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A Force to be Reckoned With

According to the Emergency Event Database, in 2022, there were 387 natural hazards and disasters worldwide. This resulted in the loss of 30,704 lives, affecting 185 million individuals, and causing economic losses of around US$ 223.8 billion. These quantums highlight the significant global impact of climate change.

Between May 2005 and May 2018, ESG was mentioned in fewer than 1% of earnings calls; however, by May 2021, it was mentioned in almost a fifth of earnings calls aligned to increasing awareness and activity to address issues. This trend is also partly explained by the significant rise in global ESG regulations issued over time – with 2021 being a record year for new regulation, as shown in the chart below.

The next few years are unlikely to be different, with several emerging trends in the regulatory landscape.

Increasing financial impact to drive behaviour

European regulators have started increasing penalties for non-compliance. Human rights supply chain due diligence is a good example. There has been a voluntary requirement for companies to identify and mitigate human rights abuses in their supply chains. Additionally, the EU is finalising the implementation of a human rights supply chain due diligence requirement that would have a financial impact of potentially more than 5% of global revenue should companies not comply.

The US market is similar in driving a financial impact; however, there is a divided policy approach. The Inflation Reduction Act (IRA) is funneling $394bn into green projects, including consumer and producer subsidies to incentivise better protection of the environment. This should help the US reach net zero. On the other hand, anti-ESG regulations in certain states, and further regulations to push back against those anti-ESG regulations are leading to increased policy uncertainty in the region.

South Africa’s carbon tax is a local example of the increasing financial impact stemming from regulations. Once phase 2 starts in 2026 and allowances are slowly phased out, companies will pay increasing taxes based on their carbon footprint.

We expect a continued trend for regulators to either incentivise or tax consumer and producer behaviour.

The global nature of ESG regulations

The JSE All Share index is largely made up of foreign revenue, with more than 50% non-South African revenue. While this makes for a good source of diversification, it also exposes local companies to the broader global regulatory environment. Therefore, investing in local companies means careful consideration of how changing global regulation will impact earnings and business models.

South Africa also stands to benefit from the greater global drive towards sustainability as a commodity-producing country through an increasing demand for so-called “green” metals. Regulation implemented by SA’s trading partners, such as the EU’s carbon border adjustment mechanism, will also impact the competitiveness of our products in those regions.

The heightened regulatory environment and drive by ESG policymakers to create a financial impact in a globally connected industry means ESG is becoming a greater force to be reckoned with. At Truffle, we place a strong focus on ensuring we understand the global ESG regulatory market, the evolving trends and their potential impact on the companies in which we invest. Robust and up-to-date research means we can avoid being swept away by the storms of change.

Rising regulation is set to change behaviours. This will impact corporate business models and their financial results, globally.

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