Over the past ten years, there have been positive moves in South Africa’s corporate sector regarding strategic decision-making on ESG (environmental, social and governance) matters, but research carried out by Henley Business School and Risk Insights, reveals that this is not translating into significant strategic change or innovation. ESG remains just skin deep and is not yielding the kind of impact that South Africa, which is the most unequal country on the planet, needs.

Of course, this mirrors a global trend. After a decade of growth, ESG is facing ‘a mountain of challenges’ globally, from net outflows of ESG funds towards the end of 2023 to mounting negative scrutiny, fuelled in part by economic pressures, such as inflation and the rise in populism in some parts of the world.

Yet ESG matters for companies now more than ever. Unpredictability and disruption—from climate change-related impacts to social unrest, economic migration, and geopolitical tensions and conflicts—continue to underline the importance of effectively assessing and mitigating ESG risks. Furthermore, society is relying heavily on the private sector to drive the innovation needed to tackle these collective problems.

What’s stopping companies?

It is, therefore, a useful discipline to “look under the hood” and understand the internal motives for adopting ESG and, more importantly, what’s stopping companies from going further, faster.

The Henley research provides a comprehensive analysis of ESG practices among 63 Johannesburg Stock Exchange-listed (JSE-listed) firms, exploring various aspects of ESG, including demographics, motivations for ESG adoption, stakeholder engagement, materiality approaches, governance structures, and ESG reporting frameworks.

Most companies surveyed were large or very large, with 30% employing over 10,000 employees and 70% reporting annual revenues of more than R90bn (£3.7bn).

There was also a high level of ESG maturity (the number of years since the company adopted ESG) among these firms, with over 60% having adopted ESG principles more than six years ago, 27% of which have more than a decade of experience.

Avoidance strategy

What is immediately clear from the survey is that most firms are using ESG to avoid the destruction of value and optimise existing value, rather than to create new value. Of the survey’s respondents, 46% said they adopted ESG to mitigate risk and improve risk management and 30% to improve financial performance.

While fostering innovation was cited as one of the top three reasons for adopting ESG, there are reasons to believe this is mostly referring to operational efficiency gains rather than more fundamental innovation or strategic shifts such as introducing new products and services, asset divestment, mergers and acquisitions, change of distribution channels, and joint ventures.

ESG covers a variety of issues related to the environment (including climate change, energy and water use, carbon emissions), social responsibility (such as fair trade principles, human rights, product safety, gender equality, health and safety), and corporate governance (for example, board independence, corruption and bribery, reporting and disclosure, shareholder protection).

In the South African context, perhaps not surprisingly, ESG has mostly focused on social factors and governance improvements. Incremental improvements have been made on diversity and inclusion, and health and safety conditions, for example, while the environmental focus is lagging.

Despite some gains, ESG potential in South Africa is largely untapped. For instance, the country has a huge opportunity to be the first coal-based economy in the global south to successfully transition to a low-carbon economy, especially in the energy sector.

According to the Climate Bonds Initiative, green bonds can be a part of the solution. Global experience to date has shown they are a vital tool in harnessing the increasing investor appetite for investments with green and social impacts, and yet, currently, no firm is pushing the boat out to take a risk on this.

One reason for this could be that corporates feel relatively low pressure from marketplace stakeholders (suppliers, customers, and competitors), reinforcing the idea that the main motivations for ESG are not strongly competitive in nature. But this is not the case.

Barriers to innovation

While interest in ESG and willingness are certainly there, South Africa’s corporations face barriers when stepping up ESG execution, especially the innovation of financial instruments. One of the key issues identified is around resources and access to resources.

More than two-thirds of executives reveal that there is often a fight for ESG resources among different business units, while around half said there was a lack of integration within the organisation, which resulted in decoupled business and sustainability strategies. Most organisations have allocated ESG to a chief sustainability officer and a small team, moving it away from the company’s core business interests.

Furthermore, limited board involvement means that motivated executives are often isolated and not empowered to make decisions and implement strategies. They lack legitimacy, resources and the mandate to pursue often difficult long-term strategies that create sustained value for all.

Some executives also bemoaned the lack of incentives tied to performance on sustainability as well as the different views among the board and top management teams regarding prioritising ESG.

What seems unequivocal is that board engagement has the potential to be a major catalyst for ESG acceleration. Currently, ESG in South African firms is being driven primarily by operational requirements, but a strategic-level review that starts with purpose would likely be far more effective in galvanising employees and providing strategic clarity. And research has shown that a purpose-driven approach can lead to higher future accounting and stock market performance.

Company boards, therefore, have a significant opportunity to drive purpose-driven ESG innovation in areas such as asset divestment, mergers and acquisitions, change of distribution channels and joint ventures to unlock competitive advantage.

A fundamental strategic move, for example, could be acquiring companies with ESG capabilities to involve joint ventures to help compete and innovate products and services that are environmentally and socially sustainable.

While critics claim ESG is ‘woke capitalism’, ESG initiatives have been shown to stimulate job creation and economic upliftment. Instead of ticking boxes and playing it safe, companies could make a deeper commitment to the ESG agenda and empower those at the top of their organisations to make the decisions that will benefit themselves and the wider societies and economies within which they operate. The long-term gain will likely set companies of the future apart.

Filipe Morais is a lecturer in governance and programme director of the MSc in Management for Future Leaders at Henley Business School. Vickey de Villiers is a research consultant at Henley Business School Africa.

Read the full report The State of ESG Integration in JSE Listed Companies.