Emerging sustainability regulations are shaping the future of business globally. Regulatory decisions made in the EU and the US have reverberating implications for the startup ecosystem in Africa. Newly introduced regulations such as the Sustainable Finance Disclosure Regulation (SFDR) which came into effect in March 2021, have caused an undeniable shift in the finance industry and set a standard for future regulations. The net-zero transition is increasingly driving financial decision-making, as hundreds of financial institutions that control trillions of dollars are committing to achieve net-zero emissions by 2050. Bloomberg reports that sustainability and ESG-driven investment is one of the fastest-growing investment approaches, with global ESG-driven assets expected to surpass $50trillion by 2050. As such, sustainability regulations are crucial to enabling the climate transition by making financial flows consistent with net-zero commitments and climate targets. As the startup ecosystem in Africa is fuelled by financial flows from Europe and The Americas, there is a growing need for sustainability integrations in these fast-growing companies to hedge their risks and encourage impactful innovation. Enabling the climate transition requires dutiful regulations on climate-related disclosures and a wider sustainability review for organisations.
A 2021 Africa Investment report highlighted that 62.5% of growth capital funnelled into African startups came from the United States, 7.5% from the United Kingdom, and active participation from other EU countries such as Germany, France and Switzerland. Additionally, African startups are increasingly incorporating their businesses in foreign countries. The AVCA 2020 report on Africa’s investment landscape identified that about one-fifth of VC deals made between 2014 and 2019 were to African startups registered outside of Africa, with most registered in the US. This means that in addition to funding benefits and relative ease of doing business, these startups are bound by the laws and regulations of the land they are incorporated into. Here are some of the key regulations that may have immediate implications for the African startup industry.
Key regulatory instruments for African Startups
1. Sustainable Finance Disclosure Regulations (SFDR) – The pioneer regional regulation entered into force in December 2019 and its provisions became effective on the 10th of March 2021. The regulation requires financial market participants, fund managers, qualifying venture capitals & social entrepreneurship funds and alternative investment fund managers (AIFMs) to disclose periodically on consideration of sustainability risks, sustainable investments, and principal adverse impacts of investment decisions on sustainability factors. This regulation provides entity and product-level requirements, which means funds will be required to disclose on the impacts of their portfolio companies as well. The regulation defines 3 classifications of funds that all EU funds must fall into;
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- Article 6 – Catch-all category. These are funds that don’t integrate sustainability considerations or meet the criteria for Articles 8 & 9.)
- Article 8 – Light green funds. These are funds that promote environmental or social characteristics.
- Article 9 – Dark green funds. These are funds that expressly have sustainable investment as their objective.
Consequently, startups that are managed by European qualifying investors will be required to measure and potentially report on their considered sustainability risks and impacts to establish the classification of their fund.
2. Taskforce on Climate-related Financial Disclosures (TCFD) – In October 2021, the UK announced mandatory TCFD disclosure requirements for the private sector. This compulsory regulation came into effect in April 2022 and requires companies to disclose climate-related risks and opportunities. These disclosures will mandate thousands of financial institutions in the UK to evaluate climate-related risks for their organisations and their investments and make better informed financial decisions. Some of these disclosures include; the organisation’s risk management process, an assessment of the climate resilience of an organisation’s business model and strategy, and targets relating to environmental impact reduction. Thus, financial flows from the UK into the African startup ecosystem will now require stringent assessments for sustainability impacts. A failure to comply with disclosure obligations carries reputational and potential legal risks for fund managers. But also, for startups that fail to integrate sustainability objectives as they risk losing investment and competitiveness.
3. The US Securities and Exchange Commission (SEC)’s proposed rule on climate-related risks disclosures – This yet-to-be-implemented rule would require companies that are registered with the SEC to include specific climate-related disclosures during registration and submit periodic reports about risks that may have a material impact on “their business, results of operations, or financial condition.” This rule predicted to take effect between 2023 and 2024, would require disclosures covering Scope 1 (direct), Scope 2 (indirect) and Scope 3 (through activities in the value chain) emissions. Additionally, it would require disclosures on how identified climate-related risks have or may affect business strategy, model, or outlook. As a significant number of African startups register in the United States and may currently, or in the future, register with the US SEC, the ratification of this rule will directly affect their disclosure requirements.
The climate transition is shaping the future of business. As the western world leads the charge in mandating sustainability disclosures, much of the global world will emulate them. As financial disclosures became a requisite for business organisations, sustainability-related disclosures are likely to follow suit. There is already an emerging archetype of countries that have implemented other regulations/guidance (e.g., principle-based regulations, disclosure standards, stress tests, and best practice guidance). For example, in March 2021, Egypt’s Financial Regulatory Authority published resolutions that require listed companies and non-bank FIs to make ESG disclosures and TCFD disclosures, depending on their size. Kenya, Nigeria, Ghana, Morocco and South Africa are some of the other African countries with emerging climate-related disclosure regulations. As a business in Africa, are you prepared for the sustainability-driven future of business?
Regulating sustainability impacts through financial flows is no small feat, particularly so in Africa, where sustainability remains a novel priority for businesses. However, building a successful business today would require prioritising sustainability measurement.
