on their plans to address climate change, have met with poor response. “None of our resolutions try to tell managers anything other than to make better disclosure for the sake of better risk assessment,” she notes. Opposed to negative screening – “How can you affect change from outside the company?” – she suggests that the pension-fund owners of companies would become more activist if more of their trustees were below the age of 40.

Breaking the mould

Nonetheless, there is progress. Breaking the mould that frightened asset managers from collaborating (“colluding” being too fraught a word), a unique example was evident at the Sasol agm when six of them together tabled resolutions related to climate change.

The six were the investment-management units of Old Mutual, Sanlam, Coronation, Mergence, Aeon and Abax. Although other big gorillas were prominent by their absence, the pressure worked. Sasol, SA’s second largest carbon emitter after Eskom, did follow up with publication of a climate change report. It committed the company to reduce its greenhouse gas emissions by at least 10% by 2030. A detailed roadmap is to come. Climate change was similarly prominent at the agms of Standard Bank and First Rand where discussion focused on lending to users of fossil fuels. As some asset managers are seen to gain credit for taking up the cudgels, it might be anticipated that they’ll incrementally be joined by others for accountability of JSE-listed companies across the spectrum of ESG criteria; from board composition to workplace pay, for example. All the while, the ogre of prescribed assets continues to lurk. And then from a government

pretty useless at investing in its own enterprises and

slow in offering bankable projects for infrastructure


Impact investment

The alternative to prescribes is argued by Susan de Witt, of the Bertha Centre at the UCT, who’s working with National Treasury and has emerged as a champion of “impact investment” (see article on next page). Given the contentious nature of mandated investment, she says in a recent paper, it should be attractive instead to introduce products that put the decision to invest retirement contributions in development impact initiatives in the hands of beneficiaries.

However, De Witt adds: “Pension plans and trustees will understandably want to ensure the provision of options with expected financial performance suited to funding the retirement needs of beneficiaries as a matter of principle. In any case, there are clear indications that asset owners can participate in responsible and impact investments without facing sub-par returns or an imprudent level of costs.”

The point is so self-evident that it needn’t be laboured, but the imperative that it be emphasised for traction certainly is. There’s no shortage in the investment industry of sustainability specialists – Malcolm Gray, Heather Jackson and Rhona Stewart spring quickly to mind – from whom expertise can be drawn to help formulate an action consensus. And, of course, hard-pressed FSCA regulator Olano Makhubela could always do with assistance.

After consultation with over 40 investment-management firms representing £5 trillion of assets, the UK Investment Association has sought to create a common language through the wide range of responsible-investment approaches. The trade body wants definitions adopted so that consumers won’t be left “confused” or “unable to find investment opportunities” that match their RI goals.
Stewardship is the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society e.g. setting expectations, oversight of assets, engaging with issuers and voting.
ESG integration is the systemic and explicit inclusion of ESG factors into investment analysis and investment decisions e.g. statement of commitment, firm-wide policies.
Exclusions prohibit certain investments from a firm, fund or portfolio. They may be applied on a wide variety of issues, including alignment with client expectations, and at the level of sector, business activity, products or revenue streams, companies or jurisdictions/countries e.g. ethical, values-based or religious exclusions.
Sustainability focus refers to investment approaches that select and include investments on the basis of their fulfilling certain sustainability criteria and/or delivering on specific and measurable sustainability outcomes e.g. sustainability-themed, positive tilt, best in class.
Impact investments are made with the intention to generate positive, measurable social and environmental impact alongside a financial return e.g. social-bond funds, private impact investing.
In the UK, Mark Carney has retired as Bank of England governor to become the UN special envoy for climate action and finance. He warns that a substantial proportion of corporate assets are at risk of becoming worthless.
Unless companies and investors act now, in the face of extreme weather events, he believes that it will soon become too late to do anything about it: “A question for every company, every financial institution, every asset manager, pension fund or insurer: What’s your plan?”
Pension funds must make the case for their investments in such companies as oil and gas that have been showing attractive returns, he insists: “We can’t have a financial sector that ignores the issue and then suddenly has to deal with it.”
In the US, the giant CalPers released the first climate-risk assessment of its $394bn pension fund. The report found that one-fifth of the fund’s public-market investments were in sectors that have high exposure to climate change. These include energy, materials, buildings, transportation, agriculture, food and forestry.
The financial risks stem partly from physical impacts such as rising sea levels, fiercer storms and heat waves. But company profits can also be hit by, amongst others, regulations to curb global warming and lawsuits against polluters.
Pension funds are confronted by a whole series of new investment challenges.