Demystifying ESG: From global origins to South Africa’s leadership in sustainability

Insights by Patricia Umeche, Impact and ESG Officer.

When I began my career in private equity, I found it challenging to fully grasp the concept of ESG, its origins, and its intended objectives. This challenge is common for individuals encountering ESG for the first time, as well as for companies required to comply with new investor-driven ESG reporting requirements.

To understand ESG we must look back a few years, as this movement has its roots in the growth of corporate responsibility, responsible investing and sustainable development. During the 1960s and 1970s, growing awareness of social and environmental issues prompted investors to divest from companies engaged in unethical practices. These practices included arms manufacturing (probably fuelled by the horrors of the Vietnam War), the tobacco industry, or supporting the apartheid regime. This era focused on a rather exclusionary approach, where the goal was to divest in these “sin” stocks.

The environmental and social awareness of the 1980s and 90s was spurred by global challenges such as pollution and the beginnings of climate change awareness. This era saw the birth of the Brundtland Report by the World Commission on Environment and Development (WCED) which popularised the concept of sustainable development. Defining sustainable development as ‘development that meets the needs of the present without compromising the ability of future generations to meet their own needs’, a definition that still rings true today. During this time, investors became more aware of the potential impact of environmental and social problems on long-term financial success.

The term ESG first appeared in the early 2000s as a means of incorporating environmental, social, and governance considerations into investment strategies. The 2004 publication of the UN Principles for Responsible Investment (PRI) solidified ESG as a core element of mainstream investment strategies. These principles urged institutional investors to use ESG criteria in their decision-making processes while providing a robust framework that could be applied to a multitude of different sectors.

In 2006, the ‘Who Cares Wins’ initiative highlighted the benefits of integrating ESG factors into investment analysis, demonstrating their potential to enhance long-term returns. The Dow Jones Sustainability Index emerged at a similar time, offering companies the tools to assess performance in these areas.

By the 2010s, ESG was widely recognised as a critical element of investment strategy. The 2015 Paris Agreement on Climate Change boosted the campaign to urge businesses to embrace sustainable practices, particularly in terms of carbon emissions. Meanwhile, significant institutions such as BlackRock, Vanguard, and State Street began to demand greater transparency on ESG performance.

The 2020s saw a considerable expansion into the ESG market, fuelled mostly by growing regulatory obligations and investor demand. In Europe, the European Union compelled asset managers to declare how they integrate and manage ESG aspects through the EU Sustainable Finance Disclosure Regulation (SFDR), while ESG funds and sustainable investing experienced tremendous growth. These days ESG is a focus for investors and corporations around the world who view this lens as a contributing factor to their long-term success

ESG has gained traction in South Africa’s legal and commercial landscape as a result of regulatory reforms, international pressure, and the desire to develop sustainable company practices. But how exactly have we implemented this as a country?

South Africa has been proactive, owing to its close relations with international institutions (such as the United Nations and the Commonwealth of Nations) and the necessity to address the country’s own social and environmental concerns, such as inequity, environmental degradation and poverty.

Beginning in 1994 with the King Report on Corporate Governance (these are guidelines for the governance structures and operations of South African corporations), also known as the King Code, which has been an essential driver of corporate governance, ESG principles, and sustainability. This report has had multiple editions (King I, II, III, and IV), but King III was particularly groundbreaking. This edition incorporated integrated reporting, which considers environmental, social, and economic issues in a company’s performance. The most current incarnation, King IV (2016), emphasized the adoption of sustainable, responsible practices and integrated thinking, calling businesses to consider the broader impact of their actions on society and the environment. These codes have had a huge impact on driving ESG policies in South Africa.

As a member of the United Nations and a signatory to various global treaties, South Africa has been encouraged to adopt ESG-related standards, such as the UN Sustainable Development Goals (SDGs) and the Paris Agreement on Climate Change in 2015. These frameworks have influenced and shaped local policy and behaviour.

Great steps have been taken regarding legislation, with both mandatory and voluntary compliance measures being introduced. Legislation such as the Companies Act of 2008, the National Environmental Management Act of 1998 (NEMA), the Carbon Tax Act of 2019, and the Broad-Based Black Economic Empowerment Act of 2003 (including the Financial Sector Code) address key aspects of ESG management. The Protection of Personal Information Act (POPIA, 2020) also contributes to the broader ESG framework. ESG had also been included in Regulation 28 of the Pension Funds Act, requiring pension funds to consider ESG factors when investing. These regulations address different but critical components of Environmental and Social Governance and provide a solid foundation and framework.

With the advancement of the King IV Report on integrated reporting (as previously stated), the Johannesburg Stock Exchange (JSE) mandated certain non-financial disclosures relevant to ESG, albeit this was not legally necessary initially. It has also become the norm in South Africa for companies (publicly listed or not) to integrate ESG into their financial or non-financial reporting, with the increase in the publication of Annual Sustainability reports that emphasize ESG-related opportunities and challenges.

ESG is and has been a ‘hot topic’ for the last few decades. As we work through the correct management and implementation of environmental and social governance considerations, I encourage you to engage with professionals in your sector to exchange insights on managing ESG and mastering relevant frameworks and principles. ESG can sometimes feel complex or even daunting, but each year brings greater clarity and improved understanding.