Feature: Divestment from fossil fuels

Given the key role universities play in a society, various stakeholders – including donors – are beginning to challenge universities to reconsider their role in ensuring a sustainable world. This has led to universities developing and implementing strategies aligned to the Sustainable Development Goals adopted by the United Nations, aiming to achieve a more sustainable future for the world.

The implementation of such strategies will require universities to reconsider, for instance, their carbon footprint, including investments they hold in fossil fuels through their foundations.

In March 2022, the University of Cape Town (UCT) Council announced that it had agreed in principle to the divestment from fossil fuels. The UCT Council stated that the in-principle decision will be executed in a responsible and transitionary approach:

• Through the immediate divestment from internationally exposed fossil fuel investments and immediate investment in renewable energy and/or a green economy instead of new investments in fossil fuels, and
• In the local economy, UCT will work towards achieving a goal of being net positive by 2030

This was not an easy decision for Council, given that the South African economy is largely dependent on coal and oil, but several factors contributed to this. We will provide considerations for other foundations and universities in setting and developing their own responsible investing (RI) frameworks.

Responsible investing approaches
Financial sustainability is key to ensuring that universities deliver on their mandate of teaching, learning and research, as well as achieve social impact. One of the areas through which universities can enhance their financial sustainability is the establishment of foundations. A foundation is formed to accept, hold, invest and administer endowed trust funds for the benefit of a university.

The opportunities and risks inherent in a low-carbon transition from the perspective of a university or university foundation is a very broad topic. Globally, the transition to tackle one our largest environmental risks, namely climate change, is gaining traction.

Governments (from mainly developed economies) are pledging to meet net zero targets by 2050 (some earlier), and even universities and companies are committing to such targets. The Intergovernmental Panel on Climate Change (IPCC) has indicated that the situation is dire in their April 2022 report and that immediate ‘rapid and deep’ cuts in carbon emissions in all sectors will be required to limit global temperature increases to 1,5 °C.

For a South African university foundation, what are the implications of this for their investment strategy and what is expected of universities, their foundations and their stakeholders?

Impact Investing South Africa, which is hosted by UCT’s Bertha Centre, outlined the key differences in investment approaches that could be pursued when setting an RI framework. These are shown in the graphic below:

Traditional investing generally involves seeking commercial returns with no regard for any environmental, social and governance (ESG) risks, whereas philanthropy is on the other side of the spectrum, as it seeks to address societal challenges without necessarily generating any return for its investors. Sustainable, responsible and impact (SRI) investing falls in between, depending on whether investors are explicitly seeking commercial returns and also the extent to which ESG risks are being assessed, mitigated or countered. We will focus on the latter in the next section, which is the extent to which ESG risks are being managed, especially for an investor that seeks commercial returns.

ESG risk management
As more investors move away from traditional investing and adopt more responsible approaches, the management of ESG risks will become mainstream. But how do we start managing ESG risks? Is it simply to:

• Assess and consider ESG risks, or
• Mitigate ESG risks through engagement with suppliers, broadly known as positive engagement or ‘positive screening’, or
• Avoid such ESG risks through disinvestment, broadly known as ‘negative screening’, or
• Explicitly counter or offset ESG risks by seeking to create a positive ESG impact through a change in capital allocation (but still achieve a commercial return), or
• Apply all or a combination of the above

Most institutional investors have started to integrate ESG risks with their decision-making processes, so option 1 has been the norm for some time now. Option 2 is probably implied and expected from most institutional investors as part of their basic risk management process and active ownership responsibilities. Option 3 is increasingly being pursued by investors, mainly in developed countries, by divesting from fossil fuels as part of their climate change strategy.

Option 4 is impact investing as defined in the previous section and was an aspirational objective and expected mainly from large investors initially, who are able to use their size and influence to generate both commercial return and positive impact. However, even impact investing is gaining traction and can be a good way to offset ESG risks that can’t immediately be reduced or mitigated.

Practical examples – decarbonisation considerations
Let’s consider a practical example of how to apply this risk management process to an issue like decarbonisation:

Another specific example would be the case of Thungela Resources, the coal assets that were recently unbundled from Anglo American. The share has yielded good short-term returns since the unbundling. Does this mean that decarbonisation should be ignored and impact is irrelevant in the face of searching for good risk-adjusted returns? How likely will performance be sustained over the long term? Could foundations be criticised by beneficiaries for sacrificing short-term returns, even though there is a significant risk of the assets being stranded in future? Should the foundation disinvest now or perhaps into the future? If the foundation did disinvest, what are the knock-on effects? Given that the SA economy is still heavily dependent on coal, would disinvestment raise the cost of capital to such an extent that it puts jobs at risk and lowers the company’s profitability?

Would this lead to lower tax revenue for government, when it is already stretched fiscally? Should the impact on government finances even be of concern for foundations?

It is also important to understand how Thungela complements the rest of the foundation’s portfolio. Perhaps the foundation has sufficient exposure to renewable energy assets to justify holding Thungela over the short term while demonstrating to beneficiaries how the overall portfolio is managing and offsetting its overall carbon exposure, if this is important to them. Are your beneficiaries based in the areas where Thungela operates and are they directly affected by their operations? What are their thoughts around investing in the company? Perhaps the community feels that the positive economic impact of the company’s operations outweighs the costs such as poor air quality and exacerbating climate change. As companies are already starting to de-carbonise themselves, perhaps taking no direct action is the appropriate approach?

These are all difficult questions with no easy answers, but they demonstrate the type of ESG considerations confronting a university or foundation when faced with such issues. What is important is that you start having these conversations with your asset consultant and are able to demonstrate and explain an appropriate approach to your beneficiaries and stakeholders.

Social transition targets?
While the world is transitioning to a low-carbon economy, we believe that South Africa requires an additional transition. Perhaps South Africa should transition to a zero-poverty level and single-digit unemployment level by 2050 with a GINI coefficient more in line with peers? Is this realistic and can universities and endowments play a role in taking advantage of these social transition opportunities, similar to climate change transition opportunities? We certainly think so, if there was greater collaboration among universities and other stakeholders.

Arguably, some believe that tackling climate change, inequality, poverty and unemployment is not the job of universities and endowments. Others believe that these are material ESG risks that, if left unchecked, will affect the long-term performance of any investor’s assets. As South Africans, we have a moral obligation to address remnants of our past and improve the well-being of our society and environment for future generations, especially in areas that are within our control.

While this all sounds well in theory, balancing risk, return and impact is much harder to do in practice. It requires trade-offs and a deeper understanding of the role of each asset in the foundation’s portfolio. It also requires foundations to come up with its own set of beliefs and preferences through perhaps surveying their beneficiaries and stakeholders.

We are all connected (as South Africans and as the human race) and events that affect one part of the system will inevitably have consequences, whether good or bad, in some other part of the system. Not only must South Africa do its part in mitigating climate change but at the same time transition to a stable and prosperous society with zero poverty and low inequality and unemployment.

South Africans are resilient, tend to punch above their weight and lead the world in many areas. We certainly believe that if we worked together and universities and endowments realised their true power and critical role they play in our economy, South Africa has the potential to achieve both its decarbonisation and social transition targets.