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02 Nov 2021
BY James Brand

Taking Stock of ESG Regulatory Developments in South Africa

This week marks the start of the 2021 United Nations Climate Change Conference, also known as COP26, to be held in the city of Glasgow, Scotland. This week also marks the introduction of South Africa’s Climate Change Bill to parliament, outlining a coordinated response to the threat of climate change. While these developments provide focus to climate change law, climate change is but one of the identified sustainability related risks that our societies and economies face and is one of many relevant considerations that falls under the E of ESG.

financing a sustainable economy

There have also been developments in the broader Environmental, Social and Governance (“ESG”) space. On the 15th October 2021, South Africa’s National Treasury published an updated version of its draft technical paper called “Financing a Sustainable Economy”. The paper serves as a foundational step towards identifying ESG gaps in South Africa’s legal and policy framework. Last week marked the first ESG Legal Summit as lawyers from around the globe met virtually to consider ESG and what it means for our clients.

Investors typically focus on shareholder returns, however ESG encourages investors to be cognisant of how their investment decisions impact broader stakeholders, including the societies in which they operate and the environment. This is viewed as being in the best interests of the investors as well as it allows for greater stability in our financial institutions. Taking the learnings from the 2008 financial crisis, where exposure to subprime assets were inadequately priced into the market, the financial sector recognises the systemic risks posed by climate challenges, biodiversity loss and governance failures and are seeking to shine a light on these issues to better understand the risks.  

ESG related regulation is maturing from soft law recommendations to hard law obligations in multiple jurisdictions worldwide, including most notably in the EU as a result of the European Green Deal. One key piece of the ESG regulatory puzzle is disclosure, obliging investees to report and disclose on their risks according to ESG related criteria. This allow investors to assess similar information across an asset class to better inform their decision as to where to redirect their finance to ESG aligned assets. In South Africa, ESG related disclosures are required through multiple legal instruments, but we can expect greater consolidation and harmonization of South Africa’s ESG disclosure requirements over time in line with global developments.

Another piece of the ESG regulatory puzzle is the obligation on investors to take ESG related criteria into account so as to have the information they need to understand the risks of investing in assets that are not ESG-aligned. This arguably exists according to the fiduciary duties doctrine, as the links between ESG factors and financial performance are increasingly being recognised. But taking ESG related criteria into account is also specifically required in certain sectors according to statute, most notably for institutional investors in South Africa, in terms of regulation 28 of the Pension Funds Act, among others.

South Africa’s new draft taxonomy

“Green-washing” is a phenomena that has the potential to taint the sustainable finance decision making process as assets, activities and projects are touted as having ESG aligned credentials when in fact they don’t. For this reason taxonomies are being developed globally, setting out detailed criteria to be met in order for an activity or project to be verified as being ESG aligned – a further piece of the ESG regulatory puzzle. This regulatory space is moving quickly and is being led by developments in the EU. On 9 October 2021, South Africa’s National Treasury published its own detailed draft taxonomy and investees should be paying attention to the stipulated technical and legal criteria that would allow their assets, activities and projects to be classified as ESG aligned.

supply chain due diligence

The sustainability enquiry is recognised as being complicated making it difficult to have full sight of the entire value chain. In the green-house gas emissions sector, the initial focus was on direct emissions from core operations (“Scope 1” emissions) and purchased energy (“Scope 2” emissions). However, there is increasing focus on the whole value chain, including emissions produced by suppliers and customers (“Scope 3” emissions). This level of enquiry is likely to be replicated outside the air emission space to other contexts where human rights abuses, deforestation or other ESG unaligned activity may arise.

Recognising this, on 10th March 2021 a resolution was adopted by the EU Parliament setting out principles for proposed new legislation on corporate due diligence and accountability for human rights, environmental and governance impacts within businesses' operations and through their value chains within the EU internal market. This potentially signals a further piece of the ESG Regulatory puzzle – the ability to trace critical sustainability issues in company supply chains. How something similar would be achieved in South Africa without statutory intervention is unclear as the statutory duty of care in section 28 of NEMA presumably only extends so far.

the role of certification schemes

Companies and stakeholders in industries with complex supply chains, such as the agricultural, forestry, fishing and retail industry, have joined forces to develop voluntary verification schemes in order to trace the sustainable use of commodities collaboratively. But are these voluntary initiatives enough or will legal intervention be required to ensure greater sustainability?

South Africa was a trail blazer in this regard before the term ESG even existed. In May 2000 diamond-producing states met in Kimberley, South Africa, to discuss ways to stop the trade in “conflict diamonds”. Later that year the UN General Assembly met and by November 2002 the Kimberley Process Certification Scheme, a voluntary verification scheme, had been created. But to give this certification scheme teeth, amendments to South Africa’s Diamonds Act, 1986 were required and in 2005 a statutory obligation was created ensuring that all unpolished diamonds exported from, or imported into South Africa were accompanied by a Kimberley Process Certificate.

At the time Nelson Mandela was quoted as saying that the Kimberley Process has the “proclivity to do the right thing, especially when pushed”. We already have a number of voluntary certification programmes in a number of sectors and we have a precedent for amendments to laws to allow for mandatory certification schemes as well. The indications are that future ESG regulation is likely to provide the regulatory push to unlock the right things in multiple sectors throughout the value chain.

Reviewed by Jessica Blumenthal, Banking and Finance | Executive

 

James Brand

Natural Resources and Environment | Senior Associate

jbrand@ENSafrica.com

+27 79 877 7778