The changing landscape of sustainable finance

By the Bureau for Economic Research

The effects of rising carbon emissions are fast becoming too costly to ignore. Although there is broad consensus that the associated extreme weather events may result in physical and economic risks, these are difficult to measure and forecast – even in the short or medium term. South Africa faces the additional complexity that the projected negative impact of climate change is hard to weigh against the immediate challenges associated with high levels of poverty and unemployment.

But perhaps the trade-off is not that stark. Extreme weather events may cause business disruptions, lower production, profits and wages, disrupt service provision and affect the availability or cost of credit and liquidity. This might further translate into financial risk. As a result, the global financial sector is beginning to require more information and greater disclosure about firms’ exposure to climate and other environmental, social and governance (ESG) risks. Some of these developments may impact on South African firms, especially those that operate in foreign markets. Shareholders (including some asset managers) are increasingly urging firms to take climate and other ESG criteria into account. To deliver high returns and limit risks in the long run, asset managers can encourage firms to disclose their exposure to climate related risks, or even engage more directly with firms about best practices or climate transition plans.

One of the unintended consequences of these trends might be ‘greenwashing’, whereby firms create the false impression that their actions are more environmentally friendly than in reality. To address this issue in Europe, the EU Taxonomy Regulation will take effect from January 2022 to provide a classification system for green and sustainable economic activities. A working group chaired by National Treasury has also released a draft Green Finance Taxonomy for South Africa.

The Sustainable Finance Disclosure Regulation (SFDR), introduced by the EU Commission in March of this year, sets mandatory obligations to allow for a more harmonised approach for sustainabilityrelated disclosures. It applies to all financial market participants and asset management firms that operate in EU markets, irrespective of whether they focus on ESG or sustainability investments.

Greater disclosure of climate-related and other ESG risks might help to minimise the impact of climate change on financial stability. Incorporating such recommendations into business practices – even if not yet mandatory – may reduce the risk that South African firms are left behind. It could also contribute to South Africa’s shift towards a “Just Energy Transition”.