/ 10 May 2023

What is ESG and where does it fall short?

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South Africa is on the path to a just transition. But does it make sense? (Getty Images)

Environmental, social and governance (ESG) investing has become an increasingly important and popular part of the investment landscape not only in South Africa, but across the world. 

A key motivation for investors to consider ESG issues as part of their financial analysis is to gain a better understanding of the companies in which they invest or to improve internal investing. 

ESG is a strategy used to help stakeholders (investment community, customers, suppliers and employees) understand how an institution is managing related risks and opportunities. ESG has changed how capital allocation decisions are made by many financial services firms, corporate entities and asset managers.

Environmental factors include direct and indirect greenhouse gas emissions, management’s stewardship over natural resources, and the firm’s overall resilience against physical climate risks, like climate change, flooding, and fires. 

The social factors include human capital management metrics like fair wages and employee engagement but also an institution’s impact on the communities in which it operates. 

Governance factors seek to understand how leadership incentives are aligned with stakeholder expectations, how shareholder rights are viewed and honoured, and what types of internal controls exist to promote transparency and accountability on the part of leadership.

Although ESG investing has become popular in the investment landscape and some institutions are using it to replace corporate social investment (CSI), it has presented shortfalls in accounting for some values. CSI, an element of corporate social responsibility (CSR), is when a company directs monetary investment towards causes or initiatives that are aligned with the company’s mission or contribute to social welfare. This practice contributes to business operations, sustainability and development. It’s bigger than random charity and philanthropy. 

Businesses have an intrinsic relationship with a large segment of the population through employment provision and labour markets, service provision, commodity markets, environment and resource use. While the government is the primary agent to address social issues, CSI is a tool with which businesses can bring social change and, as such, there is a need for companies to shift to a more strategic, collective response. The business sector has emerged as a key player and has had to accept responsibility and work in collaboration with entities including the government and civil society organisations to address social issues.

Although CSI is an optional practice, there are five main policies affecting CSI in South Africa that provide business incentives to comply (there are additional policies, such as the Occupational Health and Safety Act that specify health, safety, and wellness requirements for corporate employees).  

  1. The King Reports I (1994), II (2002), and III (2009) set the broad framework, establishing a code of ethical corporate conduct including encouraging investments in broader social and environment welfare.  
  2. The Companies Act creates a CSI monitoring function through required social and ethics committees. 
  3. The Johannesburg Stock Exchange Social Responsibility Index rewards social responsibility with “best performer” rankings.  
  4. The Broad-Based Black Economic Empowerment (BBB-EE) Act provides concrete targets across a broad checklist of activities which includes socioeconomic development activities. 
  5. CSI enables businesses to get tax advantages such as tax rebates from the South African Revenue Services (SARS).

Collectively, the CSI policies act as a catalyst for companies to act as responsible corporate citizens, invest in their communities, support South Africa’s racial transformation agenda, and care for the health of their employees.

The shortfalls with ESG as an investment approach is the lack of standardised criteria for what makes an investment sustainable or an agreed definition of what ESG means, so businesses may be marketing something that may not be in line with what it means to be a responsible corporate citizen in the context of South Africa. 

In other words, businesses may neglect investing in their communities, supporting South Africa’s racial transformation agenda, and caring for the health of their employees, because managers can cherry pick impacts they are willing to invest in. Increased incentives and an effective regulatory landscape, seeking to improve transparency and standardise reporting requirements for sustainability funds needs to be established. 

For example, some investors accept anthropogenic greenhouse gas emissions as an existential threat and so will have an aversion to oil companies that produce hydrocarbon fuel, while others think that global warming is no big deal and so are happy to invest in oil majors.

Another challenge is that ESG scoring methodologies tend to focus on how well companies manage their internal processes, rather than the real world impacts of their products and services. There are companies that have displaced communities, contributed massively to greenhouse emissions and pollution, have affected the health of communities, degraded land usage and have racially discriminated against black South Africans through their service or product offerings. 

Despite all these, these companies continue to be scored highly for ESG. Therefore, diluting the principles of social collective responsibility, contributing to social welfare and what it really means for corporations to work with government and civil society organisations to address social issues.

ESG as a strategy plays on “guilt-free returns” leading to investments, hence there is a massive focus on the E and G in ESG and a neglect in the S. Companies are excluding fossil fuel investments and are prioritising sectors like green energy, while others are  greenwashing to look good on the E front, which is when an investment or company claims to be environmentally friendly but may not be. 

Some companies are focusing on board compositions, accountability and transparency and shareholder engagements, while others may be neglecting important social issues like gender and diversity (especially fighting against racial, gender, and sexual discrimination), community relations, social justice and protecting human rights, which CSI pushed for.

On the business development front, while ESG involves investors changing the environmental and social impact that their capital is having, there is concern that impacts may come at the cost of economic gains. 

The value of budgeting for CSI initiatives separately is that companies could still focus on the core of the business, and that is profit making while their CSI departments focus on social responsibility initiatives. To avoid a cost in economic gains, companies should employ a variety of analytical approaches to address ESG considerations. 

Understanding the relative merits and limitations of ESG information and approaches can help to form a more complete picture of ESG risks and opportunities.

While ESG plays a vital role in business development, CSI is equally important in driving effective business operations. Both strategies should co-exist in companies to help recognise that a company cannot continue being successful or grow at the expense of the natural environments or local communities within which it operates.

Karabo Mokgonyana is an award-winning legal and development practitioner and programme director for the Sesi Fellowship and Skill Hub, a womxn- and youth-led organisation that provides young womxn with mentorship and skills development.

The views expressed are those of the author and do not necessarily reflect the official policy or position of the Mail & Guardian.