The Role of Governance in Sustainable Investing

As a responsible investor, and signatory to the Principles for Responsible Investing and Code for Responsible Investing SA, Futuregrowth’s investment process has always considered Environmental, Social and Governance (ESG) aspects in our due diligence and investment decision making.

Increasingly, our focus has been on the “Governance” element of ESG – we believe that good governance lies at the heart of a sustainable business that delivers returns for ALL the stakeholders of a business, viz shareholders, lenders, employees, customers, suppliers and society at large. ESG factors are integral to the investment analysis and due diligence process and we apply this to all our investments - including listed and unlisted assets, equity and debt and across the various sectors we invest in on behalf of our clients. In this context governance is an important risk indicator to the fulfillment of an entity’s mandate and its ongoing operational sustainability.

Our focus on ESG in our investment decision making has recently been affirmed by the release of the King IV Report on Corporate Governance. In addition to a focus on ethical and effective leadership and transparency, there is a specific principle (Principle 17) that is directly applicable to institutional investors in King IV. Principle 17 requires “the governing body of an institutional investor to ensure that responsible investment is practiced by the organisation to promote the good governance and the creation of value by the companies in which it invests”.

Recent events during 2016 in the State-Owned Entity (SOE) sector lead to us suspending new funding to six SOEs on governance concerns. Following this public stance, we committed to embarking on an in-depth review of the corporate governance practices of these entities with a view to better understanding the governance mechanisms underpinning them, the risks and opportunities, and to facilitate an engagement process with the management of the SOEs. Our vision was to create a long-term foundation for better governance, better transparency and disclosure and long-term sustainability of our investments.

Typically to date, governance reviews of large listed corporate and SOEs have followed a tick box/desktop analysis approach. Publicly available information is limited to what is presented in the integrated annual reports, on the entities’ websites and media reports. In the past, we have relied on these sources as inputs to our due diligence process. The recent and concerning news flow in the SOE sector prompted us to amend our approach and expand the scope of our review further to a detailed assessment of policies, process and practices, an assessment of the relevant Board’s independence and commitment to fiduciary responsibilities and an understanding of the relationship with the shareholder.

Governance is a dynamic process, the monitoring of which requires ongoing attention and engagement with management and shareholders. An important aspect of our governance reviews is encouraging enhanced governance practices through specific recommendations and increasing public disclosure and transparency to create sustainable improvements. More frequent and dynamic reporting over and above what is currently available has already been negotiated and agreed with Land Bank, the Industrial Development Corporation and the Development Bank of South Africa. Most significantly, this information will be made available to the broader market via SENS announcements, on the relevant SOE websites and in their annual Integrated Reports – our hope us that this will shine a light on governance and contribute to improved standards in governance practices which will benefit all stakeholders.

Our review allowed us to make certain recommendations to improve governance and disclosure and included (but was not limited to) restricting the authority delegated to certain sub-committees to more appropriate levels, improvements to how Director’s conflicts are dealt with, the implementation of “cooling off” periods for Board members conducting business with the entity once their Directorship has ended, the implementation of an appropriate Politically Exposed Persons (PEP) policy and increasing the quorum and voting requirements for board and sub-committees. Additional public reporting agreed includes disclosure of board charters, reporting on significant changes thereto, loans approved per transaction approval level, reporting on changes in the Board composition, details of loans made to PEPs and the performance of these over time.

Policies and procedures form the skeleton of corporate governance but ethical and effective leadership is the heart of sound corporate governance. Policies and charters only tell a small part of the story and, on their own, are not enough for an entity to claim that their governance is sound. An ongoing commitment by the shareholder, the Board and executive leadership to implement and practice good governance on a day to day basis is of paramount importance in ensuring the SOEs can sustainably execute their mandates. We also recognise that sound corporate governance is a journey and that ongoing improvements and corrections are necessary to ensure ongoing focus and execution.

Overall, the engagement with the SOEs has been positive and constructive. The Boards and the Executives have been open and proactive. Futuregrowth has resumed lending to Land Bank, the Industrial Development Corporation and the Development Bank of South Africa, subject to some conditions and agreed amendments. We are proud of the outcomes achieved following the governance reviews and believe that the changes and additional reporting negotiated will contribute to better standards which will ultimately benefit our clients and the broader investment community.