Investing towards Zero: How to approach a Just Transition in South Africa

It took many years, but climate change is no longer a matter of global debate: it is upon us. Already, the Earth’s average global surface temperate is set to warm by a minimum of 2 degrees Celsius should the pace of aggregate national CO2 emissions reductions not accelerate from their current level. And the impact of global warming will not be uniform: studies show the African continent will be among the most negatively affected in terms of human vulnerability to climate hazards and changes, while also being the least able to finance the transition to a lower-carbon economy.

How can South Africa manage this transition in a just but timely way, without doing serious damage to our people, society and economy? There is no doubt that it will be a serious challenge for the government, the private sector and individuals alike. According to the SA Presidential Climate Commission’s latest report, the country is facing a shortfall of some R315 billion of its estimated R1.03 trillion funding target required to reach its own environmental targets for the 2023-2027 period alone.

Here we examine how M&G Investments is approaching a Just Transition within the South African context as a long-term, active global investment manager, and explore the powerful role retirement fund Trustees can also play in making a positive impact on the climate.

A Just Transition

 A Just Transition is internationally defined as “a set of principles, processes and practices that aim to ensure that no people, workers, places, sectors, countries or regions are left behind in the transition from a high-carbon to a low-carbon economy."  In our view, our role is to actively channel capital to companies that can help achieve a just transition, as well as provide finance to enable high-carbon companies to shift to green business models, through engagement and collective action. A divestment-first approach will not achieve the sustainable economic transition the country, and the world, need.

We see divestment, for the sake of reducing direct exposure for its own sake, as merely allowing capital ownership to change hands, rather than depriving a high-carbon company of capital, and driving transition costs for those companies higher. It reduces investors’ influence and engagement, and can also drive more ownership into private hands, which are less transparent and accountable.

While suitable for markets with very large investment universes, a “screening” approach to the transition process, in which investors automatically reject companies with prescribed characteristics, is also flawed given that it assumes that all investment options with associated climate issues are investment risks, when they may not be. In South Africa our universe is small enough that we can understand our stocks sufficiently well, without using third-party providers’ underlying assumptions of exposures and risk.

In fact, in South Africa our sources of CO2 emissions are relatively concentrated when it comes to the universe of JSE-listed companies and debt issuers. Eskom (whose debt is listed) accounts for approximately 43% of the country’s emissions, and Sasol is responsible for another 12%. All other JSE-listed companies combined account for less than 6% of South Africa’s carbon emissions.

Engaging with Exxaro and Sasol

We use Exxaro and Sasol here as prime examples of listed fossil fuel producers who have both committed to achieving net-zero carbon emissions by 2050, but require two very different journeys to achieve a successful transition to greener business models.  

In our view, Exxaro is a favourable example of a company that has already embraced the net-zero goal and taken positive steps toward planning and implementing it. Its chief advantage has been its strong balance sheet, with sufficient cash to meet dividend expectations and fund its ongoing operations and maintenance, while also financing its ventures in green minerals and renewable energy at the same time. The group has already built up significant existing stakes in green energy, and has other green projects underway behind the scenes.

Exxaro management has also played a proactive role in providing clear project guidance, complete with milestones, to company stakeholders. Regular, detailed interactions with the Board Chairman and key non-executives have also aided in the transparency of the group’s plans and progress, making it much easier for us as investors to map and analyse their operations and understand their plans for utilising their cash.

Although Exxaro is not guaranteed to reach net zero by 2050, it is positioned, and already acting, to pivot and explore the opportunities of green minerals and green energy.

Meanwhile, Sasol is a much more complex case, with operations that require significant technological advances globally before they can achieve a successful transition. The group also has relatively complex debt structures in different geographies, although it has been paying them down as a priority. As such, debt repayments, ongoing operations and dividends compete for cash with its current pilot projects focusing on new technology to become a greener organisation. The pilot projects are timeous, and the infrastructure challenges of changing feedstock from coal to transition gases, and then green gases, are tremendous. These factors all make its path to net-zero, including ongoing goals and timelines, much more uncertain. And while it counts among the world’s biggest polluters, making its transition all the more urgent, it also plays a very large and important role in the South African economy and industrial complex, and is a major employer. Its transition is therefore more likely to be a bumpy one.

With Sasol we consider it vital to remain actively engaged with key role players on various levels of the company, from oversight by non-executive directors and the executive team themselves, to new technology teams on the ground, in order to understand clearly their transition plans. M&G’s equity analysts question and challenge their people, technology, infrastructure, finances and strategic milestones, in an effort to gauge the company’s commitment and ability to succeed. For us, Sasol represents a large-stakes test of the role active investors can play in helping South Africa achieve a Just Transition.

What tools do Trustees have?

As guardians of large amounts of retirement fund savings, Trustees can play a powerful role in helping South Africa achieve a Just Transition.  It is important for them to understand the chosen asset managers’ investment philosophies, processes and structures, and the importance they place on environmental, social and governance (ESG) factors in their investment decisions.

This understanding can be achieved by addressing the following factors:. 

• Do they philosophically align with your members?

Is it just about returns, or is there also a broader goal of doing good for the country, the community and more?

• What about DNA?

Are ESG factors embedded in their fundamental processes, or are they a “bolt on” organogram block?

Do they have tangible structures and processes in place that ensure that ESG and climate outcomes are tightly incorporated in their investment decision-making, and are there secondary controls to ensure integration? 

• What is the evidenced action?

Do they actively engage with the companies in which they invest the retirement fund’s money?

Do they provide regular reporting and feedback?  Although there is not always the level of detailed data we would like to see, are they nonetheless developing targets and modelling?

• Are they accountable?

Is someone responsible for issues of sustainability and ESG?

Is the company a signatory to the United Nations Principles for Responsible Investing (UNPRI) and other global and local organisation and working groups? 

• What about their communications?

Is the investment manager clear about developing and articulating their own goals and intentions, and providing a consistent approach to the integration of ESG into their process?

Does their track record show this?

• Are they able to adapt?

Are they able to improve their systems to account for the new risks, data collection and measurement associated with climate change?

Do they progressively improve their policies and practices?  

• Are they involved?

Do they regularly engage government and regulators, and work with their peers and other professional bodies to meet and overcome challenges?

Are they a force for good?

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If aligned to the above, asset managers will be well equipped to help Trustees make a positive difference when it comes to combatting climate change and for South Africa to achieve a Just Transition over time. While it will undoubtedly be a complex path ahead, with many twists, turns and even detours, in our view it is a challenge we are committed to undertaking.

M&G plc is a signatory to the UNPRI, the Net-Zero Asset Owner Alliance and Climate Action 100+, among many other global organisations related to ESG investing, and M&G Investments plays an active role in supporting the group in these initiatives.