The adoption of environmental, social and governance (“ESG”) criteria is on the rise, unlocking capital for ESG compliant projects. Despite Africa’s diverse natural resources, renewable energy potential, human capital and significant development opportunities, connecting investors (many situated offshore) with investees on the continent is not straight forward. This gives rise to missed opportunities and stifles the ability of ESG investment to flow into projects in Africa that would otherwise support ESG investment mandates. African investees need to position themselves to take advantage of ESG-related opportunities to appeal to investors.
ESG in the EU
The EU has taken many steps in recent years to promote ESG in regulatory environments and markets. This includes the Action Plan on Financing Sustainable Growth (2018) and the European Green Deal (2019), and the EU is considering imposing a carbon border adjustment mechanism, more commonly referred to as a carbon border tax. This would tax carbon emissions associated with goods imported to the EU and if implemented, this could create serious near-term challenges for African companies with a large greenhouse gas footprint that are exporting into the EU. The largest export and import partner for Africa is the EU, which makes up 31% of the continent’s exports and 29% of their imports. Keeping an eye on the ESG regulatory developments that are taking place within the EU is therefore critical for African enterprises.
In the EU, ESG is moving from being a soft law voluntary instrument to a mandatory obligation. For example, the EU regulation on Sustainability-Related Disclosures (“Disclosure Regulations”) will take effect from 10 March 2021 and are part of a suite of legislative interventions designed to ensure that financial service providers play their role in building a sustainable economy. The Disclosure Regulations aim to promote transparency in the integration of ESG considerations into investment decisions and recommendations and will apply to asset and fund managers, insurers, pensions-based product providers, investment firms and insurance intermediaries providing advice.
The suite of legislative interventions also includes the Taxonomy Regulations, which entered into force on 12 July 2020 and are due to apply from December 2021. The Taxonomy Regulations will establish a framework for classifying financial products as “sustainable investments”. This aims to prevent “greenwashing” which is the practice of gaining an unfair competitive advantage by marketing a financial product as environmentally-friendly, when in fact it does not meet basic environmental standards. ESG accreditations have become crucial in preventing greenwashing, as well as the need for thorough due diligence. The Taxonomy Regulations should be read together with other legal instruments such as the EU Non-Financial Reporting Directive (Directive 2014/95/EU). From 1 January 2022, large companies including banks and insurance companies will need to qualify, quantify and state the proportion of turnover, capital expenditure and potentially operational expenditure aligned with the EU Taxonomy in their non-financial statement. Other amendments to various pieces of legislation will require asset managers to integrate a consideration of ESG factors into their organisational and operational controls and risk management processes.
ESG in Africa
In contrast, when looking at the country-by-country analysis of voluntary or mandatory measures to incorporate a consideration of ESG factors (as set out on the Principles for Responsible Investment’s website), Africa is far behind. However, the focus on the continent is different. Institutional and private investors of developed countries are able to bring vast investment to the ESG table (and as such legislation is needed to direct these funds to sustainable investments). Africa’s contribution is the potential it has for projects aligned with ESG related criteria that are able to achieve the United Nation’s sustainable development goals. There are many sustainable projects, innovations and companies operating across Africa whose operations align with ESG related criteria. The key to unlocking this potential is getting investors comfortable with the risks typically associated with investing in developing markets and identifying “sustainable investments” that can deliver adequate returns.
What is considered to be a sustainable investment?
Within the EU, there has been a lot of debate about what qualifies as a “sustainable investment.” This important question has implications for investors to ensure compliance with the suite of EU ESG laws discussed above. From the investee's point of view, this is required to ensure eligibility for investment. The development of any new regulation is accompanied by issues about standardisation, classification and defining concepts to find universal meaning. However, this is an especially difficult task when dealing with an inherently polycentric topic like ESG, which involves technical, scientific, technological, legal, policy, and economic input, and is also contextually influenced.
Projects involving sustainable investment are required to meet the relevant host country’s regulations, which in most cases in Africa includes environmental compliance . In addition to being required to understand their own regulatory requirements within the EU, EU investors should also familiarise themselves with the regulatory environments surrounding a particular investment or project in Africa to understand if it is compliant with local laws and regulations on environmental, social and governance issues. The UN Environment Report found that despite a 38-fold increase in environmental laws put in place worldwide since 1972, failure to fully implement and enforce these laws at domestic level is one of the greatest challenges to mitigating climate change, reducing pollution and preventing widespread species and habitat loss.
Only if an investment is compliant with both the investors’ and investees’ regulatory frameworks on ESG criteria, will the investment be truly ESG compliant and constitute a holistic “sustainable investment”. It is crucial that both investors and investees familiarise themselves with the contexts and regulatory environments of both the jurisdictions from which and into which money is being invested. Responsible investing and jurisdiction specific due diligence will be key.
In September 2020, the leaders of the Big Four accounting firms came together in a joint initiative to unveil a reporting framework for ESG standards. The drive to create a common ESG accounting framework has been sparked by rising frustration among investment groups over the plethora of competing systems for measuring sustainability. To report against the core ESG metrics in the framework should not be a challenge for ‘mature’ businesses who have an established ESG reporting programme. However, for those businesses that do not report on ESG factors, significant work will be required to gather the necessary information. The proposals are voluntary so no business will be compelled (at this stage) to report against them, but it is expected that pressure will inevitably grow for organisations to adopt them. African companies that get ahead and start adopting the metrics, increase their potential attractiveness to investors. Embracing the framework is an opportunity for African businesses to send out a strong message to investors internationally about their commitment to the ESG agenda.
Exploitation of African resources has left its mark on the continent, with countries facing complex legacies and challenges. Africa as a continent is one of the least responsible for climate change, but stands to suffer the most from its impacts. As a result of COVID-19, stimulus spending amounting to the equivalent of trillions and trillions of dollars are being injected into the global economy at scales that are unprecedented and that have never been seen before. To benefit from ESG and impact investing, African companies need to position themselves to take advantage of these new funding opportunities as the world seeks to build back better.