Verification of ESG Merit
A critical question arises: How do retirement funds really know if their investments are truly supporting ESG goals? Transparency with stakeholders is paramount, yet some funds may rely on internal methodologies rather than established disclosure frameworks such as the IFRS S1 and S2 standards. These standards are essential for capturing the material impact of ESG efforts, ensuring that investments genuinely contribute to sustainable development.
It's crucial to remain vigilant against greenwashing due to the absence of standardised ESG metrics and the challenges of evaluating ESG performance. Retirement funds can safeguard both themselves and investors by employing rigorous ESG data verification techniques. This includes leveraging independent ESG advisors to scrutinise the sustainability claims of their investments, corroborating data from different sources, and conducting on-site verifications.
Challenges with Implementation
Market behaviours result in several challenges to ensure a sustainable finance market[1]. These include:
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Lack of Standardised Terminology: The lack of universal, legislated or standardized terms in sustainability topics makes it difficult for stakeholders to communicate and understand each other. This is due to the complexity and diversity of these topics.
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Inaccurate and/or Misleading Information: Without standardised terminologies, there is a higher risk of misrepresentation and inaccurate claims regarding sustainability objectives. Untrustworthy data verification agencies make the problem worse.
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Weak or Undeveloped Understanding of Sustainability Concepts: Sustainable and green projects can be unfamiliar and uncertain, hindering market participation.
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Inconsistent, Unreliable (or No) Disclosure and Reporting Requirements: Corporates may use various methods to disclose or report their sustainability performance. This can make it difficult to compare and evaluate their impact or returns.
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Lack of Suitable Products, Services, and Markets: There is a need for better-designed financial instruments, products, and services that meet customer needs and support sustainability objectives.
The FSCA emphasises that the development of disclosure and reporting requirements must be accompanied by assurance services to verify compliance. It is imperative to collaborate with stakeholders in accounting, credit rating and auditing to effectively address these challenges.
The Role of IFRS S1 and S2 Standards
Since the release of the FSCA’s statement, there has been a positive development with the introduction of the IFRS S1 and S2 standards. These standards provide a strong framework for ESG reporting, that not only boosts the credibility and comparability of sustainability disclosures but also integrates smoothly with the European Sustainability Reporting Standards (ESRS) and Global Reporting Initiative (GRI) components. This all adds up to a more comprehensive and unified approach to ESG reporting.
There isn't a specific mandatory requirement for South African retirement funds to adopt IFRS S1 and S2 now. However, with the growing global focus on ESG reporting and the possibility of future regulatory changes, it would be wise for funds to start considering these standards.
IFRS S1 and S2 offer a strong foundation for ESG reporting but applying them to South African retirement funds brings its own set of unique challenges.
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Data Availability and Quality: Finding consistent, reliable, and comparable ESG data on retirement fund investments, especially private assets, can be challenging.
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Portfolio Complexity: Retirement funds often have diversified portfolios spanning various asset classes, making it complex to aggregate and report ESG information.
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Resource Constraints: Smaller retirement funds may lack the necessary human and financial resources to implement and maintain ESG reporting systems.
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Alignment with Existing Frameworks: Integrating IFRS S1 and S2 with existing reporting frameworks and regulations demands significant time and resources.
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Investor Expectations: Understanding and meeting the evolving ESG expectations of retirement fund members can be challenging, especially given the complex nature of ESG disclosures.
FSCA’s Programme of Work
The FSCA’s programme of work for sustainable finance is structured around five pillars, which align closely with the objectives of the IFRS S1 and S2 standards.
The Path Forward
With the frameworks now in place, the focus must shift to implementation. Retirement funds should engage assurance experts to validate the authenticity of their ESG initiatives. This will not only ensure regulatory compliance but also build trust with stakeholders, demonstrating a sincere commitment to sustainable investing.
Conclusion
The integration of ESG considerations into retirement fund investment policies is not just a regulatory requirement but a crucial step towards sustainable economic growth. With established frameworks and standards, the time for implementation is now. Engaging assurance service experts will be key to validating the ESG initiatives and ensuring they adhere to the required standards. Ultimately, this will build trust and demonstrate a sincere commitment to sustainability.
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[1] As set out by the Financial Sector Conduct Authority (FSCA) in its Statement on Sustainable Finance and Programme of Work.