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ESG Industry Report Card Chemicals

Highlights

The most meaningful risk for chemical companies arises from their environmental exposure. The global trend toward more stringent environmental regulation heightens this risk that virtually all chemical companies around the world face.

Social factors also pose significant risk, only marginally lesser than environmental issues. Demographic changes and customer preferences and awareness of risks related to the uses of chemicals are key social risks.

How individual companies deal with these key risks is an important factor in assessing their governance.

The ESG Risk Atlas

Jun. 03 2019 — To calibrate the relative ranking of sectors, we use our environmental, social, and governance (ESG) Risk Atlas (see "The ESG Risk Atlas: Sector And Regional Rationales And Scores," published May 13, 2019). The Risk Atlas provides a relative ranking of industries in terms of exposure to environmental and social risks (and opportunities). The sector risk atlas charts (shown below) combine each sector's exposure to environmental and social risks, scoring it on a scale of 1 to 6. A score closer to 1 represents a relatively low exposure, while 6 indicates a high sectorwide exposure to environmental and social risk factors (for details see the Appendix). This report card expands further on the Risk Atlas sector analysis by focusing on the credit-specific impacts, which in turn forms the basis for analyzing the exposures and opportunities of individual companies in the sector.

Environmental Exposure (Risk Atlas: 5)

Chemical companies, including specialty and commodity chemical producers, face environmental risks arising from their exposure to waste, pollution, and toxicity. Many chemical products, raw materials, and by-products or effluents are polluting and toxic, and as a result several chemical companies face ongoing liabilities or litigation. Controversies related to the use of asbestos and lead paint and related litigation against chemical companies are well illustrate such risks. Several chemicals are classified as hazardous by institutions such as the United Nations. Such classifications underpin regulation of the manufacture, storage, and transport of these chemicals. Chemical companies also face risks related to water use, scarcity, efficiency, decontamination, and climate impact. For example, an international treaty phased out the production and use of chloroflurocarbons, used in multiple applications including as a refrigerant. Companies account for some risks as liabilities in their financial statements. Because of the long-term historical exposure of the industry to these issues, there is considerable regulatory focus on chemical companies. The impact on, and costs to, companies from regulatory requirements vary across the globe, but generally speaking, regulatory stringency has increased over time.

Social Exposure (Risk Atlas: 4)

The key social risks for chemical companies are demographics, safety management, and the growing influence of consumer behavior. Chemical companies face demographic changes from rising populations, urbanization, and greater economic development in many parts of the world. While the overall continued rising demand for chemical products may provide growth opportunities for well-prepared companies that can innovate, they also amplify risks related to the manufacture, transport, and consumption of chemical products. For example, some chemical companies have faced increasing local resistance to setting up plants in certain locations. We also consider changes in consumer sentiment toward chemicals, plastics, and other products such as seeds and traits. We believe that social awareness about chemical products, particularly with regard to health and environmental issues, is likely to further increase. For example, the willingness of some consumers to pay a premium for farm produce grown without the use of chemical pesticides or fertilizer, or increased customer focus on buying foods produced without chemical preservatives or other substances, could diminish demand for chemical products. Although some of these evolving trends do not meaningfully affect demand, social perception of chemical products and consumer preferences could pose important long-term risks to companies.

Finally, chemical companies face risks from the fallout of accidents in the manufacture or transport of certain hazardous chemicals. Such low-probability but potentially high-impact accidents can jeopardize lives and the environment. In addition, they can result in financial claims, loss of operational licenses, or damage to public perception of chemical companies. The chemical sector is associated with what is considered the worst industrial accident ever--the 1984 release of the chemical methyl isocyanate at Union Carbide Corp.'s then-majority-owned joint venture in Bhopal.

Governance

Overall, governance is the most idiosyncratic risk, as it usually reflects a company's particular corporate culture, strategy, geographic footprint, and group complexity. Still, at the sector level, we consider companies' structure in terms of ownership and control. We consider mergers and acquisitions (M&A), growth strategies and their execution, and where relevant, environmental and social risks.

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