ESG investing: Sustainable value in chemicals

12:41 PM | March 30, 2020 | Vincent Valk

Environment, social, and governance (ESG) principles have long been an operational part of the chemicals sector, whether the focus is on safe operations, regulatory compliance, or reputational issues. Compliance with complex regulations, whether related the environment, or the health and safety of the public and of workers, is generally the price of doing business as a chemical company—especially in developed economies. All of that is as true as ever, but concern around ESG has recently popped up in a new place: shareholders.

The investment community has a significant and growing interest in ESG. Small investors with a particular focus on sustainability were at the leading edge, but in recent years leading institutional investors such as BlackRock, Fidelity, and State Street Capital have put dollars behind ESG-related investment decisions. BlackRock and Fidelity, for example, both run ESG-focused funds, some of which own shares in chemical manufacturers.

Publicly traded chemical makers say that ESG is now a major theme in discussions with investors, a trend that seems likely to accelerate. “Today, financial markets recognize the opportunities of sustainable business approaches and investors are increasingly interested in sustainable business management,” says Tim Balensiefer, investor relations manager/sustainability at BASF. “We can see a larger group of investors becoming more attached to the ideas of ESG investment.”

Heard on the street

Among institutional investors, BlackRock has been especially vocal on ESG issues. The firm, which is the world’s largest fund manager with $7.4 trillion in assets under management as of the end of 2019, has issued guidance to fund managers stating that ESG issues should be incorporated into investment decisions, and not just those regarding ESG-focused funds. “Integrating ESG information, or sustainability considerations, should be part of any robust investment process,” BlackRock says.

“The evidence on climate risk is compelling investors to reassess core assumptions about modern finance,” BlackRock chairman CEO Lawrence Fink said in a letter to other corporate CEOs earlier this year. “Indeed, climate change is almost invariably the top issue that clients around the world raise with BlackRock. From Europe to Australia, South America to China, Florida to Oregon, investors are asking how they should modify their portfolios.”

SCHWANE: Short-term
investors interested in ESG,
as well.

This may seem high-minded, but in reality it is often a matter of profits and losses. “There is a better understand of how ESG information changes risk,” says Andre Bertolotti, head of global sustainable research and data with BlackRock. “There is increasing evidence that ESG is a material issue and that makes it mainstream and makes it part of our investment decisions.” This includes carbon prices in some regions, central banks discussing the issue, and insurance companies aiming to measure climate risk in their portfolios, Bertolotti adds.

The interest in ESG isn’t just coming from long-term shareholders, however. “We’ve seen increased interest [in ESG] also from short-term investors,” says Fabian Schwane, investor relations manager at Evonik. “At the end of last year, we had a road show with … some hedge funds. Typically, their first question is about cash flow or debt. But this time it was about decarbonization. Short-term investors have an increased awareness around ESG because they see it as a potential risk for them.”

Bond investors also expressing greater interest. “Over the past year, interest [in ESG] has gone from zero to sixty in a matter of months,” says John Rogers, vice president with Moody’s Investors Service (New York, New York), a credit ratings agency. “In 2019, almost every investor we talked to had some concerns around ESG.” Bond investors have particular interest in downside risks. “As a bondholder, your upsides are limited so what you are trying to do is check the downside,” Rogers says. “Investors see a focus on ESG as a way of protecting the downside.”

Social and governance

The ‘environmental’ portion of ESG has generally attracted the most attention at chemical makers. Chemical companies are subject to environmental regulations, and they emit greenhouse gases (GHGs). Chemicals can both enable and undercut efforts at environmental sustainability. Manufacturers of chemicals are part of a vast global supply chain that includes oil and gas firms, consumer goods companies, automakers, and other industrial firms, many of which both have significant environmental footprints and are integral to modern life.

But the social-and-governance aspects of ESG remain important. Diversity—particularly with regard to gender—has been an important focus for many companies. For example, Dow’s chief human resources officer, Karen Carter, also has the title chief diversity officer. “Human capital management,” which encompasses diversity and inclusion, is a key consideration for Ecolab, says Emilio Tenuta, Ecolab’s chief sustainability officer.

For investors, the demographics of their client base is changing, which creates a greater focus on all aspects of corporate social responsibility. “There is a thought that millennials are looking for a different type of investment,” Bertolotti says. BlackRock looks at inclusion, diversity, and external community relations as part of its ESG process, Bertolotti adds. Board independence and minority representation on boards are also considerations, he says.

Some socially-conscious investors use the proxy process to raise awareness around ESG issues. “Proponents have filed at least 429 shareholder resolutions on environmental, social and sustainable governance issues for the 2020 proxy season,” according to Proxy Preview 2020, an annual report from a consortium of sustainability-focused investors. Many were focused on environmental issues, but resolutions related to pay disparity and diversity are also common, with the latter “surging” this year, Proxy Preview says.

Among chemical makers, 3M is facing a pending resolution regarding high CEO pay in comparison to subordinates. ExxonMobil is facing a pending resolution about the construction of petrochemical facilities in flood-prone areas, including the US Gulf Coast. The resolution, put forward by non-profit shareholder advocacy group As-You-Sow (Berkeley, California), requests that ExxonMobil “publish a report … assessing the public health risks of expanding petrochemical operations and investments in areas increasingly prone to climate change induced storms flooding and sea level rise.”

Disclose it

Investors with a more conventional outlook than As-You-Sow are also interested in climate risk, including the location of facilities and severe weather impacts. “Climate risk is kind of its own category.” Bertolotti says.

NEXT FRONTIER: Investors are watching developments in plastic waste,
circular economy.

ESG and sustainability reports are a key way that companies disclose these sorts of risks, in addition to operational issues like GHG emissions and water usage. Many chemical makers have been publishing such reports for well over a decade, but they have in recent years become more integrated with financial reporting. “In the past, companies would use the reports internally or share them with relevant communities,” says Troy Keller, of counsel with Dorsey & Whitney (Minneapolis, Minnesota), a corporate law firm. “They didn’t share them with investors, because investors didn’t care. But now companies share them with investors, or pull them into financial reporting.”

For publicly traded US companies, some level of climate-change-related risk reporting is mandated by the Securities and Exchange Commission (SEC; Washington, DC), and greater disclosure in annual reports, also known as 10-Ks, is increasingly common. Ecolab has “some language” in its annual report that “talks about climate resiliency,” Tenuta says. This is not unusual. “About half of companies now include risk factors on climate change” in annual reports, according to Keller, who was previously an associate general counsel with Huntsman and often works with chemical companies.

SEC requirements are only one piece of the disclosure puzzle, however. BASF, Ecolab, and Evonik all publish reports in accordance with standards set by the Global Reporting Initiative (GRI), as do many other chemical makers. BASF’s “corporate strategy gives sustainability targets equal billing to our financial goals,” Balensiefer says.

GRI is not the only standard in existence. Other organizations, such as the Task Force for Climate-Related Disclosures (TCFD) and the Carbon Disclosure Project (CDP) set various standards around ESG-related disclosures and reporting. Sometimes, investors push companies to embrace these standards. “In the middle of last year, we had some feedback from Scandinavian investors asking us to align our reporting towards TCFD standards,” Evonik’s Schwane says. “We were able to align our disclosure to that more in the short-term.” Evonik has not yet adopted all TCFD standards, as work towards this goal only began last year, but the company is moving in that direction. BASF and Ecolab are also incorporating TCFD standards into their ESG reporting practices.

While sustainability-minded investors have generally embraced such disclosures, the alphabet soup of different standards can get confusing. BlackRock “works with data providers” but also “has a house view on ESG and we define what it means,” Bertolotti says. Differing views in ESG and sustainability in the investment community, and at organizations that set standards, gather data and build metrics can make it hard to create apples-to-apples comparisons on ESG issues. “There are probably 20 or 30 different firms out there providing metrics,” Rogers says. “It’s a challenge because a lot of them are going off of what is in filings, and you can have two companies with very different disclosure practices that get very different ratings even though they do the exact same thing.”

Targets are also important. Companies almost invariably describe their targets as “ambitious,” an adjective that often lies in the eye of the beholder. But it is true that most of the leading chemical companies, at least in the developed world, have targets related to GHG emissions reduction. Targets related to water usage, recycling, and diversity and inclusion are also quite common. Some companies, such as Ecolab, are moving from targets tied to emissions efficiency—lowering GHG emissions per unit of revenue—towards absolute targets, a big step. Ecolab currently has a goal of reducing GHG emissions by ten percent for every $1 million of revenue, which is sunsetting at the end of this year, according to Tenuta. The next goal is to cut absolute GHG emissions by 50% by 2030, in accordance with UN Global Compact climate goals, he adds.

Holistic approach

That the chemical industry is both an emitter of GHGs and an enabler of sustainability puts it in a unique position. Companies are looking to reduce their emissions, in line with investor priorities. At the same time, many chemical makers are tying sustainability and decarbonization into new product development, which can be a major selling point for ESG-minded investors.

There are issues around the supply chain, too, as both suppliers and customers for many companies are themselves growing more mindful of their environmental impact. Ecolab’s goal of cutting GHG emissions by 50% by 2030 includes emissions from the supply chain, transportation and logistics, and power generation, which are defined as ‘scope 1,’ ‘scope 2,’ and ‘scope 3’ by CDP. “We have lots of chemicals and materials companies as suppliers,” Tenuta says. “So we are reaching out to them to partner on carbon reduction targets because they need to support us in hitting our targets.”

Investors understand that the chemical industry sits as the center of a vast supply network, and that the industry’s products can have both environmental benefits and drawbacks. To the extent that products have benefits, that’s seen as a positive. “Our investors know that this is an energy-intensive industry, but they also look at the benefit of what the industry can bring to overall sustainability,” Schwane says.

BASF and Evonik both have targets related to higher sales of sustainability-enhancing products. “The market is demanding more sustainable products and we are well prepared to meet that demand,” BASF’s Balensiefer says. Evonik incorporates a global carbon price of €50/ton into investment decisions and profit calculations, according to Schwane. “Investors want to see how your product portfolio is aligned with sustainability, and customer demand for sustainable, resource-efficient products is increasing,” he adds. Both companies often aim for sustainability-related advantages in the R&D and product development process. “Currently, around half of our total annual research and development spending goes toward developing product and process innovations where the R&D target is related to energy or resource efficiency and climate protection,” Balensiefer says.

Ecolab views its water management business as a key enabler of sustainability. The company has developed technologies that enable firms that use lots of water in industrial processes—including chemical manufacturing—to reuse so-called ‘grey water’ rather than repeatedly tap local water supplies. “Investors like to see … that we are developing technologies to help our customers meet their climate-related goals and help them save money by reducing energy and water usage,” Tenuta says.

Another key aspect of sustainability, that is both a challenge and opportunity for the chemicals sector, is the circular economy. Investors are interested in building the circular economy, as are NGOs, non-profits, governments, and manufacturers. “There is potential upside for leaders in spaces like circular economy to develop a competitive advantage,” Bertolotti says. While issues like ocean plastic and recycling have loomed larger in the public consciousness than they have investment portfolios as of now, that could very well change. “For companies that are out in front on these issues, it could be an advantage,” Bertolotti adds.

ESG proponents such as As-You-Sow have put forward proxy proposals related to plastics, although these have generally focused on downstream users such as consumer goods firms and makers of packaging. But, “it impacts the chemical industry because the industry is making those materials,” Keller notes. Initiatives such as the Alliance to End Plastic Waste (AEPW), which includes many leading chemical makers, have mostly focused on the manufacturing value chain and have arisen largely in response to public, rather than investor, pressure. But investors are watching these developments. “Investors care, downstream customers care, employee bases care,” Keller says. “Showing that your company is forward-looking is important these days on all angles.”