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Carbon Tax: does it impact the financial services industry?

Although the financial services industry does not emit any carbon itself, or does so in very small quantities, the introduction of the carbon tax will continue to play a role in the growth, development and governance of the financial services industry in South Africa.

Having signed the Paris Agreement in 2016, South Africa has undertaken to reach a goal of net-zero carbon dioxide emissions by 2050. To this end, South Africa introduced the Carbon Tax Act, 2019 as its chosen carbon pricing method.

Carbon tax is a tax on greenhouse (GHG) emissions. The Carbon Tax Act provides that those who conduct activities listed in Schedule 2 to the Carbon Tax Act (such as electricity production, coal mining or steel production) in South Africa, and whose activities result in GHG emissions that are equal to or above a specified threshold as set out in Schedule 2, will be liable for carbon tax.

A companies’ exposure to carbon emissions can be:

  1. Scope 1: direct, for example, through burning fuel;
  2. Scope 2: indirect, for example, through electricity consumption; or
  3. Scope 3: embodied, for example, through business travel or purchased materials.

ESG

The carbon tax affects the financial services industry through its impact on the entity’s environmental, social and governance (“ESG”) criteria, which are a set of standards for a company’s operations that socially conscious investors use to evaluate prospective investments.

Many companies have made commitments to a net-zero emissions economy, meaning that companies will seek to reduce their emissions and that any remaining emissions which are released as a result of the company’s actions are balanced by using an offset mechanism to absorb an equivalent amount from the atmosphere.

For example, where a company flies its employees overseas for business, it could compensate for this through afforestation (planting more forests) or through the use of technological options such as direct capture (a chemical process that extracts CO2 from the air).

The “enterprise value” of a company, the measure of a company’s total value, will likely be affected by how closely the company can get to “net-zero”, and future investors will likely seek to understand the true carbon cost of each company before investing.

In a similar vein, the King IV Code regulates the corporate governance of South African companies and emphasises the importance of sustainable development in a manner that does not compromise “the ability of future generations to meet their needs.” 

Furthermore, the company’s governance structure will have to be adapted as the role of an entity’s chief financial officer will grow since carbon tax has such a large financial aspect to it and will consequently require financial consideration.

Similarly, there is an increased need for the disclosure of information concerning the risks associated with carbon pricing. As investors continue to focus on “enterprise value”, it is expected that companies will be required to enhance disclosure so as to diversify their investor base and ensure the stability of their financing.

Increased input costs

Regardless of where the liability for paying the price of carbon lies, a large part of the cost will be passed on through the supply chain, making it important to consider an entity’s own liability as well as the exposure it has to carbon through its suppliers.

Input costs, such as electricity, paper or plastic, and logistics costs, such as flights or road travel, are likely to have increased. The impacts on cost within the supply chain, however, depends on each supplier’s ability to absorb increased expenses and remain competitive.

In this regard, increased input costs may lead to product switching, and the degree to which carbon costs can be passed along will therefore depend on the price elasticity of the relevant product.

To this end, it is important that the governance bodies of each entity maintain an understanding of where carbon costs are most likely to be incurred, as well as the dynamics of their target market, as correct management of the entity’s financial, operational and strategic performance will enable the necessary mitigation of the entity’s carbon price exposure.

The effects of the pricing of carbon emissions will depend on a company’s carbon footprint coupled with its negotiation power with suppliers and customers. There are other financial and commercial aspects of the financial services industry that will be affected by carbon tax, including:

  • the viability of investments to reduce carbon exposure;
  • the impacts of a carbon price on decisions related to mergers and acquisitions;
  • the options for carbon offsets in order to utilise the carbon offset allowance;
  • customer negotiations;
  • costing and pricing strategies for products and services; and
  • a changing cost base.

During the 2022 Budget, the future carbon tax price path was made known:

“To prepare South Africa for the structural transition to a climate‐resilient economy, government proposes to progressively increase the carbon price every year by at least US$1 to reach US$20 per tonne of carbon dioxide equivalent by 2026. For the second phase, government intends to increase the carbon price more rapidly every year, to at least US$30 by 2030, accelerating to higher levels by 2035, 2040 and up to US$120 beyond 2050. The basic tax‐free allowances will also be gradually reduced to strengthen the price signals under the carbon tax from 1 January 2026 to 31 December 2030.”

In addition, emissions which exceed mandatory carbon budgets will be penalised

“The mandatory carbon budgeting system comes into effect on 1 January 2023, at which time the carbon budget allowance of 5 percent will fall away. To address concerns about double penalties for companies under the carbon tax and carbon budgets, it is proposed that a higher carbon tax rate of R640 per tonne of carbon dioxide equivalent will apply to greenhouse gas emissions exceeding the carbon budget. These amendments will be legislated once the Climate Change Bill is enacted.”

It is clear that there will be a downscaling of high carbon emitting sectors and key new growth sectors for opportunity creation such as new mineral mining, green hydrogen and renewables will emerge. The issue is whether business will be able to afford the steep increases in the carbon tax and at the same time mobilise the capital needed to transition to low-carbon operations.

In March 2022 South Africa’s Green Finance Taxonomy (GFT) was published. South Africa’s GFT was developed by the Taxonomy Working Group, as part of South Africa’s Sustainable Finance Initiative, chaired by National Treasury. The GFT is a classification system or catalogue that defines a minimum set of assets, projects, activities and sectors that are eligible to be defined as "green" in line with international best practice and national priorities. It can be used by investors, issuers, and other financial sector participants to track, monitor, and demonstrate the credentials of their green activities.

New opportunities

The introduction of the carbon tax provides the financial services industry with the opportunity to develop new financial products aimed at increasing investment in sustainable finance, such as bonds, stocks, derivatives and funds linked to carbon pricing.

Conclusion

It is evident that the introduction of carbon tax in 2019 as South Africa’s chosen carbon pricing mechanism has impacted the financial services industry. The financial services industry must carefully consider the effects of the carbon tax on the company’s competitiveness and ESG criteria and adapt to ensure a sustainable financial, operational and strategic performance.

Mansoor Parker

Tax | Executive

mparker@ENSafrica.com