BHP Billiton ESG downgrade prompts asset owner questions: MSCI

MSCI has given BHP Billiton a red flag in its MSCI Controversies Research and downgraded BHP Billiton in its ESG Rating Research, a move that could impact on the portfolio construction and screens of asset managers and owners around the world.

Michael Salvatico, Executive Director, MSCI

Michael Salvatico, Executive Director, MSCI

MSCI recently held a webinar to discuss the circumstances that led to BHP Billiton receiving a red flag in its controversies ratings, and discuss what this could mean for investors.  MSCI gave BHP Billiton a red flag in the wake of the Fundão tailings dam bursting at Samarco in November 2015. The red flag also impacted on MSCI’s ESG ratings of BHP Billiton, which had already been in the lower quartile for performance around environmental and human rights issues, said Chris Vernon, research analyst, MSCI.

BHP’s MSCI ESG rating is BBB, downgraded from A last November.

“We wanted to speak with investors, to address the number of questions that I was receiving about BHP because changing a rating or a flag for a controversy does potentially have an impact on an investment strategy,” said Michael Salvatico, executive director, MSCI ESG Research. “So it was a matter of educating people on the events at BHP and distinguishing between the controversial behaviour and the ESG rating which represents more the financial and material risk that BHP is exposed to.”

Asset owners and managers that use MSCI ACWI and screen out red flagged companies or companies that have poor ESG ratings could be in a position where they have to make an investment call on BHP Billiton, which is a significant component of the ASX.

“We’re speaking to 30 asset owners in Australia and NZ alone and in some cases, the investment strategies are excluding red flagged companies, and excluding companies that fail [United Nations] Global Compact compliance,” Salvatico said. “In our research, we’re mapping across the controversies to the Global Compact. So there’s concern, for an Australian investor, because BHP is a huge part of the index, while for an international  investor, it’s one of thousands that they can invest in across ACWI. But when it does have a big impact, clients want to understand the basis of the ratings and the basis of the controversy flag.”

Vernon noted that since the Samarco incident, MSCI has spoken with BHP Billiton more than five times to verify data disclosed by BHP Billiton.

“When trying to assess the overall context – BHP Billiton is a massive company – we looked into three main areas to assess the overall context,” Vernon said. “We looked at lost production, corporate remediation and legal liabilities. … It’s difficult to actually put a number on it. Basically, even BHP said in their annual report that their potential costs have a high degree of uncertainty and can’t be reliably estimated at this time.  Even BHP with all their knowledge refused to put a number on this, because of the unknowns, particularly from a legal liability standpoint.”

Tailings dams are more prone to failure than water dams, Vernon noted, and the elevated risk of failure of tailings dams in general has prompted the industry to review its operations. Vernon last year conducted a review of the global mining and extraction industry sector, which gave greater context to events at BHP Billiton. He also pointed to industry protocols such as the Mining Association of Canada’s Towards Sustainable Mining (TSM) as a voluntary framework of best practice.

“Basically, we have enormous amounts of data on companies, and we’re looking at risk metrics from an industry viewpoint. We can tie it back to BHP, which had the biggest increase in tailings intensity of any group from 2012-2014, but that overall number is still relatively low,” he said. “Tailings dams also have an increased risk of failures compared to other water dams of roughly ten times because of the complexity of mining tailings. The International Council of Metals and Mining and has launched a global tailings management review for all members globally.”

The red flag for controversies and impacts on the ESG Rating for BHP Billiton may not lead to divestment from BHP by Australian investors, but it does highlight the impact of ESG risks to portfolios.

“The story for me is that the world has changed, the risks companies face have changed, and therefore the risk investors face have changed, and we need to take into account those changes when we’re assessing a company,” Salvatico said. “ESG has become the catch-all for those risks that are outside of a traditional analysts’ focus. This isn’t new… but if you’re making an investment decision and you’re not taking into account the ESG exposures, you’re making a decision with one eye closed.”