Don’t just think of ESG factors as representing an opportunity to own assets because of corporate policies and practices concerning the environment or social and governance issues. They can also serve as a warning sign about the risks of owning certain securities, those that score low on the ESG continuum.
It’s the latter approach that Sustainalytics uses in its report “10 for 2018” focusing on “10 ESG risks that could have a significant impact on shareholder value” in 2018 and the industries that are most affected.
Following are the 10 primary risks discussed in the report, the industries affected and the varied ESG standings of individual companies within those industries.
1. Hazardous Chemical Releases: Diversified Chemical Companies
This is a primary risk for diversified chemicals company and a long-lasting one, according to Sustainalytics. Chemical companies face legal and clean-up expenses and substantial reputational risk. Between 2013 and 2017, 33 diversified chemical firms were linked to 145 incidents involving contamination of land and water, and polluting air emissions.
Of the 127 global diversified chemicals companies Sustainalytics analyzed, only 6% were well prepared to mitigate hazardous chemicals risks and 57% were poorly prepared. The best prepared were Germany’s Evonik Industries and Norway’s Yara International; the worst prepared was Chemours, a U.S.-based spinoff from E.I. du Pont de Nemours.
2. Water Use and Community Opposition: Copper Mining
Mining companies are especially vulnerable to this risk, according to Sustainalytics. There are currently more than 200 conflicts between mining companies and local communities in Peru, most concerning water, for example.
Copper mining companies in Chile face similar risks but how they address those challenges differs substantially. Sustainalytics notes that BHP Billiton has and Antofagasta score highest on their water and community risk management capabilities while KGHM Polska scores lowest. Its top pick: Antofagasta Plc.
3. Energy Demand and Greenhouse Gas Emissions: Semiconductor Industry
Investors may not view this industry as a major air polluter or consumer of vast amounts of energy but they should, especially among companies operating in Asia where 45% of chip production takes place, according to Sustainalytics.
Many of those companies will face energy supply challenges as more Asia countries adopt greenhouse gas emission regulations.
Taiwan Semiconductor Manufacturing Co., with an 11% share of global fabrication capacity and demonstrated ability to manage power shortages and purchase renewable energy power is well positioned in facing these challenges. Samsung, which has less than half of TSMC’s global capacity and a renewables and emissions score close to 30 versus TSMC’s 63 is poorly positioned.
4. Carbon Emissions Regulation and Transition Risk: Oil and Gas Sector
This is a huge risk for oil and gas companies especially those that are not well diversified, have high production costs and are involved in carbon-intensive projects such as oil sands and Arctic drilling.
Those producers that “disclose strategies to manage the regulatory market and reputational risks posed by climate change are better prepared to compete in the low carbon transition than firms that do not,” according to Sustainalytics. Recommendations from the Taskforce for Climate-Related Financial Disclosures (TCFD), headed by Michael Bloomberg, provide a template for those disclosures.
Sustainalytics gives Royal Dutch Shell (high marks — a perfect score of 100 for greenhouse gas risk management — for being the only oil and gas company that has set carbon reduction targets and for entering the electric vehicle market, but it would like to see more disclosure on how the company intends to evolve its business model. Exxon Mobil (XOM), in contrast, has a score of 50.
5. Climate Change Risk: Real Estate
Rising sea levels and temperatures plus an increasing number of severe hurricanes and wildfires pose a risk to the real estate industry. “We anticipate investors will continue to express concerns about how the physical impact of climate change could affect the value of their holdings,” according to the Sustainalytics report.
The firm assessed 306 listed real estate firms,including REITS, developers and property managers and found that only 19% are well prepared to manage those risks while 51% are poorly prepared. Its analysis of 101 Asa-Pacific real estate firms found that those in Australia scored the highest for managing those risks, led by Stockland and GPT Group, which had scores of 100 and about 82, but many scored at 50 and below.
6. Antitrust Risk: Major Tech Companies
Dominant software and services firms like Google’s Alphabet, Facebook and Microsoft face anti-competitive regulations, especially in Europe, according to Sustainalytics. It cites the 2.4 billion Euro fine levied by the European Commission against Alphabet in June, after which its quarterly net income fell 28%.
Microsoft, Intel and most recently Qualcomm have also been hit with hefty antitrust fines.
“Major technology companies will increasingly need to balance their ambition with their responsibility to the stakeholders,” concludes Sustainalytics.
7. Health Risks: Sugary Soft Drink Industry
Concerns about the health risks of excessive sugar consumption are slowing sales at many beverage companies who also face increased regulations and lawsuits, adding pressure to adjust their business models, says Sustainalytics. In addition many jurisdictions around the world have either implemented taxes on the consumption of sugary drinks or are considering doing so.
Some companies like Danone and Nestle are responding by offering premium healthy drinks, and they receive the highest marks for product health risk management score from Sustainalytics. Coca-Cola, in contrast, scores much lower.
8. Data Protection Regulatory Risk: Financial and Technology Industries
Starting in late May any company that collects data from residents in the European Union will be subject to the General Data Protection Regulation (GDPR) and noncompliance could result in fines. The regulations are expected to have the biggest impact on financial firms and technology companies, which have the greatest exposure to personal data.
AXA, the French insurance company, which bought U.S.-based Equitable Life and MONY years ago, is well prepared to meet the new guidelines and manage associated regulatory risks, says Analytics. AXA has already implemented its own policies to safeguard personal data and has adopted Binding Corporate Rules, an international standard to protect personal data that has been approved by French and European data protection authorities.
9. Supply Chain Risks: Apparel Companies
Since the Rana Plaza collapse in Bangladesh in 2013, which killed over 1,100 people working in several garment factories, apparel producers have faced increased regulatory and public scrutiny over their working conditions. As a result, many have raised wages and increased other expenditures; others have relocated to other regions where they can still hire cheap labor but are still implementing policies to protect labor rights, according to Sustainalytics.
Its assessment of 117 global retail, textile and apparel companies al, textile and apparel companies found that only 20% are well prepared to address key supply chain standards and management issues and 54% are poorly prepared.
“Firms that get tangled in supply chain controversies risk experiencing disruptions to shipments, legal actions by consumers, investors and workers, and increased public scrutiny and reputational damage,” according to Sustainalytics.
Earning high marks are H&M (100) and Hugo Boss (about 85) and earning low marks are luxury apparel company Hermes (about 22) and Pou Chen (15), the original equipment manufacturer for Nike, Reebok, Asics, New Balance, Converse and Timberland and others
10. Bribery & Corruption Risks: Aerospace and Defense Industry
Agencies around the world have beefed up enforcement against bribery and corruption, increasing cross-country efforts, and the aerospace and defense industry is a common target.
Sustainalytics analyzed 80 global A&D companies and found that 59% are not prepared to address the risks; only 21% are well prepared.
One interesting finding was the difference between the scores of Boeing and Embraer, which it’s in discussions to acquire. Embraer was fined about $200 million in 2016 by U.S. authorities to settle claims related to violations of the U.S. Foreign Corrupt Practices Act (FCPA), including paying third parties to bribe officials in the Dominican Republic, Saudi Arabia, Mozambique and India to secure government contracts.
Embraer is now facing class action lawsuits alleging the firm had made material false and misleading statements related to the FCPA investigation.