Active stewardship is becoming an increasingly important aspect for asset managers and forms a key element of Truffle Asset Management’s approach to responsible investing. As part of stewardship, our preference is to engage company management and stakeholders around Environmental, Social, and Governance (ESG) concerns, as opposed to excluding a company with a good investment case facing a particular ESG risk. We believe engagement is a strong tool to drive positive outcomes.
Engagement topics are typically informed by ESG research, data, and news flow, as well as topical themes that vary across companies and sectors.
Evolving environmental regulation
An important theme informing our current research and engagement activity is the evolution of regulation relating to environmental protection. Countries with specific targets to manage climate change are regulating the business environment to reduce the impact of carbon emissions and achieve “net zero” targets by 2050. However, they are finding it increasingly important to ensure the “same rules apply”. A good example is the European Union’s (EU) Carbon Border Adjustment Mechanism (CBAM) which was adopted in 2023.
According to the Climate Action Tracker, less than 5% of global emissions have carbon pricing at, or above, the $40–$80/tCO2e range that is estimated to be consistent with a 2°C global temperature reduction pathway (“State of Climate Action”, November 2023). Europe is one jurisdiction that has regulated carbon pricing to fall within this range, meaning the cost of production for certain goods and services in the EU is higher than in other countries. The EU has therefore established CBAM to equalise the production cost across imported and homegrown products. Through CBAM, an EU carbon tax is imposed on large importers based on the exact carbon emissions embedded in those imported products. These importers may claim back any carbon tax paid in the country of origin as applicable. The aim is to align the carbon tax paid on carbon intensive goods produced in the EU to the carbon price paid on carbon intensive goods imported from other countries.
Unpacking the potential impact
Initially, CBAM will apply to high carbon emitting sectors, like electricity, cement, fertilisers, iron and steel, aluminium, and hydrogen. By 2030, additional sectors such as oil refining, all metals, pulp and paper, glass and ceramics, acids and organic chemicals will be included. Trade and Industrial Policy Strategies, an economic research organisation, estimates that based on the initial number of sectors impacted, 2.2% of South Africa’s exports are at risk. This amounts to approximately 0.8% of our GDP.
Given the potential financial impact on certain sectors, Truffle engaged companies in the iron and steel, aluminium and oil refining sectors to understand how they are preparing for potentially higher taxes on products exported to the EU. Given the nature of products exported by these companies, the current impact is limited. However, the EU’s carbon tax on imports may just be the start. The pressure on countries in developed markets to reduce carbon emissions and support the path to net zero is increasing. Other countries, such as Japan, are also considering implementing their version of a carbon border adjustment mechanism. At Truffle, evaluating the introduction of new regulations, means gaining an understanding of the financial and business impact on the companies in which we invest. Critically, this informs our engagement agenda with company management and ensures we remain aware of the implications of environmental regulations for each business and sector.
