Each week Emerging Markets ESG publishes an interview entitled, “Five Questions about SRI.” The interview features a practitioner’s insights about SRI in emerging markets and through Emerging Markets ESG shares this expertise with a wide global audience. The goals of Five Questions about SRI are fourfold:
- To collect a catalogue of examples of SRI in practice in emerging markets;
- To raise awareness about SRI in emerging markets;
- To reflect on what SRI in emerging markets means to practitioners; and
- To enable SRI practitioners in emerging markets to network with peers around the world.
This week’s interview is with Mike Davies, Managing Director, Kigoda Consulting, South Africa.
Kigoda Consulting is an independent consultancy specializing in research and analysis of environmental, social and governance (ESG) issues affecting sustainable investment across all asset classes in Africa. Services include company ESG assessments, sector reports, thematic analysis and engagement support. Mike Davies is a political and ESG risk consultant with specialist knowledge of the emerging market economies of sub-Saharan Africa. Mike has significant research and consulting experience and has led numerous projects analyzing the political, environmental, social and governance risks and opportunities associated with investing in Africa.
Emerging Markets ESG: How would you define socially responsible investment (SRI)?
Mike Davies: Without getting too bogged down by the innumerable definitions and acronyms, I support those in the industry who feel that “SRI” should incorporate the key concept of sustainability. Sustainability can still be neatly defined as it was by the 1972 Bruntland Commission: “development that meets the needs of the present without compromising the ability of future generations to meet their own needs.” This also reflects the shift from using exclusionary criteria or “negative screening” to remove companies from an investment portfolio on social, ethical or religious grounds, which is more commonly associated with socially responsible investment, to one which looks to positively integrate the analysis of sustainability factors into investment decisions.
Emerging Markets ESG: What distinguishes SRI from mainstream investment?
Mike Davies: The main distinctions are broad differences in the degree to which extra-financial issues are integrated into investment analysis and in investment timeframes. SRI strategies implicitly recognise and try to price in externalities, particularly those relating to environmental, social and governance issues. While traditional, mainstream investment should take a long-term view, SRI absolutely requires a long-term commitment to the actual outcome (ie the outcome that includes extra-financial factors) of investments rather than only the financial outcomes. Active engagement is another key characteristic of many SRI approaches.
However, the distinguishing features are becoming narrower and the lines between SRI and certain mainstream investment strategies are blurring. In some cases, it is now more an issue of perception than reality. Many mainstream investment strategies are increasingly moving towards taking sustainability factors into account. For example, the recent impact of labour issues in South Africa’s platinum mining sector or environmental pollution in the Niger delta cannot be excluded from mainstream investment analysis.
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for companies in African emerging markets to manage?
Mike Davies: The 54 countries in Africa each present very different challenges and opportunities for companies. Even within countries, there are significant regional variations. Sector-specific issues are also important. As a result, the most challenging factor is understanding the specific country, region, sector, and even, project-specific dynamics, which requires genuine specialist expertise. The issues facing a mining project in North Kivu province in the Democratic Republic of Congo are very different to a FMCG company with interests across Nigeria.
However, it is important to note that, in the majority of cases, these issues can be managed. Companies that undertake proper due diligence, engage with stakeholders and adopt a sensitive approach towards local communities and the wider environment in which they operate will significantly reduce potential negative impacts and, as a result, their risk exposure. They will also be better placed to maximize potential opportunities that arise.
Emerging Markets ESG: Which extra-financial theme – environmental, social or governance – is the most challenging for investors in African emerging market companies to analyze?
Mike Davies: Again, it is difficult to generalise across the continent. All extra-financial themes will present a challenge for investors at some point. Environmental, social and governance factors are also fluid. The key is for the analysis to be as relevant to the specific market, sector and asset as possible, which is what Kigoda Consulting strives to achieve.
A major issue is that the disclosure of extra-financial information by companies, even those listed on the various African stock exchanges tends to be extremely weak outside of South Africa. The majority of companies have become more transparent and have embraced websites as a tool to communicate and engage with investors. However, Kigoda Consulting recently found in a survey of the top 100 listed companies (by market capitalization) in sub-Saharan Africa outside of South Africa only 12 have published a separate sustainability report. Even multinationals, which receive accolades for sustainability disclosure in their home jurisdictions, fail to disclose relevant information for their Africa-listed subsidiaries, In general, disclosure tends to be better in terms of corporate governance than on social or environmental issues. But the accuracy, completeness and comparability of data remains a challenge across all themes.
Emerging Markets ESG: From your perspective, which asset classes are most promising for SRI in Africa during the next five years?
Mike Davies: Given the relatively high returns available, and the paucity of attractive returns across the developed world at present, investor interest will continue to grow for all asset classes across Africa. We have already seen strong interest from private equity funds, many of which incorporate ESG factors into their investment analysis. This trend will continue. Steps to deepen capital markets will provide greater liquidity and invigorate both equities and debt. Alternative assets including infrastructure, commodities and forestry will also see strong demand. Meanwhile, ongoing support from institutions such as the IFC and regulatory changes such as South Africa’s revised Regulation 28, which requires funds to give appropriate consideration to material long-term factors, including ESG, will provide impetus to SRI.
The growth of Africa investment will also be supported by the shift in the perceptions of the risks and opportunities that the various countries present to investors. Increasingly, investment in Africa is no longer seen as merely a commodities story. Growing consumer demand reflected in the recent spate of news articles on “Africa’s middle class” is providing an alternative investment thesis. However, the optimism needs to be contrasted against the high levels of inequality, poor social and physical infrastructure and weak governance. These issues, among others, make it imperative that investors also consider the extra-financial factors when investing.