South Africa among global peers leading the charge on ESG

21st Century CEO Chris Blair unpacks a recent study into the adoption and application of ESG metrics.

For the first time, 21st Century (representing Africa) is part of a worldwide study of ESG (Environment, Society and Governance) metrics conducted by the GECN Group of companies covering five continents: Africa, Asia, Australia, Continental Europe and North America.

We have just completed the study across eight listed exchanges in which South Africa is the only emerging market exchange. South African listed companies can stand tall amongst the developed nations in our adoption and application of ESG metrics.

Why is ESG important?
ESG metrics can be described as non-financial metrics and are about the sustainability of the world, the continents, countries, businesses and society. Everyone knows about the dire effects that global warming will have on the earth as we know it if the increase in world temperatures exceeds 1.5°C.

Society is becoming more vocal about government and business practice as the world moves from “Shareholderism” to “Stakeholderism”. This trend has been catapulted forward due to the Covid-19 pandemic, which has highlighted the unsustainable business practices worldwide that are leading to the destruction of the environment and of society – highlighted by the growing wage and wealth gap around the world.

This year’s GECN research aimed at examining any year-on- year trends in companies using ESG metrics in executive incentive plans (both the prevalence and weighting), particularly changes in connection with the Covid-19 pandemic and the increasing market pressure for companies to increase their focus on ESG in their business strategies. Our study also identified that a growing number of companies are starting to incorporate ESG metrics in executive long-term incentive plans and that the weighting is higher than in prior years – tying sustainable metrics to executive pay in the long term.

The main trends emerging from the study are as follows:

  • A growing number of companies across the world are tying executive pay to ESG performance, particularly in the environmental area.
  • There is an increase in the number of companies using social metrics in their incentives in all regions, except Singapore.
  • The pandemic resulted in a significant shift in social metrics – away from employee engagement metrics and towards an increase in workplace policy metrics – employee wellness.
  • Companies allocate a higher weighting to ESG metrics in short-term incentives (25 percent) than in long-term incentives (20 percent).
  • The most significant increase in inclusion in long-term incentive plans is the inclusion of environment and climate change metrics.

The global average aggregate weighting of ESG metrics in incentive plans account for nine percent of the maximum total remuneration package (fixed pay plus variable pay) received by the company’s top executive each year. The question is, is the weighting of these ESG metrics material enough to actually incentivise management to act?

How does South Africa perform relative to its peers?
More than 74 percent of companies in all sectors reviewed use ESG metrics. However, how does South Africa perform relative to its peers globally? South Africa ranks fourth in the world with 75 percent of companies using ESG metrics, while Australia leads (84 percent), followed by the United Kingdom and Europe (79 percent). South Africa is just ahead of the world average – given that we are an emerging market (compared to developed markets), we should be proud.

There has been a huge swing towards social metrics, catalysed by the pandemic, which highlighted the inequity of pay and wealth around the world. The poor have borne the brunt of the fallout from the pandemic through loss of jobs, reduction in pay, increased fuel and food prices – hence there has been an increased focus on this non-financial metric.

This has been particularly prevalent in South Africa, which has the highest Gini coefficient (measure of income inequality), and one of the highest unemployment rates in the world. South Africa moves to third place for the use of social metrics (68 percent), behind Australia (84 percent) and Europe (70 percent). South Africa leads the charge on diversity, equity and inclusion (DEI) metrics with this social metric being front of mind in most companies’ strategies. Forty-five percent of companies world-wide use DEI metrics followed by 37 percent, who use employee engagement metrics.

South Africa ties in first place with Australia, with 13 percent for the most important metric of ESG – the weighting of the executive maximum total remuneration linked to ESG metrics. The link between the executive key performance indicator (KPI) and executive pay is critical in incentivising the executive to “do the right thing”. Although the weighted linkage is still quite low (and increasing), South Africa is well ahead of the global average of nine percent.

Sustainable ESG metrics
The split between weightings of performance metrics for short-term and long-term time horizons is critical in the incentivisation of executives, since this determines whether a forward-looking sustainable approach is more important than short-term wins that could result in long-term losses. Using ESG metrics is much more prevalent in short-term incentives (71 percent) than in long-term incentives (only 16 percent). We can only hope that the move from short-term towards long-term incentives continues rapidly, as this is how ESG metrics will become sustainable.

In the coming years, we expect to see the growth of the trends in companies that adopt non-financial ESG metrics in their incentive plans:
Over the long-term (5-10 years) these companies have a higher historical Total Shareholder Return (TSR) compared to the market.
They will be larger market capitalisation companies or have higher institutional shareholding percentages
They will have a higher weighting on non-financial metrics.

The world is in urgent need of change in terms of its environment, climate change, social inequity and well-being. ESG metrics could be the silver bullet that brings this change about, but only if it is universally adopted and governed. South Africa sets an example that as an emerging market, we can contribute and stand tall among our world peers.