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The current trends on the continent have an increased focus on sustainability with many African countries recognising the importance of sustainability and ESG practices and governments enacting legislation and regulations to address these challenges.
For example, in addition to South Africa’s Climate Change Bill, Kenya also launched the Kenya Green Bond Programme in 2017 to develop a green bond market which was the first shilling-denominated green bond in East and Central Africa on the London Stock Exchange. The CBK has also developed a Guidance on Climate-Related Risk Management for the banking sector which aims to sensitise stakeholders in the sector to the mitigation of climate-related risks on one hand, and harnessing of opportunities on the other.
Other trends include adopting national sustainable development plans which outline strategies to address climate change, promote social equity, and enhance governance.
We can observe the promotion of renewable energy, and conservation and biodiversity protection. While a majority of these have already formed a part of many African countries’ legislative frameworks, an increased focus can only auger well for the continent and businesses given the current climate crisis. – Daniel Ngumy, Managing Partner, ALN Kenya
Some current ESG practices in the market include green bonds, pointed out, impact investing, and socially responsible investing. Green bonds are financial instruments that are used to raise capital for projects with environmental benefits; impact investing involves allocating capital to projects or companies with the intention of generating positive social and environmental impacts alongside financial returns; and socially responsible investing involves considering social and environmental factors when making investment decisions. A number of investors in Africa are increasingly incorporating these principles into their investment strategies and aligning their portfolios with ESG goals.
Picking up on the example of green bonds, how they work is that they are typically used by governments or corporations whereby the proceeds from the bonds are earmarked for financing or refinancing specific environmentally friendly projects. Greed bond issuers provide transparency by disclosing the use of the proceeds and reporting on the environmental impact of the funded projects. They can be effective in promoting climate action by mobilising capital, encouraging sustainable investments, and building investor confidence. These are some of the ways that some of the current ESG practices can mobilise climate action despite being seen as operating passively.
The Extent of ESG’s Role in Due Diligence for M&A Transactions
In terms of due diligence, while the extent and depth of ESG considerations may vary depending on the specific transaction and the parties involved, there is a growing recognition that ESG factors can significantly impact the long-term success, reputation, and value of a company.
As M&A transaction lawyers, we have observed the shift to investors prioritising ESG and future sustainability issues as a key metric when considering potential acquisitions as opposed to just a routine compliance issue.
Some of the ESG concerns that are increasingly integrated into due diligence undertakings include
(i) Risk assessment where ESG factors are evaluated to identify potential risks and liabilities associated with a target company;
(ii) Reputation and brand risks are also considered as ESG due diligence investigates the target company’s reputation, brand image, and stakeholder perception by examining how the company manages social and environmental issues, engages with local communities, and addresses the concerns of employees, customers, and other stakeholders;
(iii) Financial performance and long-term value whereby ESG due diligence may assess the target company’s ESG performance and its potential impact on financial performance and long-term value creation, this is because ESG practices are often better positioned to manage risks, attract investment, and capitalise on emerging opportunities related to sustainability and social responsibility.
It is important to note that the level of ESG integration in M&A due diligence can vary depending on factors such as the size and nature of the transaction, industry-specific risks, and the parties’ preferences.
Contribution of ESG Transparency and Traceability to Growth of International Trade
ESG transparency and traceability promote international trade by enhancing compliance with social and environmental obligations. The global push towards greener and more sustainable trade has resulted in entities attracting sanctioning measures for breaches of ESG obligations along the production value chains. The sanctioning measures- which include fines, taxes and import restrictions, among others- create barriers to trade for goods that are not sustainably produced. Therefore, incorporating transparency and traceability allows industry sector participants to track their value chains and identify opportunities for efficient and sustainable management of resources, in compliance with their ESG obligations. Overall, these elements of ESG lower rather than raise the barriers to international trade.
The link between ESG transparency and traceability and the abolition of Non-Tariff Barriers is illustrated by the European Union Carbon Border Adjustment Mechanism (EU CBAM). The EU CBAM is part of the EU ‘Fit for 55 in 2030’ package which aims to reduce greenhouse gas emissions by 55% by 2030 from the 1990 levels. The EU CBAM seeks to introduce a carbon price on goods produced outside the EU that is relative to the monetary value of the overall emissions related to the production of those goods. Put simply, the EU CBAM seeks to introduce an internal tax/border measure to adjust the price of carbon-intensive products upwards relative to the amount of carbon emitted during their production.
Based on the foregoing, the supply chain visibility created by ESG transparency and traceability mechanisms will enable companies importing products into the EU to reduce their final sale price by cutting down on carbon emissions associated with production. This link between ESG and trade within the CBAM framework is critical to the trade flows between the EU and Africa which account for 26% of all African exports. African products will face a competitive disadvantage within the EU if they are produced in a more carbon-intensive manner than their global counterparts as the carbon price will increase the overall product price.
Notably, the implementation of ESG transparency and traceability should be uniform and based on internationally agreed best practice to ensure that these mechanisms do not create barriers to trade. In noting the need for a uniform framework, the United Nations Commission for Europe created a transparency and traceability toolbox for the garment and footwear industry. The traceability toolbox enables sector participants to make risk-informed decisions and operate within the parameters of internationally agreed social and environmental practices for these sectors. Similar frameworks will be essential in modelling transparency and traceability as enablers rather than barriers to international trade.
Dealing with Challenges Associated with a Global Environmental Scheme
a. Greenwashing is a prevalent problem that the global environmental scheme is facing whereby some companies/ entities are seen or known propagate a misleading environmentalist image. This is in a bid to be seen to align with the market which is leaning more towards ethical and sustainable products. Greenwashing is a tool used to increase a businesses’ sales and reputation in the market. It is, however, harmful in several ways. First, it misleads conscious consumers who would like to play their part in protecting the planet. Second is that from a trade perspective, companies that are true to the environmental mission lose competitiveness in the market. This is in light of the fact that the production is sustainable products is more costly.
Regulatory safeguards to deal with greenwashing: A number of jurisdictions around the world, are introducing safeguards to achieve the goal of a clean and secure environment.
In the UK for example, the Competition and Markets Authority published a Green Claims Code (the GCC) with the aim of guiding businesses in ensuring that they comply with their responsibilities to the consumers under consumer protection law while making green claims. This was after a survey revealed that at least 4 out of the 10 green claims made by a number of companies were discovered to be misleading.
The GCC sets out 6 principles which state that the claims must:
1) Be truthful and accurate;
2) Be clear and unambiguous;
3) Not omit and hide material information;
4) Only make fair and meaningful comparisons;
5) Consider the full lifecycle of the product or service; and
6) Be substantiated.
This is a concept that is gradually spreading across a number of countries. Kenya does not have laws that speak directly to greenwashing practices apart from consumer protection law that warns against the false representation that a good or service has a sponsorship, approval, performance characteristic, accessory, use, ingredient, benefit or quality that it does not have. This is a real opportunity for countries in Africa to crack down on greenwashing.
b. More specific and reliable disclosures is required in the fight against climate change
Continuing trends demonstrate that disclosures in climate change are becoming more specific. As opposed to having companies reduce carbon emissions generally, companies are now required to disclose the specific carbon emission that they are addressing, for example, reducing methane or carbon monoxide. For example, in September 2021, the United States Securities and Exchange Commission (SEC) sent comment letters to a number of companies in different industries seeking more information about their climate-related disclosures (or lack of such disclosures in their SEC filings) referencing the SEC’s 2010 Guidance Regarding Disclosure Related to Climate Change. This trend and pressure on listed companies to give specific disclosures is continuing not only in the US, but also in Europe and other countries in Africa.
This has also called for more sophisticated ESG data management systems to provide some cross-checks for data consistency. While there are some data alignment solutions being developed, there is currently no international verification system for net zero pledges. Generating clear, accessible, comparable data can bring enormous benefits. It is important that leading entities will be able to credibly demonstrate their progress to net zero. Citizens, consumers and investors will be able to reward them accordingly. This will be critical to curb concerns such as green washing and ensure transparency as companies continue to grow and make investments.
Incorporation of compliance mechanisms within the various organisations. There is a great opportunity for lawyers/ law firms to familiarise themselves with these aspects of climate change and guide companies on how to meet their obligations that are outlined in these regulations. As the legal framework on disclosure continues to be more robust, there will be a practice area that is growing for lawyers to take up.
c. Fragmentation of the framework and efforts towards protection of the environment
One of the key challenges facing the global environmental movement is the fragmentation of the framework and efforts towards protection of the environment.
We have a myriad of multilateral environmental agreements, different in membership, scope, governance structure and funding mechanisms. In fact, the plurality creates more confusion than it does providing solutions. There is therefore a need to harmonise the various laws. – Daniel Ngumy, Managing Partner, ALN Kenya
Conclusion and Way Forward
Stakeholder discussions on climate action create foundations for targeted and impactful initiatives. This article has focused on the nexus of sustainable trade and investment and raised awareness on the raft of issues to be taken into consideration in the implementation of the AfCFTA when considered in light of ESG principles of sustainability.
While the discussions have highlighted the many points of intersection between the AfCFTA and ESG, they have also drawn attention to the lack of specific measures geared towards environmental considerations. It is also of great importance for industry experts to petition the AfCFTA policy makers to entrench ESG into the AfCFTA framework in order to promote more sustainable international trade within the continent.
Should you have any questions on this article and matters regarding international trade, please do not hesitate to contact Daniel Ngumy.
1. Joanna Kahumbu – Trainee Lawyer
2. Kelly Nyaga – Trainee Lawyer