Edition: April 2016/ June 2016
Editorials

SUSTAINABILITY 1

More on the methodology

Corli le Roux and Makhiba Mollo of the JSE explain the workings of its new ESG index and the partnership with FTSE Russell.

The JSE takes a multifaceted approach to positioning itself on sustainability issues. This approach spans its regulatory role, investment products and related services as well as being an active participant in the local and global debate about sustainable development and transparency.

In regulating listed companies, the exchange’s thought-leadership work in espousing corporate governance has been prominent. The principles of the King code on corporate governance were incorporated in the listings requirements since the first iteration of the King Report. Some core principles have been promoted to mandatory obligations, while companies remain obliged to report annually on the extent to which the full set of principles have been applied, or to explain deviations.

In order to further influence issuer and investor behaviour, the JSE in 2004 became the first emerging market and first stock exchange to form a Socially Responsible Investment Index (SRI Index), to recognise the strides being made by SA companies and enable investment into those that achieved entry into the Index.

The SRI Index ran for 11 years until December 2015. It was instrumental in helping companies incorporate aspects of behaviour change and transparency into everyday business conduct. It also provided those investors, increasingly integrating responsible investment considerations, with a tool to invest in these companies and engage where considered necessary.

The SRI Index was also pivotal in driving engagement between investors and companies on sustainability imperatives. The ESG (environmental, social and governance) Investor Briefing is now established as an annual event on the JSE calendar.

New directions

The JSE had deliberately taken a developmental and evolutionary approach in its efforts to promote sustainable business and responsible investment, to ensure alignment with global and local developments and trends and to remain responsive to the needs of its clients. Subsequently the SRI Index evolved significantly. Listed companies forming part of its assessment also continuously matured in their efforts to meet the incremental requirements.

In progressing this work, the JSE announced last June that the next leap on the journey features collaboration with FTSE Russell, the global index provider. This collaboration saw the JSE adopt the FTSE ESG Ratings methodology, aligning with FTSE Russell’s evolved ESG criteria and assessment process (TT Dec ’15-Feb ’16).

Adoption of the FTSE ESG Ratings methodology enables eligible JSE-listed companies to form part of a global universe of corporates whose disclosure practices are assessed against cutting-edge ESG factors. The comprehensive methodology and expanded access to data, foreseen for the near future, will provide investors with increased opportunities to integrate ESG considerations into their investments in various ways.

The JSE’s relationship with FTSE Russell dates back to 2001 when the FTSE/JSE Africa Index Series was launched. The extension of the relationship to promote and enable responsible investment is the next step in the JSE’s sustainability work and an acknowledgement of the efforts of corporate SA in the success of the SRI Index’s evolution.

Relevant indicators

The ESG Ratings methodology developed by FTSE Russell is applied to over 4 000 companies globally. It comprises approximately 350 indicators spanning the three ESG pillars.

The pillars are divided into 14 themes each with a number of indicators. The diverse indicators are tailored for all areas of a given theme covering:

  • Qualitative indicators, assessing the quality of management and policies covering a range of elements inherent to the theme;

  • Quantitative indicators, measuring the disclosure of quantified data covering elements such as performance, consumption or statistical data;

  • Sector-specific indicators;

  • Indicators with specific geographical application.

When assessing a company, an exposure score is applied as it relates to each of the 14 themes, from 0 (exposure considered negligible or not applicable) through 3 (high exposure). Exposure is measured primarily through (a) the ICB Subsectors where a company is active, and (b) its presence in specific countries. The exposure score factors into a weighted score per pillar and overall, with those themes that have the highest exposure having the greatest impact on the score.

Themes that have an exposure score of 0 are not applied and companies are not assessed against these. What therefore results is an assessment that reflects the ESG themes that are considered to have the most relevance to a particular company. On average, companies are assessed against about 125 indicators each.

The assessment process results in an ESG rating of between 0 and 5 at various levels; by theme, by pillar and overall. The overall rating currently feeds into the various indices created by FTSE. They include the global FTSE4Good Series as well as the FTSE/JSE Responsible Investment Index Series.

To meet the need of investors for index products that reflect ESG imperatives, the FTSE/JSE Responsible Investment Index Series was launched in October last year. The new index series has replaced the JSE SRI Index and features a tradable version. Further products are in the pipeline. Flexibility of the ratings model also enables the creation of customised products.

The index series currently consists of two indices:

  • The FTSE/JSE Responsible Investment Index
    1. A market-cap weighted index calculated on an end-of-day basis;
    2. Comprises all eligible companies which achieve a FTSE ESG rating of 2.0 or above.
  • The FTSE/JSE Responsible Investment Top 30 Index
    1. An equally-weighted tradable index calculated on a real time basis;
    2. Comprises the Top 30 companies ranked by FTSE ESG Rating.

While the data assessment occurs only once a year, the indices are reviewed twice annually (in June and December) to reflect updates to ratings during the preceding six months. Currently the eligible universe for the index series consists of companies that are constituents of both the FTSE All World Index as well as the FTSE/JSE Shareholder Weighted (Swix) All Share index.

At present, this is around 85 companies. However, over time the JSE intends to expand the universe to cover more JSE-listed companies.