In South Africa, the sustainable finance agenda is well established with E&S risk management compliance and reporting guidelines in place, which have been published by regulators and industry associations. As societies expectations increase of the role the financial sector plays in promoting good E&S risk management practices amongst clients, the South African ESRM program seeks to support financial institution to enhance their environmental and social risk management systems and disclosure practices.
To promote more informed investing, lending and insurance underwriting decisions, greater disclosure by the financial sector on their exposure to environmental and social risks, including climate change, is increasingly being expected. In turn, enhanced disclosures associated with financial institutions’ operations, business, lending and investment practices will help promote a just transition to a low carbon economy and build resilience in the financial sector against environmental and social risks.
The financial sector in South Africa already plays an important role in the protection, promotion and fulfilment of social, economic and environmental rights in the country and across the continent through the leverage it exerts over clients. Leading banks in South Africa have signed the Equator Principles, participated in the development of the UNEP FI Principles for Responsible Banking and have implemented the Banking Association of South Africa (BASA) Principles for Environmental and Social Risk.
In South Africa, the program seeks to promote enhanced environmental and social risk management practices amongst financial institutions by:
Background on the ESRM Program in South Africa
In 2008, a study conducted by IFC’s Independent Evaluation Group on ‘Improving Results in Sub-Saharan Africa’ showed that financial institutions in the region, which the IFC invested in, did not achieve satisfactory environmental, social, health and safety ratings and there was a lack of capacity amongst these financial institutions to implement environmental and social risk management. In response to this, IFC developed an advisory project, the ESRM program, with the objective of increasing the uptake of environmental and social standards by financial institutions in Sub-Saharan Africa, leading to an improvement in the environmental and social performance of financial institutions and their clients in the long term.
As part of the preliminary activities for the design of the ESRM South Africa program, a baseline survey was conducted to review the existing practices of the sector and assess the local capacity available in effectively implementing sustainability best practices. The survey targeted financial institutions and consultants. Its objective was to inform the development of the ESRM program based on the analysis of the opportunities and design interventions for the challenges identified.
In summary, the baseline found that:
- The experience of banking practitioners and banking regulators in addressing sustainability issues has so far been driven by concerns of risk management. While this practice remains fragmented and incomplete, it is nonetheless increasing in both volume and sophistication.
- South Africa’s large banks typically have sophisticated environmental and social risk management systems in place, particularly for project finance transactions and corporate loans. Many of these banks are signatories to international environmental and social risk management standards, including the Equator Principles.
- Smaller independent banks in South Africa typically conduct some form of environmental and social analysis in their investment cycle, but few respondents had coherent management systems or procedures in place in the same way as larger banks.
- Lack of environmental and social risk management standards and skillsets in the market was seen as the biggest constraint for the implementation of environmental and social risk management practices by both consultants and bankers surveyed.
Overview of the South African Financial Sector
South Africa’s financial services sector is large and well developed, contributing approximately 22% to the country’s GDP, servicing clients across the continent.
The sector is supported by a sound regulatory and legal framework, making it one of the most advanced in Africa, boosting domestic and foreign institutions and providing a full range of services – commercial, retail and merchant banking, mortgage lending, insurance, and investment.
The South African banking sector is highly concentrated with the five largest banks controlling 90,5% of total assets. There are 34 banking institutions reporting data to the South African Reserve Bank. The number of foreign banks with authorised representative offices in South Africa is 36.
Currently, there is no banking specific legislation or subordinate regulation, which imposes explicit requirements on banks to manage environmental and social risks.
However, banks are subject to the Companies Act, and the principles of the King Code, as they are listed on the Johannesburg Stock Exchange. The King Code promotes the integration of natural, social and human capital alongside financial, intellectual, and manufactured capital into strategy, value creation and disclosure.
- Pension Funds
ESG Requirements of Regulation 28 of the Pension Funds Act
There are currently 5143 pension funds in South Africa. Of these 2946 were privately administered funds, 2188 were underwritten funds, and the remainder public sector funds and 1 foreign fund. Assets held by pension funds on behalf of 16.4 million members (including both contributing members and pensioners) with assets of approximately R4.04 trillion. Pension funds’ assets of 110% of GDP are almost equal to banking assets of 112%.
The primary legislation regulating the pension funds sector is the Pension Funds Act No. 24 of 1956, which provides for the registration, incorporation, regulation and dissolution of pension funds.
The updated Regulation 28 of the South African Pension Funds Act, which became effective in July 2011, included a new requirement for pension funds to consider ESG issues in assessing factors that materially affect the sustainable long-term performance of pension fund assets. The Financial Services Conduct Authority (FSCA) supports the Code for Responsible Investing in South Africa (CRISA) as a means of giving effect to Regulation 28.
Prudent investing should give appropriate consideration to any factor which may materially affect the sustainable long-term performance of a fund’s assets, including factors of an environmental, social and governance (ESG) character. Regulation 28
FSCA Guidance Notice: Sustainability of investments and assets in the context of a retirement fund’s investment policy statement.
In June 2019, the Registrar of Pension funds at FSCA published a Guidance Note on the Sustainability of Investments and Assets to provide guidance to boards of funds on how to comply with the sustainability and ESG requirements of Regulation 28.
The guidance note covers how investment policy statements should include details of the pension funds board’s processes for ensuring the sustainability of its investment and assets, as well as its active ownership policy. It sets out the FSCA’s expectation regarding disclosures and reporting on issues associated with sustainability.
Investment Policy Requirements
The Guidance Note includes guidance for pension fund boards on the details that should be included in their investment policy statement regarding how their fund monitors and evaluates the ongoing sustainability performance of the assets it owns, including the extent to which ESG factors are considered when making investment decisions, as well as its active ownership policy.
It also requests that where funds hold assets that limit the application of ESG considerations, the investment policy should state the reasons as to why this limitation is to the advantage of the pension fund.
Reporting and Disclosure Requirements
The Guidance Note encourages pension fund boards to disclose their investment policy statement on their website and make the policy available to members. It also encourages boards of funds to adopt sustainability reporting practices.
FSCA acknowledge in the supporting Communication Note that disclosures requirements need further refinement and harmonisation across the South Africa financial sector. The FSCA commits itself to continuing to refine the regulatory framework related to issues of sustainability and this may lead to more detailed disclosure and reporting requirements being incorporated into prudential and/or conduct standards in future.
The FSCA also commit to working closely with National Treasury in developing further sustainability requirements for pension funds as part of a national strategic framework on sustainable finance, which is being developed with the support of the ESRM program.
In addition, the International Organisation of Pension Fund Supervisors is also finalising Supervisory guidelines on the integration of ESG factors in the investment and risk management of pension funds and FSCA will consider to what extent these guidelines should be incorporated into the local regulatory framework.
- Private Equity
According to the South African Venture Capital and Private Equity Association (SAVCA) Industry Survey, Southern Africa’s private equity industry recorded R158.6 billion in funds under management at the end of 2017. This represents a compound annual growth rate of 9.4% since the first edition of the SAVCA Private Equity Industry Survey, which was published in 1999.
Private equity in South Africa is largely unregulated.
There is no universal approach to sustainability for the sector but many South African private equity firms have been invested in by European and North American development finance institutions and are required to abide by their stringent environmental, social and governance requirements as part of the terms of their investment, including for investee companies to meet the requirements of the IFC Performance Standards throughout the life of an investment. These investors include CDC, FMO, DEG, FINNFUND and IFC.
- Twin Peaks and Financial Sector Regulators in South Africa
As a result of the 2008 financial crises, in 2017 South Africa embarked on restructuring the regulation of the financial sector, including a move to a Twin Peaks approach. This was done to increase the South African financial sector’s robustness, reinforce financial stability and integrity, and improve protection for customers from potential poor conduct by financial services firms.
The Twin Peaks approach sees the regulation of prudential and conduct risk separated out under the supervision of two distinct regulatory bodies, the Prudential Authority – contained within the South African Reserve Bank (SARB) – and the Financial Sector Conduct Authority (FSCA). The SARB becomes the resolution authority responsible for protecting, maintaining and enhancing financial stability.
The Prudential Authority is responsible for the oversight of activities of financial institutions from a prudential perspective, and the FSCA is responsible for regulating conduct activities. This means that the FSCA is responsible for the behaviour of financial institutions (i.e. honesty and integrity) and the prudential authority is responsible maintaining the stability of the financial system, ensuring that banks and insurers control risk and have adequate capital (i.e. to avoid a financial crisis).
The new regulators have the power to create regulatory standards and have supervisory tools and enforcement powers at their disposal, to enable them to fulfill their objectives.
ESRM Program Partners
- National Treasury
National Treasury is responsible for promoting the government’s fiscal policy framework, coordinating macroeconomic policy and preparing the country’s budget. As such, National Treasury has the mandate to protect the South African economy and its citizens from major external shocks to the financial system, building resilience, through solvency and effective risk management.
National Treasury acknowledges that there is an urgent need to fund a just transition to a low carbon economy and to achieve the Sustainable Development Goals to improve the lives of citizens. Treasury has embarked on developing a sustainable finance strategy to give effect to its mandate and drive the South African economy to achieve its development goals and making a just transition to a low carbon economy happen.
Since June 2016, the ESRM program has supported the National Treasury in facilitating a Sustainable Finance Working Group and developing the Financing a Sustainable Economy Policy Discussion Paper, which is expected to recommend the development of mandatory environmental and social risk management disclosure requirements for the sector.
- Banking Association South Africa
BASA aims to facilitate the enablement of a conducive banking environment in South Africa through engagement with government and other stakeholders.
As part of the BASA mandate, in consultation with its members, it developed the Principles for Environmental and Social Risk. The principles promote the role that banks can play in the protection, promotion and fulfilment of social, economic and environmental rights in South Africa by conducting their operations, business, lending and investing practices in a sustainable manner.
All members of BASA are obligated to abide by the principles.
The ESRM Program is working with BASA’s members to support them improve their environmental and social risk management systems. BASA have also been represented on National Treasury’s Sustainable Finance Working Group
- Rhodes University Business School
Rhodes University is a public higher education institute. The business school focuses on developing leaders for sustainability and harnessing the potential that businesses have to sustainably promote the wellbeing of present and future generations.
The IFC ESRM Program has partnered with Rhodes Business School to deliver a responsible investment short course for professionals. The program focuses on the key concept of integrating E&S risks management and sustainability into investment processes and is being co-delivered by IFC and Rhodes staff.
The first short course is due to commence in early 2020.