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ESG reporting in SA: where are the gaps?

IN 2004, the JSE became the first stock exchange in an emerging market to create a socially responsible investment (SRI) index.

The intention was  to provide investors with a means of identifying listed companies with sound environmental, social and governance (ESG) policies and practices. The index uses a risk and performance assessment method similar to that of the FTSE4Good index series, but has additional criteria dealing with HIV/Aids and broad-based black economic empowerment.

Initially, companies could volunteer to participate in the JSE’s annual review process. However, as from 2013 all companies that form part of the FTSE/JSE All-share index have been subject to the annually screening process. Prior to 2013, the JSE reviewed both public and private information supplied by companies. Now only publicly available information is evaluated. The number of companies included in the JSE SRI index grew from a mere 51 in 2004 to 82 in 2014.

Much academic research has been done in the past decade on the value and risk-adjusted performance of SRI indices relative to traditional stock indices. The majority of international studies show that SRI indices tend to perform on par with traditional ones and emphasise the information benefits associated with a company’s inclusion in one or more SRI indices.

However, empirical evidence on the performance of the JSE SRI index has been mixed. Whereas some researchers found that the JSE SRI index has underperformed the FTSE/JSE All-share index since its inception, others show that it has performed on par and in some periods even better than the broad market index.

Critics of the JSE SRI index (rightfully) argue that the information content of the index is quite limited. They say the index requirements should have become more rigorous over the years and that a rating system should have been introduced. They also claim that, in its current form, the index only offers a snapshot of corporate transparency and public disclosure.

One critic remarked that companies which are included in the index meet the public disclosure requirements, “but the quality of ESG reporting (and hence ESG risk management) is not clear beyond that”. The fact that companies are not rated against any benchmarks, either within the entire index universe or against sector benchmarks, is also seen as problematic.

In a 2012 study (when the JSE still evaluated the quality of internal ESG processes) we found a statistically significant difference between the ESG disclosure scores of companies included in the index (5.26/10) and those excluded from it (4.29/10).

The ESG scores used in our study were compiled by MSCI ESG Research and consisted of a weighted average of individual environmental, social and governance pillar scores. MSCI’s scores were determined through a combination of industry analyses (to establish key issues within each industry) and the analysis of publicly available corporate information.

As expected, reporting on corporate governance considerations was significantly higher than reporting on social and environmental criteria (mean category scores equalled 6.06/10, 4.92/10 and 4.48/10 respectively). Various reasons could explain the dominance of corporate governance matters in non-financial reporting. Not only has the epic corporate failures of the early to mid-2000s focused managers’ attention on governance, but they’ve also had clear governance compliance guidelines since publication of the first King report almost 20 years ago.

It is also likely that directors have a better understanding of governance as it falls more directly into their understanding of fiduciary duties. The current Companies Act (No 71 of 2008) furthermore reinforces this kind of thinking. The low level of environmental reporting could be attributed to a tendency by some companies to regard clean air and fresh water as “free services”. Such a mindset inevitably results in less time and resources being devoted to managing these considerations, let alone reporting on it.

Water stress gets lowest overall score

The environmental criterion with the lowest overall score was that of water stress (2.77/10). This is very disconcerting as water supply and quality are becoming critical issues for the whole country, and specifically so for high-impact industries, such as resources. Other environmental criteria with dismal disclosure scores included toxic emissions and waste, biodiversity and land use as well as opportunities in green buildings and clean technology.

Despite legislation to ensure local companies prioritise health and safety issues, companies in our sample provided very little information on their policies or practices in this regard. The average for this criterion was a mere 4.24/10.

The findings of our study could be valuable for shareholder activists who are increasingly engaging investee companies on non-financial matters. Local companies that wish to avoid the wrath of discontent shareholders would thus do well by taking ESG risk management more seriously and communicating material ESG information more clearly in their integrated reports. This claim is especially important as foreign investors are increasingly looking to South Africa as a lucrative investment destination.

Our viewpoint is further supported by one of our follow-up studies focusing on proxy voting among institutional investors in South Africa. In this study, constituents of the JSE SRI index in 2013 were less likely to attract ‘against’ votes when seeking shareholder approval to elect or re-elect certain directors. Companies with high ESG scores in the same year were also less likely to provoke shareholder opposition on resolutions pertaining to the issuance of new shares or linked units and placing shares or linked units under directors' control.

However, investors should realise that a company’s inclusion in the JSE SRI index paints a very limited picture of its actual ESG performance. More in-depth research is required before making a financial commitment.

*Suzette Viviers is a professor in the Department of Business Management at Stellenbosch University. Samantha Mitchell is a lecturer in the same department and has conducted her MCom research on the topic of ESG reporting in South Africa. Eon Smit is Emeritus Professor at the Stellenbosch University Business School.

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