The Sustainalytics Podcast | Addressing Material ESG Issues: Practical Insights From our Expert Webinar Panel

Melissa Chase: Hello everyone and welcome to the Sustainalytics Podcast. My name is Melissa Chase, Content Marketing Manager with Morningstar Sustainalytics’ Corporate Solutions.

In today’s episode we’re going to switch things up a bit and share with you insights from a webinar we held in early May 2022. Inspired by our ebook, “Understanding Materiality: Lessons from Industries with High ESG Risk,” the session aimed to help corporate ESG, CSR, and investor relations professionals learn about the key material ESG issues that cut across industries, the potential impacts these issues can have if not managed properly, and the actions companies can take to effectively address these issues and hopefully mitigate risk.

For nearly 30 years, Sustainalytics has conducted environmental, social and governance (or ESG) research and analysis on companies globally, and we know that companies have opportunities to manage the relevant ESG issues they face, regardless of their industry.

MC: Joining us for the session were: France Fairhead, ESG Research Senior Analyst, covering the mining sector;  Toshi Batbuyan, ESG Research Senior Analyst, for the oil and gas sector; and our moderator Shilpi Singh, Corporate Solutions Director.

Our panel discussed the material ESG issues facing companies in five high ESG risk industries and the approaches any company can take to address these issues.

MC: So, in today’s episode we’ll talk about how Sustainalytics assesses corporate ESG risk, give a brief overview of the five sectors covered in our ebook which were:

• Industrial conglomerates,
• Steel,
• Diversified Metals,
• Precious Metals, and
• Oil and Gas Producers.

We’ll also discuss a bit about how companies in these industries and beyond can address the material ESG issues they face, and close things out with some key takeaways from the session.

The five high ESG risk industries that were identified for the ebook were based on an analysis Sustainalytics conducted at the end of 2021 of the 42 sectors in our ESG research universe.

Aside from having the highest average ESG Risk Ratings in our universe, we were interested in these industries because of the critical role they play in global economic growth and the transition to a net-zero economy. We think companies in all industries can learn from these examples and find opportunities for improving their own ESG risk management.

So, with that background, let’s move on to the info shared in the webinar.

But, before we dive in, Corporate Solutions director Shilpi Singh will explain how Sustainalytics assesses the corporate ESG risk profile of the more than 14,000 companies in our universe, and the factors contributing to our ESG Risk Rating score. 

Shilpi Singh: So, an ESG Risk Rating measures a company’s exposure to industry-specific, financially material environmental, social and governance risk, and how well a company is managing those risks. So, as such, the rating is designed to flag the degree to which the enterprise value of a company is at risk driven by E, S, G factors.

In terms of methodology, the Risk Rating uses a two-dimensional approach to determine a company's level of unmanaged risk based on its degree of exposure and management of material issues.

Levels of unmanaged risk are added up for various factors of a company vis-à-vis a set of ESG issues that are considered most material for the company to arrive at the final total unmanaged risk.

It is worth noting that controversies for a company are reviewed on a dynamic basis and can impact the top-level risk ratings. This is because increasing severity of controversy from one to five, with five being more severe has the dual effect of dilution in management scores, as well as worsening of their issue exposure.

Overall, the final risk rating assesses a company’s unmanaged risk of material ESG issues or MEIs, as we call them, and sits within five risk categories: negligible, low, medium, high, to severe. And the rating is absolute in nature and comparable across industries and regions.

In essence, the rating measures risk, a high score is considered to be poor or bad performance and a low score is considered to be good.

MC: Key to our assessment, as Shilpi mentioned, are the material ESG issues companies face.

In our analysis for the ebook, we found the five high-risk industries shared quite a few material issues in common. In all, we looked at eight MEIs impacting this group, which were:

• Business Ethics;
• Carbon – Own Operations;
• Carbon – Products and Services;
• Community Relations;
• Emissions, Effluent and Waste;
• Occupational Health and Safety;
• Product Governance and
• Resource Use. 

Now for some context, I’ll give a high-level overview of each of the industries covered. If you’re interested in learning a bit more, see the show notes for a link to download the ebook. 

MC: To start, we have industrial conglomerates which has the highest average ESG Risk Rating at 42, placing it in the “severe” risk category. Companies in this industry are diversified by nature, offering products and services ranging from aerospace systems to electrical components, to power generation technology, and even financial services. Given this diversity, industrial conglomerates face high exposure to multiple MEIs.

ESG management in this sector generally skews towards the weaker side because conglomerates face challenges in terms of applying suitable management systems across the entire company. However, as several of the industry’s most important MEIs, like business ethics, product governance, or carbon – own operations, are, as we would say “highly manageable,” with strong management programs and policies companies could meaningfully mitigate risk from multiple MEIs.

MC: Moving on to steel, it has the second highest average ESG Risk Rating at 38.9, placing it in the “high” risk category. For companies in this industry, they are also exposed to a high number of MEIs – with carbon - own operations, emissions, and occupational health and safety as three of the most material. On average, management of ESG issues is pretty strong across the board.

For companies involved in steel and related operations, gaps though still remain in managing carbon emissions and air pollution. Occupational health and safety issues are also a key area of risk for companies with almost half of those covered by Sustainalytics being involved in a related controversy or incident. 

MC: Looking at diversified metals and precious metals, these sectors have the third and second highest ESG Risk Ratings at 38.5 and 38.1 respectively, putting both in the “high” risk category.

Given the nature of what they do, there are lots of similarities between these two industries and their exposure to ESG issues. The two industries share the five most material ESG issues, those being: emissions, effluents and waste, community relations, carbon – own operations, resource use, and occupational health and safety.

When exposed to so many material ESG issues, each with important business, environmental and societal implications, should companies prioritize some over others? Frances shares her thoughts… 

Frances Fairhead: These steel makers and the miners, they definitely can’t run away from the carbon emissions. When we look at the steel industry, it accounts for about 8% of global carbon emissions, so that's really important.

Companies are being asked by investors to make targets and commitments to reduce these emissions and really manage it properly.

When we talk about all five of these industries, the reason that they are the five highest risk is because they have such high exposure to so many issues – nine issues for precious metals and diversified metals, ten issues for steel.

MC: The final industry in our group is oil and gas producers with an average ESG Risk Rating of 37.7, also landing it in our “high” risk category. 

As one of the largest industries in terms of dollar value, the oil and gas industry generates over US$3 trillion annually, making it critical to the functioning of the global economy.

For companies in the upstream segment of oil and gas, which tend to be responsible for drilling and the production of oil and gas, they are arguably facing the most scrutiny for their environmental impact.

For those companies involved in carrying, storing, refining, and selling the product in the mid- and downstream segments, they are facing more societal and governance issues, as well as environmental issues to a lesser degree. With all of that, it’s not surprising that the oil and gas producers industry is among those facing the highest ESG risk. 

Here, Toshi explains why having an effective ESG strategy is critical for companies in the oil and gas producers sector and beyond, and the challenges companies could face without one…

Toshi Batbuyan: I think, in all likelihood, a company without an ESG strategy will find it more difficult to raise capital from investors, that includes the private ones.

So, whether they're publicly funded or not, most companies will likely experience this problem, and it's not just an issue relating to raising money. I think poor ESG scores really means that a company isn't doing so well and has unmanaged exposure risks. So, they are more likely to experience a major incident like oil spills, or likely to face community opposition, and just governance issues that will require them to spend more capital to resolve this issue.

So there's an element of added costs, there too, which means, in the long term, the ones that do poorly on ESG scores face the risk of losing the competitive edge.

MC: No matter the sector they’re in, companies should strive to effectively manage their environmental, social and governance risks. Not doing so could result in a variety of issues including reputational damage, lower enterprise value, or a loss of their social license to operate.

Now let’s look into some of the MEIs identified for our high-risk industries group and how companies can address these issues. Companies outside these five industries can also apply these approaches where relevant.

For the high-risk industries that we looked at, environmental issues are key. Not only because of companies’ impact on the environment and their role in the energy transition, but also because of the physical risks the changing climate poses to those companies. 

TB: In terms of the most important issues, and why, the short answer is really issues relating to climate change, so carbon issues really.

But I think the question really relates to how oil and gas companies are navigating through the energy transition. And I really think that things like social pressure, technological changes, and just the shifting consumer demands and needs have become more widespread, and I think they're driving the transition risk of oil and gas companies.

And also, I think that the public is aware and understands the physical risks of climate change. So, essentially, they are aware that assets can be damaged because of things like extreme weather events. So really the resiliency of the oil and gas industry and the economy, overall, and just the financial market is really becoming a function of climate resilience, which is all about anticipating, you know, preparing, and responding to major events, major trends, and disturbance in the in the climate change.

MC: Although climate resilience and being prepared for more frequent and more severe weather events is especially salient for oil and gas producers, similar risks are faced by many other sectors.  

Non-environmental issues are also high on the agenda for companies and their stakeholders. For instance, an issue like business ethics, and by extension bribery and corruption, is critical for most companies.

Effective management includes taking actions like employee training and whistleblower programs. For companies in industries that require doing business with government, this is especially important, if operating in countries with widespread corruption or ambiguous laws and regulations. Having a high level of transparency in the end is key.

TB: I think, having a high ethical standard really serves in the long term for oil and gas companies, and for their businesses, especially for improving credibility.

And we can observe that some of the oil and gas companies within our research universe are, you know, starting to demonstrate stronger company wide codes that serve as a standard of conduct for both employees and the executives.

MC: Community relations is also a material issue that cuts across sectors, and for those operating in high-risk industries, it tends to be closely related to environmental issues such as resource use and emissions, effluents, and waste. For heavier industries, one good way to address community relations is to effectively manage the environmental issues impacting communities.

But for any company, it’s really important to have a strong dialogue with communities, so that you can quickly find out where there is an issue and address it promptly. Of course, it’s hard to manage what you don’t measure. Frances shares some suggestions for assessing community relations...

FF: Sometimes it's harder for community relations, especially, to get into quantitative data, but just looking at things like how often are you engaging with the community. And as long as you have some kind of channel for the community to provide complaints to you; if you track what kind of complaints you're getting, how many complaints you're getting, you can set targets to improve that.

So, as long as you're making sure that you're capturing the data, there's definitely some improvements to make there on a quantitative level.

MC: Occupational health and safety is another important social issue for a wide range of industries, but especially for heavy industries such as mining or oil and gas.

Many of the controversies we track are tied to occupational health and safety incidents. To address this material issue, companies can start by really understanding their safety risks, and which risks are most relevant to them since each operation may face unique challenges. Companies should also be learning from past incidents in order to prevent future ones.

MC: For companies wanting some direction on how to identify and manage key issues, they can turn to industry and international standards and guidance. Here, Frances shares the resources available to companies in extractive sectors. 

FF: I would say that there is no shortage of guidance. I've even heard companies complain that there's too many different guidance and they're not really sure what to follow, but some of the most comprehensive systems would be the International Council on Mining and Metals (ICMM), they have a lot of guidance for their member companies on all of the material issues that that we address.

The Initiative for Responsible Mining Assurance (IRMA) also has comprehensive guidance, and they also have the advantage that companies can be audited to their standards, which can be really helpful for customers of these companies.

For steel companies there's Responsible Steel. For carbon specifically there's the Science-based Targets initiative, which companies can use to set greenhouse gas reduction targets.

MC: Whereas the standards Frances mentioned are more specific to the mining sector and managing what’s happening at a site, the standards set out by SASB – the Sustainability Accounting Standards Board – can be applied by companies across sectors and have more to do with how you’re reporting on ESG risks and management. 

In the end, it’s crucial for companies to set ambitious targets with respect to the ESG issues that are most material to them and to communicate their progress on meeting those targets to stakeholders.

And if you’re just getting started or suffer a setback, don’t obscure the facts. Make a commitment to remediate the issues appropriately and use the lessons learned to do better in the future. The short-term financial gains of hiding or obscuring poor results may not outweigh the long-term damage to your company’s reputation and trust among stakeholders.  

TB: I think truly there's a growing need for action and transparency on social factors on top of environmental issues. I think in our increasingly globalized economy, the public expects companies to take on social matters and take account across the value chain across the business operations, and across their overall value chain.

And so, for oil and gas companies, I would agree with Francis the need to engage and the need to communicate properly with communities, especially about the project is becoming a critical element. And this is really because, I think, they understand now, and they have the experience that community opposition and employee dissatisfaction can really disrupt, can halt, can delay operations, because of things, like for instance, strikes.

We've seen it recently in the past, pipeline projects getting canceled or we have huge strikes that last for several days, so I think the message is clear.

But also, I think the COVID-19 pandemic pushed this issue to the front seat. I think, nowadays, employee and community safety issues are on the same table as issues relating to capital and operational expenditures and whatnot, right?

And of course, I think policymakers and politicians and governments, in general, around the world are making efforts. They could do better, but they're making efforts more than before on social issues in policymaking, regulations, and disclosure.

MC: And to avoid accusations of greenwashing, companies can take a few key actions in their ESG communications and reporting. 

FF: The first thing that comes to mind is acknowledging your shortcomings, especially when they're big obvious ones.

So, if companies really have major issues with their communities it doesn't help to talk about everything that you're doing right. It helps to say, you know, “we've had some third party come in, we consulted with them, we found these gaps in our management, and these are the things that we're going to do to address them.”

I think it's true that sometimes mining companies can be painted with a broad brush, with a very negative view. But, when they come in and speak about their own weaknesses, I think that's a great way to build trust with the local community, and also with other stakeholders.

MC: The effective management of material ESG issues is not going to happen overnight. It’s a process that will involve contributions from multiple teams within an organization, and possibly consultation from external experts. But it is an exercise worth doing as Toshi points out...

TB: The better performing companies, I think they understand where they stand within the ESG framework, and I think they're making efforts to ensure that their policies, their programs align with the business strategies and operations.

So, they know where they stand, and they know where they want to be in the future, suggesting that they're ahead of the competitive landscape and they'll face fewer issues in securing capital and reducing potential costs. So it may be obvious, but you know you can manage what you can measure, right.

MC: For companies serious about addressing their material ESG issues, here are a few key takeaways from the webinar:

• Climate resilience and disclosure, along with other environmental aspects remain top of mind for companies regardless of their industry and risk category.
• Social factors, such as community relations and occupational health and safety, are prominent across sectors and are gaining awareness among key stakeholders.
• Proactively reducing risks due to controversies and managing the ones that do occur responsibly is important for all companies.
• Understanding and aligning with industry standards and guidelines as well as peer leading practices can aid companies’ ESG implementation.
• Meaningful strategic ESG initiatives will ultimately guide capital deployment – whether for more immediate, straightforward issues or more long-term ones. 

And with that, we’ll wrap up today’s episode. Please be sure to check out the on-demand webinar or our recent ebook, Understanding Materiality: Lessons From Industries With High ESG Risk. Links for both will be in the show notes. If you have a question or a suggestion on what we should talk about next, please email us at [email protected].

Thanks again to Frances, Toshi, and Shilpi for sharing their insights and thank you for listening. Until next time.