Is ESG good for Africa?

Is ESG good for Africa?

ESG, or, to give it its full designation “Environment, Social and Governance” is trending, globally, including in Africa. But what is ESG, and why does it matter?

By Warren Beech CEO of law firm Beech Veltman Inc.

As the world transitions to the green economy with its emphasis on low carbon or carbon neutral status, it has become more important for investors to have a framework within which to assess investment opportunities in companies and, ultimately, to decide whether to invest in a particular company, industry or sector.

Unfortunately, while there is broad reference to ESG, the ESG elements (environment, social and governance) are interchangeably referred to as factors, principles, requirements and considerations, and there is no universally aligned data set. This makes applying ESG as an assessment tool extremely challenging because it often means that it is not possible to properly compare “apples with apples”.

Regardless of these challenges, ESG has become an important source of data that informs and guides investment decision-making and should also be used to assess country-specific risk and provide a framework for countries that want to increase foreign direct investment (a critical factor in poverty eradication, infrastructure development and transformation and growth).

Historically, investment decisions were generally based on whether there would be good financial returns within a timeframe determined by the investor, with little or no regard to the impacts or potential impacts flowing from the investment decision, including on the environment, social impacts on communities and the impacts on governance structures, such as local and traditional leaders.

A more holistic view

Changes started with socially responsible investing / corporate social investment (SRI / CSI) where the focus shifted to investment in sustainable industries, and away from industries regarded as “toxic” such as the tobacco industry, and a clothing industry that relied on child labour.

SRI / CSI did not necessarily take a holistic view which provided a framework for investment in industries, sectors and companies that were engaging in environmentally and socially responsible
operations – these industries, sectors and companies were not “rewarded” for being environmentally and socially responsible and the value of these practices and their contribution to the overall value of the company, was not acknowledged.

The more holistic approach and framework that has developed over the last few years to the current ESG, arose out of both voluntary assumption of the ESG principles by companies wanting to “do the right thing” and changes that have been forced on companies by, for example, the significant increase in stakeholder activism, including local communities, and the significant emphasis on the “social licence to operate”.

The three principles of ESG

ESG focuses holistically on three principles or components. The environmental component includes climate change and carbon emissions, preservation of water resources, alternative energy (renewable) sources, biodiversity, and the move away from fossil fuels.

The social component includes the “social licence”, looking after local communities, diversity in the workplace, anti-bribery and corruption and human rights, and employment practices that are aligned with anti-discrimination, employment equity, and health and safety.

The governance component focuses strongly on corporate governance and structures, anti-bribery and corruption, and ethical political contributions.

The components of ESG are wide-ranging, and are normally influenced and determined by the status of the economy of a particular country, political views of the day and the social and environmental drivers at a particular point in time. Regardless of these nuances, collectively and holistically, ESG is becoming an increasingly important determinator of “what good looks like”, and is, increasingly impacting on investment decisions.

Is ESG good for Africa?

Unfortunately, while ESG is a useful tool for guiding investment decisions, it also means that decisions are taken not to invest in certain industries, sectors, and companies, which may be contributing, significantly, to growth and development, poverty eradication, infrastructure development and benefits to communities. This is not necessarily a good thing, particularly given the extremely high rates of unemployment and the levels of poverty, in many African countries.

The suggestion is re-assess the ESG principles so that a balance can be achieved between long term sustainability objectives, and the short to medium term desperate need for jobs, poverty alleviation and eradication, and growth and development. It is possible to achieve this balance within a nuanced ESG framework which accommodates both the short to medium term requirements, with longer term sustainability goals.

This balance would be even more achievable if the ESG principles are applied, on a country level to governments, in parallel, to both “reward” countries that address environmental, social and governance aspects, and incentivise other countries to do so.

Countries in Africa that have made it easier to do business, through clear policy and legal frameworks, have typically attracted better foreign direct investment. Where countries have implemented good governance structures, in support of the “ease of doing business”, including stamping out corruption, and facilitating transparency and the supremacy of the rule of law, this has encouraged investment in countries such as Ghana, Tanzania, Namibia, and more recently, Zambia.

Where countries have also emphasised growth, transformation and infrastructure development frameworks which encourage investment in communities, and employment, particularly for youth and women, all aimed at social upliftment, these countries have also typically, attracted good investment. Application of ESG, at country level, clearly works.

Those companies, industries and sectors that are not doing well, when measured against the ESG principles, are facing more and more challenges from traditional investors.

What about coal mining in South Africa?

In South Africa (and several other countries), a good example is the coal mining industry. The reality is that coal mining will remain an important contributor to South Africa’s energy sources (and that of various other countries in Africa) for the foreseeable future while South Africa and these other countries transition to renewable energy.

This does not mean that reliance on coal-fired energy will be forever. Many of South Africa’s mining giants, with coal mines, have re-positioned their coal mining assets, and several have disposed or are in the process of disposing of their coal mining assets, often as a result in the shift in focus to ESG, and stakeholder demands (including shareholders) for an exit from fossil fuels.

This typically results in strong local ownership of South Africa’s coal mines, driven by South Africa’s medium to longer term reliance on coal fired power stations and the significant challenges around implementation of alternative energy sources and renewable energies. Similar considerations apply to other African countries that are heavily reliant on fossil fuel generated energy sources.

While ESG plays a crucial role in the transformation of mining industries, in many African countries, the realities of energy demand mean that the move towards holistic investment decision-making based on ESG principles will take a little longer to implement, and this reality should be acknowledged, so that a more balanced approach can be implemented which accommodates the short to medium needs with longer term sustainability goals.

Environment now more prominent

While a strong focus on the social and governance principles has developed more recently, the environmental element or principle has also become extremely prominent for various reasons including the tightening up of Environmental Laws in South Africa and various other African countries, and implementation of more complex compliance frameworks, the role of the environmental activists and non-governmental organisations, and the relevant regulators, which take enforcement responsibilities, very seriously.

Major events such as tailings storage facility failures have also highlighted just how dramatic the impacts can be, encouraging mining companies to review their environmental strategies or face rigorous enforcement, reputational damage, and vast expenditure to remedy the damage caused. While the mining industry is often in the headlines for events such as this, other sectors are also in the spotlight, such as chemical companies, manufacturers that use toxic production methodologies, and the agricultural sector, where stakeholders in the agricultural sector do not apply good farming practices resulting in impacts such as dust, and longer-term sterilisation of land.

Holistically, these aspects highlight just how important environmental management is. The current emphasis however is on the effects of climate change, particularly in Africa, where the effects of climate change currently, and unless addressed, will continue to have a devastating effect, and drive vast populations into further poverty and starvation. Industries, sectors, companies, and governments that are addressing these challenges, including through ESG, may be in a better position to mitigate the adverse effects, and could potentially recover more quickly from the aftermath of the Covid-19 pandemic.

Not a one size fits all 

As this article is being written, the world’s focus is also on COP (Congress of the Parties) 26. COP 26 (UN Climate Change Conference) held in Glasgow in 2021 is working on acceleration of action towards the goals of the Paris Agreement (the agreement concluded in Paris, at COP 21) and the UN Framework Convention on Climate Change and will be aiming to secure ambitious 2030 emissions reduction targets which include accelerating the phase out of coal, curtailing deforestation, speeding up the switch to electric vehicles, and encouraging investment in renewables.

COP26 is also aimed at protecting and restoring ecosystems, and building defences, warning systems and resilient infrastructure and agriculture to avoid loss of homes, livelihoods and  lives. The outcomes of COP26 will influence national and global legislation trends focused on the environment, in the foreseeable future, and it is likely that the outcomes will find their way into the ESG metrics.

ESG may not be a “one size fits all”, particularly in Africa, where, despite certain challenges being common to the world, there are unique challenges including extreme poverty, lack of infrastructure development, and flow of benefits to citizens from unexploited natural resources.

These aspects should be acknowledged, so that a more balanced approach can be developed which accommodates short to medium term requirements, with longer term sustainable goals and which acknowledges that, in certain instances, investments which would otherwise be excluded by applying the ESG principle strictly, could add tremendous value to a country while at the same time, creating the mechanisms for longer term sustainability goals.

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