After decades of secrecy, light is increasingly being shone on the potentially hazardous compounds produced by chemical companies. In the latest instalment of our editorial series, Link, experts from Aviva Investors’ credit, equities and ESG teams discuss the prevalence of chemicals in modern life, and how to balance usefulness and safety.

Hazardous chemicals have been added to the list of corporate sins investors and consumers worry about

In recent years, a number of high-profile legal trials against the likes of DuPont and Bayer-Monsanto have added hazardous chemicals to the list of corporate sins investors and consumers worry about. The issue is becoming even more important today, as we look for solutions to create circular economies. If products and compounds are to be reused indefinitely, we must ensure they are not harmful to humans or the environment.

Yet many companies remain secretive; for every PFAS (per- and polyfluoroalkyl substances; see explainer) or glyphosate uncovered, thousands of potentially dangerous chemicals continue to be used in everyday products. The lack of transparency also makes it difficult for investors to fully understand chemical companies’ impact on the environment, or the legal and reputational risks they are exposed to.

In June 2020, ChemSec, a non-profit organisation that advocates stricter regulatory controls on the industry, published the first sustainability rankings of 35 companies based on their production and management of hazardous chemicals.1 For the first time, investors can easily access expert assessments of this issue at the companies they research and own.

Is this the beginning of a revolution in the chemicals industry? To discuss this question, the AIQ editorial team brought together Eugenie Mathieu (EM), senior environmental, social and governance analyst, Alessandro Rovelli (AR), senior credit research analyst, Kevin Gaydos (KG), co-head of credit research, and Frédéric Guignard (FG), European equity portfolio manager. They argue that growing public awareness is pushing companies to search for safer chemicals, but the industry still needs better independent research and stronger regulation.

What is the benefit of looking at specific data on hazardous chemicals?

FG: It is valuable because it complements the other data we work with, such as MSCI ESG ratings. For instance, we are shareholders of Umicore, which operates three divisions: catalysis, battery and recycling. Umicore’s MSCI ESG rating is AAA, rewarding the company’s positioning in the clean mobility segment.

The ChemScore analysis brings a different perspective to the business case, which is why the data is so valuable

The company’s ChemScore rating is completely different; it scores very poorly due to a lack of disclosure in the recycling division and because part of its battery operations involves nickel and cobalt refining. The ChemScore analysis brings that perspective to the business case, which is why the data is so valuable.

EM: The scores are different because MSCI looks at the full range of ESG issues; it incorporates social and governance factors, and on the environment, it will consider issues like carbon emissions and water stress. ChemScore focuses solely on the sustainable management of hazardous chemicals, which we believe to be one of the most material issues. General ESG ratings are a good start, but they are a blunt tool. That is why we like to supplement them with detailed analyses by issue experts wherever possible.

KG: As investors, concerns around toxic chemicals have always been on our minds because of what they can lead to – lawsuits and the like. In the past, there was almost no information on what these companies were producing, and they clearly did not want to advertise what they were doing.

When organisations like ChemSec bring this to the forefront, it provides investors with better data and puts pressure on companies as they realise investors are aware of what they are producing. Having this data is a real benefit to investors and to get companies to make changes.

FG: Companies tend to communicate when regulators, investors and consumers push them to. There is strong momentum from consumers today for the flavours and fragrance industry to switch to natural ingredients, and this is now discussed and advertised by companies.

EM: The manufacture and management of hazardous chemicals is an issue around which, traditionally, companies have been the most secretive. This is likely to be because, of all environmental issues, it is the one with the largest current liabilities. For example, in early 2017, DuPont, and its spin-off Chemours, paid $671 million to settle several thousands of lawsuits connected to a leak of PFOA (perfluorooctanoic acid) into local water supplies from a plant making Teflon.2 In 2018, 3M – another producer of PFAS chemicals – paid $850 million to settle a similar case.3

The manufacture and management of hazardous chemicals is an issue around which, traditionally, companies have been the most secretive

Conventional analysis can give misleading impressions. For example, Johnson Controls, a provider of smart-buildings solutions, has made the World’s Most Ethical Companies list for the 13th successive year4 and ranked 18th on the 100 Best Corporate Citizens List5. However, it makes firefighting spray with PFAS, and has polluted local Wisconsin watercourses. The company estimates the liability at US$140 million, but UBS has estimated it could be as high as $4 billion. Part of this uncertainty is because we don’t know how much PFAS the company released to the environment or where. ChemScore is a vital step forward in helping investors understand which companies are producing hazardous chemicals, and who the leaders and laggards on sustainable chemical management are.

To what extent are litigation and regulation putting pressure on these firms?

FG: Hazardous chemicals are not a new topic for producers; they have known for a long time this carries reputational and financial risks, so they manage those. Excluding the agrochemical segments where the Bayer-Monsanto trial in the US has pushed it up, litigation risk has not really increased.

AR: We also cannot live in a zero-pollution environment and need to accept certain chemicals. You cannot have a house with windows without having some chemical process to make the glass. However, awareness of certain hazardous chemicals in the environment may have fallen in recent years. One of the reasons is that the US Environmental Protection Agency (EPA), which is the most important regulator in the world, has been led by people who used to work for the companies it regulates.

EM: Donald Trump decimated the EPA, not only filling it with ex-lobbyists and corporate people but taking away its power. He removed most of its ability to fine and enforce, so litigation risk has probably dropped significantly in the last four years. It seems likely Biden will restore the powers of the EPA, and perhaps commit it further to taking action than was the case four years ago.

AR: There are two more endemic problems with chemical pollution. The first is that the EPA screens 85,000 chemical substances, with around another 1,500 added every year. Even under the previous administration, it didn’t have enough resources to study the effects of all these substances. That means this research is generally outsourced to the chemical companies themselves, which is a conflict of interest. Taxpayers don’t want to pay a lot of money for these resources, and we end up with companies rating their own products.

Academic research is often sponsored by chemical companies

The second endemic problem – still mostly focusing on the US – is that academic research is often sponsored by chemical companies. In the litigation for Monsanto, internal emails emerged showing employees had been ghost-writing reports signed by academics.6

DuPont Teflon is an important case from that perspective. It emerged after a Teflon plant started operating in West Virginia, when a farmer’s cows started dying in droves. As a small, independent farmer, he didn’t have the means to fight DuPont, one of the most powerful companies in the US with great political, media and academic influence. However, a lawyer he contacted eventually managed to bring the case against DuPont, and even followed with a class action lawsuit.

It is exceptional, because victims of this type of pollution generally don’t have the resources to sue, or even to study what is in the products. Without independent research available, the link is very hard to prove, even if they have cancers or their children are born with malformations.7 These are big problems with the sector.

What about the Bayer-Monsanto litigation?

AR: We have had multiple calls with Bayer, led by our ESG team, who had concerns at how it acquired Monsanto without proper due diligence. Bayer had a relatively pristine reputation, bought Monsanto which was the opposite, and expected its good reputation to fix all the problems. Actually, the opposite happened.

This has impacted my recommendation on the company’s bonds, even if the company has enough cash to withstand a heavy fine – the estimate right now is between $10 and $11 billion. I think the company may end up splitting pharma and agrochemicals. You have to wonder whether Bayer couldn’t have made money in better ways.

FG: A big worry for me is that, in my many meetings with industry CEOs, I had word that glyphosate is probably the least harmful compound they are selling to agriculture today. Yet modern agriculture needs yield, and yield comes from those kinds of products. It is on us to decide what we agree to live with or not.

How can we manage the issue of the chemicals we should tolerate versus those we should ban?

AR: My view is we should tax chemical companies and use those tax revenues to pay for proper independent research to assess the toxicity of companies’ chemicals.

FG: I would offer two examples. The first is Umicore. It has a recycling division, which is part of the solution, but you need to use toxic chemicals for recycling to separate different compounds, so you cannot always avoid them. We need stronger regulation, and we need to assess how those chemicals are managed after use.

The second example is a company called Arkema. Eight to ten per cent of its portfolio involves fluoride gases, which are used in refrigeration but damage the ozone layer. In 1987, the Montreal Protocol implemented a set of measures to regulate and phase them out, and to promote alternatives. This pushed the company to review its strategic options and explore possible alternatives, so regulation can have an impact on businesses.

What about persistent chemicals?

Companies that are reacting quickly are the ones further downstream, because end consumers want safe products

EM: The persistent chemicals we have been looking at in the most detail are PFAS. In December 2020, a group of EU countries are launching a proposal to restrict their use, so they may be the next to be regulated. They have been linked to cancers, hormone disruption, lower birth rates and negative effects on the immune system. This seems to be one of the categories the EU is looking at more urgently.8

Are some firms already committing to developing safer chemicals?

FG: Companies that are reacting quickly are the ones further downstream, because end consumers want safe products, for example in the coating and painting industry. That is why companies like AkzoNobel are trying to use safer compounds and being more vocal on the topic. But it is happening downstream rather than upstream, which is much further removed from the final consumer.

EM: For that reason, I would guess clothes and retailing will be the first to focus on safer chemicals. Many school uniforms use perfluorinated chemicals to make them stain resistant, but people don’t want their children to wear clothes made with toxic chemicals. That is why Marks & Spencer, for example, has eliminated PFC chemicals from all its clothes and shoes. ChemSec has drawn up a commitment to ban PFAS chemicals in clothes and food, which some big retailers have signed up to, like H&M and Inditex.9

FG: For upstream, it will be a question of political and social will. It is too early to say what will happen with upstream and intermediate chemicals, but taking the earlier example of fluoride gases, we know pressure from regulators and consumers works.

AR: It is also important there is a clear alternative, albeit a more expensive one; otherwise it is hard for companies to switch to safer products.

FG: Unlike in renewable energy, there is no government commitment to push innovation and make it cost effective through subsidies. Chemical companies have to innovate without any assurance the new process will be competitive. It makes change much more difficult unless consumers are willing to pay a premium, as they are with organic food. That is also why it can be easier to switch and sell a more expensive chemical downstream.

Have the DuPont and glyphosate trials helped change companies’ attitudes and practices?

AR: Once there is massive class action in the US and movies made about this topic, it comes to the fore and that will bring about change. I’m quite optimistic, but of course, for those two substances, another 1,500 are added every year that people wouldn’t know about.

KG: I have been covering chemicals for 12 years; over that time, I have seen a shift in how management deal with investor concerns. A few years ago, it was just talk about how positive their companies were from an ESG perspective. Over the last couple of years, we have started seeing a lot more discussion over making real changes.

There will be a continuum of change with investors at the forefront

Some of that is superficial and some is real, but there will be a continuum of change with investors at the forefront, making sure the companies understand their cost of capital or equity multiples will be hit if they don’t pay attention. It is slow, but it is progressing.

PFAS explained

PFAS are a group of more than 4,700 man-made chemicals (OECD, 2018). They are used in a wide variety of consumer products and industrial applications because of their unique chemical and physical properties, including oil and water repellence, and temperature and chemical resistance. PFAS have been used in firefighting foams, non-stick metal coatings for frying pans, paper food packaging, creams and cosmetics, textiles for furniture and outdoor clothing, paints and photography, chrome plating, pesticides and pharmaceuticals. Of the relatively few well-studied PFAS, most are considered moderately to highly toxic, particularly for children’s development.10

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