Edition: Edition: December 2015 / February 2016


Change in the climate

Pension funds and their asset managers are in the front line for appropriate
behavioural responses. Seeing will be believing.

Rea . . . outspoken

The respite for the silent majority, who’d
tended to treat investment matters of ESG (environmental, social and governance) as peripheral, has come to a clunking halt. Cabinet has now, after five years of consultation, published for comment a draft bill that will impose a tax on polluters. Denialism is rendered irrelevant.

The tax, National Treasury explains, seeks to price carbon “by obliging the polluter to internalise the external costs of emitting carbon and contribute towards addressing the harm caused by such pollution”. Effects will differ from company to company; the greater the carbon emissions the heavier the tax. Investors had better sharpen their pencils and focus their minds.

There can be no downplaying the impact of government actions to counter the effects of climate change, both directly in affecting the profitability of companies through a targeted tax and also consequently on investment returns significantly for pension funds. The advantageous flip side would be incentives for green initiatives.

Take a leaf from the UK where 19% of FTSE 100 companies (a higher percentage in the JSE’s top companies) are in the natural resources and extraction industries. Bank of England governor Mark Carney recently took the unusual step of warning that these companies could be left “stranded” by tougher rules to curb climate change.

He gave notice that the exposure of investors to these shifts is potentially huge: “The challenges currently posed by climate change pale in significance compared with what might come. Once climate change becomes a defining issue for financial stability, it may already be too late”.

Climate change fits narrowly into one aspect of the ESG matrix but it pervades the “sustainability” whole; through companies’ socially-responsible investment (SRI) practices to boards’ governance over them and stakeholders monitoring of them. The logic for proactive intervention by asset managers and owners, particularly insurance companies and pension funds, is no longer for esoteric debate. It must be recognised and implemented as integral to fiduciary duty.

Enter the newly-launched JSE/FTSE responsibleinvestment index series. Says the JSE: “It offers an objective methodology that further promotes the aims of stimulating greater transparency by corporates on ESG considerations and enabling them to integrate these considerations into investment and stewardship.”

Will it? So far, responses range from the cautiously favourable to the outright sceptical. Vociferous in the latter category is Michael Rea. For analysis, depth and comparison of hard ESG data, the annual report of his Integrated Reporting & Assurance Services is in a league of its own (TT Sept-Nov).

More than 11 years since birth of the first SRI index series by the JSE, he reckons that that it still can’t seem to figure out how to reach investors at the level of their specific needs: “That index was on too few radar screens to make it meaningful, and nobody is doing what needs to be done to change this sentiment.” On the new index, he argues:

  • Quantitative ESG tracking (as opposed to the predominantly qualitative tracking of the old SRI index) holds the potential to advance responsible investment. But by cutting back on the population sample to only the largest 83 companies by market capitalisation, the JSE has pretty much disincentivised the other listed companies from paying attention to ESG matters;
  • Because companies knew that the JSE was paying attention on the old index, some such as Illovo Sugar had significantly improved their ESG reporting. Based purely on market cap, however, Illovo Sugar has been excluded and relative laggard Tongaat Hulett included on the new index. Smaller-cap companies might revert to poorer reporting;
  • FTSE has stated that it is not in a position to compare companies by actual performance but only measure them by what it can find in response to its indicators. For instance, it suggests that the Lost Time Injury Frequency Rate cannot be used to assess the safety performance of companies because“it is not comparable between companies”. However, ignoring that a standard definition of LTIFR does exist for all industries, it will look only at the number or rate of fatalities. If the only thing worth measuring is deaths, it’s a horrible benchmark for“sustainability”. The goal of safety measurement and monitoring is to avoid work-related deaths. The goal of ESG indices should be about predicting such risk;
  • Comparability between companies – the cornerstone of all benchmarking – will diminish. FTSE deems the indicators that will be sufficiently“material” and will consider others for which investors ask. But investors don’t know what they don’t know, so are unlikely to ask e.g. about water and electricity consumption, the instability of both creating vulnerabilities for the operations of SA companies.

“We make it easier to invest in companies that invest in the future,” runs the index’s payoff line. Various companies, in the sectors about which Carney warned, have made it onto the index; presumably more for their reporting than their reliance on carbon emissions.

Another query is about the index using only the information published in companies’ annual reports, not necessarily inclusive of data to back up their assertions. It leads to the temptation for company reports merely to be heavier with spin and prettier with pictures. Unless investors interrogate them, it can be akin to marking one’s own homework.

A cross-section of SA investors and consultants– some large and some small, some better-schooled in ESG than others – offers a range of views on whether the new JSE/FTSE index will have the desired impact.


Jon Duncan of Old Mutual:

It’s a welcome addition to the SA investment landscape. There’s potential to help pension-fund trustees in providing a benchmark for ESG performance. But it does require that the trustee fully understands the ESG-screening approach and specifically what the ESG scores communicate about companies’ ESG practices.

Also, since the inclusion process uses only publiclyavailable information, it can be an important driver for greater ESG disclosure by issuers wishing to be included.

David Couldridge of Investec Asset Management:

Some matters still need to be finalised. A rule-driven approach will be less controversial than the old SRI index where some companies, that had been excluded, put great pressure on the JSE to be reinstated.

As trustees take their place at the head of the investment chain, the index can help them build greater awareness of sustainability. They are required to ensure the integration of material sustainability issues (ESG factors) as part of their fund’s investment strategy and included in mandates to service providers.

It is important to understand why certain companies are included and others excluded from the index, then to see which companies are included or being considered for inclusion in the fund’s portfolio. No index can respond to all the variables of investments, but it can be used to identify questions that help assess service providers’ ESG progress.

To ensure a broad-based index, the threshold for inclusion is low. Inclusion therefore does not imply that there is no requirement for engagement with investee companies. This should still take place to ensure that disclosure practices continue to improve.

Jerry Mnisi of Stanlib:

In the past few years we’ve seen ESG come into the mainstream as asset managers increasingly incorporate it into their investment processes and asset owners ask more questions on how their investments are being managed in terms of it.

The index will help this process by providing a benchmark for companies to assess themselves and a platform for investors specifically to target these companies.

Asief Mohamed of Aeon Investment Management:

Although I welcome the additional disclosure that the index will encourage, what appears lacking is an equivalent disclosure score similar to the pay-ratio rule that the Securities & Exchange Commission in the US has introduced.

Worsening inequalities in SA and globally require disclosure of historic trend and current practice for all remuneration. The ratio might be different for different industries, but better disclosure would raise the level of dialogue and debate.

I’d also feel more comfortable if it could be taken for granted that institutional investors actually read annual reports. That this might not be the rule is indicated by some curious approvals of executive remuneration. Also needed is a requirement that retirement and investment funds report quarterly on what they’ve been doing. This will help to keep asset managers active and diligent in their ESG assessments.

Tracey Want of Investment Solutions:

Much depends on whether companies aspire to become constituents on the index. As a start, they must publically disclose certain metrics that the index uses to assess their ESG performance. Disclosure is positive because it allows investors to track the performance of these companies over time, and to compare them with peers in their respective sectors.

Whether the index is useful to pension funds will depend on their governance budgets. For bigger funds, which are well resourced and can afford the raw data, analysis should be able to show them where potential problems lie and how companies are managing them. Simply to consider the index will be insufficient.

Transparency is a key driver. However, it isn’t clear what percentage of each company’s overall score (for getting it onto the index) is based on quality. For instance, the Top 30 index simply weights the scoring companies equally while the main index weights the included companies by market capitalisation. Hence there is no weighting for quality.

The previous index rated all companies. Because at present the new index rates only 83 companies, others might be discouraged by not qualifying for assessment.

Heather Jackson of Atlantic Asset Management:

The new series is an improvement, particularly in creating an equallyweighted Top 30 index. It’s encouraging that this index will promote those companies that best integrate long-term business-risk factors pertaining to ESG.

There’s also now a distinction between sustainability in the way that a company manages its own business and the way in which it provides proactive goods or services that address social and environmental challenges. Both are important.

A concern is that the factors determining a company’s score need to be transparent for investors to validate how and why ESG matters for a company’s long-term performance.

Clive Eggers of GTC:

Development of a revised investable benchmark, constructed using internationally-recognised standards, improves the infrastructure critical for the adoption of ESG/SRI principles by SA owners and managers.

While the index provides the opportunity for improved ESG reporting by companies and compliance by pension funds, changes in investment behaviour are largely driven by motivation. Until there is significant change in the motivation of asset owners and managers in adopting ESG principles, their behaviour is unlikely to adapt.

Kobus Hanekom (with Dirk Oosthuizen) of Simeka:

It will become easier in principle for the average trustee to formulate a strategy and direct the selection of assets to ESG, although it might take a while before we have clarity and buy-in on the weightings. Clarity and simplicity are important determinants for use.

The old index was obscure in its composition. The new one seems to be an improvement in that it incorporates international views and methodology.

Some things about the new index need to be properly understood, for instance the exclusion of Shoprite. On the other hand Sasol, one of our largest polluters, is included. It does disclose a lot of information, as do the extractive industries. Will the green-informed then use the index?

We don’t anticipate that pension funds will quickly move from the Alsi, Capi or Swix to the new index, at least until there’s greater clarity on its composition.

Malcolm Fair of RisCura:

Getting scored on 125 or so ESG criteria does find its way into the growing list of matters on which chief executives of JSE-listed companies will need to be accountable. Rating methodologies play an important role in raising consciousness of matters vital to stakeholders.

For pension funds, the challenge is to make trustees aware of the role they play as shareholders. Rating methodologies, as now applied by JSE/FTSE, provide information that funds and their service providers can use about the owned companies.

While I don’t think that the new index will directly cause greater compliance by pension funds with Reg 28 (which obliges them to consider ESG in their investment decision-making), what could encourage greater compliance is linking the new data (provided by the ESG rating methodology) into improved training and education of pension funds and their service providers.