Edition: September / November 2015


Heightened awareness,
stodgy progress

Woolworths, BAT and Sanlam are best performers. Waseem Thokan*
discusses the findings of Legae Securities’ 2015 survey.

Clear to investors globally is that a multidimensional approach towards management of investment risk has become increasingly necessary. For SA, this concept is embodied in Regulation 28 of the Pension Funds Act which obliges institutional investors to consider environmental, social and governance (ESG) issues in their investment decision making.

While the role of companies in society has been debated for generations, the rise of the modern corporation has brought into sharper focus the need to scrutinise the costs and benefits accruing from companies’ impacts on society and the environment, and on how these are managed. Given SA’s context of inequality and poverty, as well as the resource bias within the economy and the attendant intensity of environmental impact, these issues are particularly pertinent for SA companies and investors.

Accordingly, Legae Securities has rated the ESG performance of the JSE’s top 100 listed companies using 83 different metrics defining issues such as environmental and social policies, resource use, emissions, workforce dynamics, transformation, occupational health and safety, board independence and executive compensation.

In 2015’s second iteration, we found that the companies’ awareness of these issues is improving.

However, active measures to mitigate ESG risks are conspicuously lacking.

Overall company performance remains disappointing. There’s an average score of 43,5% and no company scored above 65% overall. A meaningful proportion of companies are ignorant of the need to address these issues with 11 of the top 100 scoring less than 30% overall.

The top ESG performers are Woolworths, British American Tobacco and Sanlam. At the bottom end are Reinet and The Capital Property Fund – representing a broader theme whereby attention to ESG issues amongst holding companies and property companies remains underwhelming.

Thokan . . . way to go

The labour unrest at Marikana, the collapse of African Bank and the governance issues at PPC demonstrate the ability of issues that were historically considered “non-financial” to dramatically and sometimes irrevocably compromise a company’s operational, reputational and ultimately financial performance. Fundamentally, environmental and social compliance can no longer be seen as a compliance cost. Rather, they are a business imperative from a risk perspective. They have the potential to differentiate companies and underpin financial performance.

ESG considerations have historically been the concern of governments, regulators and civil society. But in the context of a more active stakeholder base (whether a more stringent approach to regulation by governments, a more contentious labour-relations environment or a more educated and mobilised customer), they are factors which companies and ultimately providers of capital need to consider and manage.

This is reflected in our study where the extent to which the high regulation of an industry is positively related to sustainability performance.

Thus, within the sample, banks, insurance companies, telecoms and healthcare companies tend to outperform. This is likely a consequence of companies tilting their strategic priorities to more closely resemble those of the governments or regulators which control their licenses to operate.

Historically, a company’s primary purpose was to deliver shareholder value. This idea was predicated on the work of Milton Friedman and his view that the only social responsibility of business was to engage in activities designed to increase its profits. But these days a review of global academic work on responsible investing indicates that companies with better ESG performance have a lower cost of capital.

Further, studies indicate that in 89% of cases better ESG performers exhibit market-based outperformance and 85% of cases exhibit accountingbased outperformance. Thus there is a robust and emerging body of evidence to suggest that maximising Friedman’s shareholder value requires a more holistic approach towards stakeholder value, particularly as companies grow larger.

Although our report highlights that application on these issues is still emerging, integrated reporting (amongst other factors) has driven a consistent improvement in policy and disclosure over the past five years. The report indicates, for example, that 92% of companies within the JSE top 100 have environmental policies in place.

While the trend towards awareness of ESG issues is clear, there remains limited progress in integrating sustainable business practice into company operations and creating chains of accountability to top management. Although the Companies Act now mandates the creation of a social and ethics committee, the vast majority of JSE-listed companies lack executive directors specifically responsible for ESG issues. And although many companies mention environmental or social factors within their strategies, few integrate them into executive remuneration.

Although broader performance leaves much room for improvement, there are examples of companies which directly address responsible corporate citizenry as a core strategic differentiator. Woolworths, the best-performing company on our ESG scorecard, has integrated sustainability robustly within its operating model through the “Good Business Journey”. To the extent that environmental and social awareness is important to Woolworths’ consumer base, this grants it some market power contributing to the ability of the business to achieve superior margins.

Reappraisal of the role of regulatory authorities globally, together with the emergence of technologies such as social media, has empowered company stakeholders such as governments, labour and customers. These stakeholders increasingly influence companies’ reputational, operational and ultimately financial performance.