The Financial Sector Conduct Authority says it is exploring whether to introduce more regulations for Environmental, Social and Governance (ESG) and sustainable finance.
This is according to a statement on 12 March in which the FSCA announced the publication of the results of a survey conducted across investment providers. The survey provides insights into the extent to which investment providers are integrating sustainable finance and ESG considerations into their investment strategies.
In March last year, the FSCA published its “Sustainable Finance Programme of Work”, signalling the Authority’s intention “to prioritise certain regulatory and supervisory activities aimed at promoting the availability of credible and consistent information regarding sustainable finance in the South African market”. The survey flows from this policy decision.
The “Investment Providers Sustainable Finance Survey” was conducted from 22 August to 3 November 2023. The survey was sent to 1 046 participants via bulk email. Only 119 responses were received (11% of the total population). Some organisations provided group responses, so the response rate may be greater than 119.
The survey was sent to Category II, Category IIA, and Category III FSPs and authorised managers of collective investment schemes, but not participation bonds and property schemes.
The survey focused on three themes: governance, operations and product design, and risk management and disclosures.
“While the survey findings indicate that a significant portion of the industry recognises the importance of ESG principles, adequate and effective integration remains challenging,” the FSCA’s statement said. It said the key problems include:
- Regulatory uncertainty, which limits the adoption of standardised ESG practices.
- The lack of consistent ESG ratings, which affects investment decision-making.
- Greenwashing, which raises concerns about misleading sustainability-related information.
The FSCA said it is “exploring the need for further regulatory interventions, including those aimed at strengthening transparency requirements, refining ESG disclosure guidelines, and aligning with emerging global frameworks”.
Most respondents incorporate ESG
The survey asked respondents to elaborate on their efforts to actively integrate ESG and sustainable investment considerations into their business operations. Of the 119 respondents, 78% (93) said they incorporate ESG and sustainable investing considerations in their organisations.
The investment providers who said “yes” are doing the following:
- They mix ESG into their decisions, talking to the companies in which they invest and owning stocks to create value over time that fit with sustainable goals.
- For responsible investing, they pick outside money managers who follow their rules, making sure ESG is part of the plan and watched over by important company committees.
- They are putting money into sustainable finance, particularly “green” projects such as renewable energy, and focusing on areas such as healthcare, retail, and manufacturing.
- They are working on a responsible investing framework that keeps evolving, focusing on ESG, active ownership, and investing to make a positive difference.
- They check companies’ annual reports to see how they’re handling their carbon footprint (such as offsetting emissions), dealing with climate change, and helping with social projects.
- They have investment policies that explain their approach to responsible investing, including ESG guidelines and rules about which industries they won’t invest in.
Although most respondents have ESG principles embedded in their investment and organisational strategies, less than half – 45% – offer ESG investment products.
Fifty-two of the 119 respondents (46%) stated they offer ESG products only at the request of investors, in accordance with their investment philosophy.
“A respondent pointed out that there is currently no requirement in the FAIS Act to provide ESG product choices; the requirement is to provide suitable advice to clients, which is duly done,” the report says.
Twenty-two percent of respondents said they do not incorporate ESG and sustainable investing considerations in their organisation. Their reasons were:
- ESG is an additional cost burden.
- ESG is not relevant to their line of business, and of no interest to them now or in future.
- They are taking baby steps to include ESG in their investment process.
- ESG can conflict with investment objectives or is not feasible within the organisation’s investment mandate.
- The ESG framework is under-researched, and proper definitions, measurements, deeper discussions, and the identification of unintended consequences of ESG are needed.
- ESG considerations are not viable because the business is small.
Board involvement
As previously stated, the first part of the report looked at governance, which it describes as “evaluating and integrating strong governance principles and practices into financial decision-making processes. It highlights the importance of strong corporate governance, ethical behaviour, risk management, compliance with regulations transparency, and a commitment to long-term sustainability.”
A total of 73 respondents out of 119 (61%) said they have established an ESG policy or framework within their organisational structures. Of these 73 respondents, 54 stated that they obtained approval from their respective boards of directors.
The FSCA is of the view that for sustainable finance to be implemented successfully, it should be included as policy and driven by the board of directors.
Demand for ESG products?
Slightly more than half (52.1%) of respondents stated there is no evident trend that highlights a demand from retail investors for ESG products.
The remaining 47.9% of respondents stated that retail investors seem to show interest in ESG products. These respondents also said they have noticed increased interest from their clients globally in ESG reporting.
Possible regulation tools
The “risk and disclosure” section of the report discusses respondents’ views of what role the FSCA should play in facilitating ESG and sustainable investing practices.
Most respondents are in favour of the FSCA providing guidance on sustainable finance. They believe this will enhance readiness by standardising practices and ensuring clarity within the industry.
Although there is widespread support for a standardised ESG rating system, concerns were raised about the potential for greenwashing and the creation of a mere checklist activity. Some respondents expressed doubt about the feasibility and accuracy of current ESG information for effective product-level assessment.
Views are divided on the extent of the FSCA’s involvement in standardising ESG ratings. While some argue for regulatory intervention, others caution against potential overreach, advocating for a principles-based approach instead.
Respondents emphasised the importance of aligning any rating system or guidance with global standards and frameworks, to ensure consistency and comparability across markets. Furthermore, respondents acknowledged the challenges involved in achieving standardisation because of the diverse nature of ESG approaches and reporting practices. A flexible approach, they believe, may be more effective than rigid standardisation.
Concerns about greenwashing
Most respondents agree that South African investors lack the knowledge to identify ESG practices and greenwashing (fake sustainability claims). Only 21 of the 119 respondents said their consumers can identify greenwashing.
Most of the respondents (82%) said they do not have any processes in place that can identify or mitigate greenwashing risks.
Respondents highlighted difficulties in identifying greenwashed products due to a lack of clear standards, data consistency, as well as the existence of skills gaps.
Some respondents said that they have KPIs to measure greenwashing, but did not elaborate further, while others stated they conduct due diligence on potential investments to ensure they align with established ESG criteria.
Respondents submitted various suggestions on how to counteract greenwashing and remedy challenges experienced in implementing ESG practices:
- The FSCA should introduce clear guidelines, definitions, standardised reporting, and third-party verification.
- The industry should collaborate to develop best practice and promote investor education and/or continuous training on greenwashing risks.
- Existing frameworks should be leveraged for similar requirements in South Africa.
- There should be clear disclosure requirements, independent verification, and penalties for greenwashing and/or promoting greenwashed products.
- There should be thorough due diligence by investment providers.
Recommendations for the FSCA
The report concludes with respondents’ recommendations on what the FSCA should consider to enhance the adoption of ESG and sustainable investing. These are:
- Develop a comprehensive framework for sustainable finance that outlines the regulatory requirements, standards, and guidelines for financial institutions and market participants. This framework should incorporate internationally recognised principles and standards while considering the country’s socio-economic context and development priorities. There is also advocacy for aligning with global frameworks such as the Financial Stability Board’s Task Force on Climate-related Financial Disclosures and the United Nations’ Sustainable Development Goals
- Collaborate with international partners to help strengthen regulatory frameworks, enhance institutional capacity, and promote the harmonisation of sustainable finance standards and practices across borders.
- Invest in capacity-building initiatives and awareness-raising campaigns to enhance the knowledge and skills of regulators, financial institutions, investors, and other stakeholders on sustainable finance principles and practices.
- To prevent greenwashing, ensure transparency and accountability when promoting investor protection, as part of Treating Customers Fairly.
- Encourage innovation and support emerging markets and SMEs in the journey of sustainable goals for long-term value creation.
- Create and foster an enabling environment for innovation and market development in sustainable finance by incentivising the adoption of ESG integration practices, green financing solutions, and impact investing initiatives. This may involve offering financial incentives, tax breaks, or regulatory support for sustainable finance projects and initiatives that contribute to the country’s sustainable development goals.
