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Water Scarcity and Sustainable Usage
Laura Lutton, Director of ESG Product Management
The Water Use – Supply Chain Material ESG Issue (MEI) focuses on how companies utilize water and manage associated risks within their production processes and supply chains. The sustainable utilization of freshwater, a finite natural resource, gains significance amidst escalating global water scarcity. Projections from the United Nations warn of a potential 40% water deficit by 2030.
Identifying Risks: Factors Contributing to Water Vulnerabilities
Water risks predominantly arise from a company's reliance on water for internal processes and raw material production. Sectors such as mining, agriculture, and semiconductor manufacturing exhibit heightened water intensity.
Navigating Geography: Contextualizing Water Risks
Assessing a company's water risks necessitates consideration of its facility and supplier locations. Factors influencing water availability encompass water reserve presence, permit requirements, water network quality, and local water demands.
Hotspots of Concern: Focusing on Water-Stressed Regions
Particular attention is warranted for companies operating in water-stressed areas like portions of Chile, the United States, and Australia, where water scarcity exacerbates risks.
Stewardship Strategies: Mitigating Water-Related Risks
Companies committed to water stewardship are better equipped to mitigate water risks. Embracing an adaptive business model entails water risk assessments, supplier and community engagement, and the implementation of water recycling systems.
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Evaluating Structures and Risks
Adam Fleck, Head of Research
The Corporate Governance Material ESG Issue (MEI) examines a company's operational and control frameworks, encompassing mechanisms, policies, and practices governing management. The quality of corporate governance significantly influences risk management, efficiency, and reputation, necessitating transparency to shareholders.
Assessing Governance Risks
- Our comprehensive evaluation at Morningstar Sustainalytics entails examining board effectiveness, including composition, roles, and supporting committees. We assess director expertise, independence, and structures to ensure effective discharge of duties.Addressing Executive Compensation Risks
- Within our ESG risk ratings framework, we evaluate risks associated with executive compensation. Emphasis is placed on aligning remuneration with shareholder interests through transparent disclosures, performance-based incentives, and sustainability targets.Analyzing Shareholder Influence
- We investigate the impacts of majority shareholders and voting rights, focusing on potential risks to minority shareholders and adherence to the one share/one vote principle.Navigating Governance Controversies
- Lastly, we consider controversies surrounding corporate governance, including mergers, shareholder disputes, and remuneration issues, to identify and address potential challenges impacting a company's governance landscape. -
Understanding Stakeholder Impact
Adam Fleck, Head of Research
The Stakeholder Governance Material ESG Issue (MEI) centers on comprehending a company's influence on various stakeholders and its adept management of these impacts.
Tailoring to Business Models
- Prioritizing stakeholders aligns with a company's distinct business model. Evaluating environmental and social risk management strategies provides insights into stakeholder engagement approaches.Assessing Governance Risks
- Our analysis, within the Morningstar Sustainalytics ESG risk ratings framework, scrutinizes board oversight, committee structures, and alignment of disclosures with best practices to mitigate unmanaged risks.Scrutinizing Policies and Programs
- We delve into a company's policies and programs governing its impact on specific groups. Evaluations range from environmental policies managing harm reduction to discrimination policies promoting workplace equality.Commitment to Global Standards
- Exploring UN Global Compact membership reflects a company's dedication to universal principles on human rights, labor, environment, and anti-corruption, underscoring proactive societal contributions. This framework offers a nuanced understanding of governance practices, providing a comprehensive evaluation of stakeholder impact and sustainability commitment. -
Access to Basic Services: An ESG Imperative
Adam Fleck, Head of Research
The Access to Basic Services Material ESG Issue (MEI) focuses on managing access to vital products and services, such as healthcare, for disadvantaged communities.
Global Healthcare Challenges Amid Escalating Costs
- As healthcare costs surge globally, accessibility remains a pressing issue. The COVID-19 pandemic has amplified concerns over pricing and access, prompting institutional investors to push for transparency and collaboration among pharmaceutical companies.Evaluating Industry Risks: A Holistic Approach
- ESG Risk Ratings combine inherent risks with those unaddressed by company programs and policies.In the U.S., with the highest healthcare costs per capita, annual spending on prescription drugs hits USD 1,200. Elevated drug prices not only strain healthcare budgets but also hinder access to essential medications, raising sustainability concerns. Through our ESG Risk Ratings framework, investors can identify and assess companies most vulnerable to this evolving issue
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Comprehensive Ethical Management
Adam Fleck, Head of Research
The Business Ethics Material ESG Issue (MEI) focuses on managing general professional ethics, covering taxation, accounting, anti-competitive practices, and intellectual property. In industries lacking a separate Bribery and Corruption issue, Business Ethics may also encompass this area, along with specific topics like Medical Ethics and Financial Services Ethics.
Global regulatory fines for anti-money laundering violations reached USD 26 billion from 2008 to 2018, prompting regulators to mandate robust compliance systems. Business ethics controversies can significantly impact top companies.
Morningstar Sustainalytics’ Assessment Approach
- Morningstar Sustainalytics assesses business ethics by considering risks associated with the absence of active management through policies, programs, and systems.Regulators intensify scrutiny on compliance systems, especially in banking and finance. Legal or ethical misconduct carries financial and reputational risks. A strong ethical framework is crucial. Investors can use Morningstar Sustainalytics’ ESG Risk Ratings to identify exposed companies and evaluate risk management effectiveness.
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Engaging Local Communities
Adam Fleck, Head of Research
The Community Relations Material ESG Issue (MEI) focuses on company engagement with local communities, including indigenous peoples, covering development, participation, and impact mitigation.
Community and indigenous opposition has been decisive in halting major projects, such as the Keystone XL pipeline in the US and the Pascua-Lama gold mine in Chile. In Brazil, tailings spills have devastated entire communities, leading to significant compensation and restoration obligations. With diverse regional needs, including land, biodiversity, and water, companies are under mounting pressure to balance environmental stewardship with economic growth and community well-being.
Morningstar Sustainalytics' Evaluation Method
Morningstar Sustainalytics’ ESG Risk Ratings assess companies' total risk exposure and the extent to which it's managed. A wider gap between exposure and management signifies higher unmanaged risk levels for a company. -
Assessing Privacy and Cybersecurity Risks
Adam Fleck, Head of Research
The Data Privacy and Cybersecurity Material ESG Issue (MEI) focuses on data governance, ensuring safe handling of personally identifiable information.
Personal data protection is critical, with stricter laws like GDPR and rising awareness. Data breaches cost millions, with the US facing the highest expenses.
Morningstar Sustainalytics' ESG Risk Ratings integrate inherent risks with management practices, including policies and transparency measures. Effective practices mitigate risks of data collection, usage, and safeguarding.
Protecting Financial Interests
Data management affects financial value. Failing to protect data incurs escalating costs. Investors can identify exposed companies and assess risk management using our ESG Risk Ratings. -
Managing Environmental Impact
Adam Fleck, Head of Research
The Emissions, Effluents, and Waste Material ESG Issue (MEI) focuses on managing emissions and waste from company operations, excluding greenhouse gases. The emphasis on particular waste streams varies depending on the subindustry.
Trends in Environmental Regulation
Environmental regulations are tightening due to heightened societal awareness and scientific understanding of pollution impacts. Companies face legal and reputational risks, including for legacy pollution issues like groundwater contamination.Courts globally are holding companies accountable for environmental violations, with increasing enforcement actions seen, exemplified by India's National Green Tribunal.
Corporate Responsibility Amid Rising Environmental Standards
As pollution concerns grow, companies must navigate stricter regulations and public expectations. The US EPA's rising enforcement actions reflect a global trend toward stronger environmental standards. -
Navigating Carbon Impacts: Evaluating Product and Service Use
Adam Fleck, Head of Research
The Carbon – Products and Services Material ESG Issue (MEI) evaluates how companies handle energy efficiency and GHG emissions during product and service use, excluding financial services, which are assessed separately.
A significant portion of global GHG emissions stems from energy production and usage, impacting sectors like transportation and manufacturing. Companies in these sectors face risks associated with consumer-use carbon emissions.
Legal and regulatory challenges contribute to the rise in incidents related to product and service carbon impacts. Companies with high carbon portfolios face reputational risks and regulatory scrutiny.
Regulatory Shifts and Corporate Responsibility
Governments respond with regulatory measures to curb carbon impacts, such as fuel economy requirements and the shift to electric vehicles. Oil and gas sectors address emissions through clean fuel standards.Evaluating Unmanaged Carbon Risks
Morningstar Sustainalytics' ESG Risk Ratings integrate business model risks and management practices effectiveness related to carbon impact, aiding investors in identifying vulnerable companies and assessing risk management efficiency. -
Assessing Environmental and Social Impact: Evaluating Products and Services
Adam Fleck, Head of Research
The Environmental and Social Impact of Products and Services Material ESG Issue (MEI) evaluates how companies manage the environmental and social impacts of their products and services, considering aspects from input materials to use, disposal, and recycling.
Understanding Environmental and Social Impact Management
As regulations and consumer demand for sustainable products grow, companies face both risks and opportunities in addressing environmental and social impacts.How Morningstar Sustainalytics Evaluates Companies on the Environmental and Social Impact of Products and Services
By leveraging our ESG Risk Ratings framework, we score companies based on a set of subindustry-specific exposure and management indicators. Our assessment considers whether a company sells products with known human and environmental concerns and evaluates their commitment to sustainable products. Depending on the subindustry, we scrutinize management practices related to product stewardship and participation in relevant industry initiatives. -
Upholding Human Rights: Managing ESG Impact
Laura Lutton, Director of ESG Product Management
The Human Rights Material ESG Issue (MEI) focuses on how companies uphold fundamental human rights within their operations, including civil, political, and economic rights, as well as protections against child and forced labour.
Spotlight on Human Rights Challenges
Human rights have long been a central concern for companies, prompting regulatory frameworks and increased consumer and investor awareness. Scrutiny of companies like Boohoo PLC in 2020 highlights the importance of addressing human rights practices in supply chains.Evaluating Human Rights Risks
ESG Risk Ratings for Human Rights MEI assesses inherent risks in a company's business model and operations, alongside risks from inadequate implementation of relevant programs and policies.With growing awareness among investors, regulators, and consumers, companies face heightened scrutiny over human rights risks. Our ESG Risk Ratings framework helps investors identify companies most exposed to this issue and evaluate risk management effectiveness.
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Maximizing Human Capital: Prioritizing ESG Impact
Laura Lutton, Director of ESG Product Management
The Human Capital Material ESG Issue (MEI) focuses on effectively managing human resources, addressing skilled labor scarcity, career development, and labor relations aspects.
Unleashing Value through Human Capital
- Human capital is a key asset driving company value. A well-managed workforce supports growth, while neglecting employees may lead to decreased productivity. Research shows a correlation between employee satisfaction and shareholder returns.Analyzing Unmanaged Risks in Human Capital
- Morningstar Sustainalytics' ESG Risk Ratings assess a company's human capital management, including risks not actively managed through policies and programs.In a rapidly evolving digital landscape, companies must adapt to remain competitive and create sustainable value. Success depends largely on effective human capital management.
Using Morningstar Sustainalytics' ESG Risk Ratings, investors can identify companies exposed to human capital risks and evaluate their risk management strategies.
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Navigating Land Use and Biodiversity
Laura Lutton, Director of ESG Product Management
The Land Use and Biodiversity Material ESG Issue (MEI) focuses on how companies manage the impact of their operations on land, ecosystems, and wildlife, covering land conversion, rehabilitation, forest management, and biodiversity protection.
Assessing Environmental Challenges
- Concerns over land use, biodiversity, and deforestation are increasingly prominent. Reports highlight significant forest loss and accelerating species extinction rates, with implications for the global economy and health.Morningstar Sustainalytics' ESG Risk Ratings assess companies' exposure and management of land use and biodiversity issues through subindustry-specific indicators. This includes evaluating deviation from default exposure and management effectiveness in areas like biodiversity programs and deforestation policies.
Deforestation's Global Impact
- As ESG investing expands, attention to land use and biodiversity issues grows. Shareholders can contribute to better management through engagement and voting initiatives, recognizing the impacts on the economy, food system, and climate. -
Ensuring Workplace Safety
Laura Lutton, Director of ESG Product Management
The Occupational Health and Safety Material ESG Issue (MEI) focuses on managing workplace hazards for employees and contractors, prioritizing safety measures.
Workplace health and safety lapses not only impact employees but also carry significant costs for businesses, as highlighted by studies like the 2020 Workplace Safety Index.
Evaluating Occupational Health and Safety Risks
- Morningstar Sustainalytics' ESG Risk Ratings assess occupational health and safety risks, combining inherent risks with those not addressed through systems and policies.The Covid-19 pandemic underscored the importance of prioritizing workplace health and safety. Morningstar Sustainalytics' ESG Risk Ratings helps investors identify companies equipped to manage these challenges effectively.
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Integrating ESG: Financial Sector Impact
Laura Lutton, Director of ESG Product Management
The ESG Integration – Financials Material ESG Issue (MEI) encompasses all ESG integration activities in financial institutions, spanning investments, lending, and product offerings.
Meeting Global Investment Goals
Initiatives to integrate ESG factors into finance are driven by global sustainability goals, requiring significant private capital investment.Evaluating Financial Sector ESG Risks
Morningstar Sustainalytics' ESG Risk Ratings assess ESG integration in financial institutions, considering business model risks and management practices.Regulators and stakeholders scrutinize companies' ESG efforts. Firms must integrate ESG considerations into business models and products while supporting clients in responsible investment practices.
Using Morningstar Sustainalytics' ESG Risk Ratings, investors can identify companies managing ESG integration risks effectively.
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Prioritizing Product Quality and Safety
Laura Lutton, Director of ESG Product Management
The Product Governance Material ESG Issue (MEI) focuses on how companies manage risks related to product quality, service safety, and responsible marketing.
Maintaining Customer Trust
- Ensuring product safety and reliability is critical for customer satisfaction and long-term profitability. Active oversight demands access to reliable data and collaboration across the business.Evaluating Product Governance Risks
- Morningstar Sustainalytics' ESG Risk Ratings assess product governance risks, combining inherent risks with those not actively managed due to lacking programs and policies.As awareness of product governance risks grows, companies face increased scrutiny. Morningstar Sustainalytics' ESG Risk Ratings help investors identify companies managing these risks effectively.
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Building Financial Resilience
Laura Lutton, Director of ESG Product Management
The Resilience Material ESG Issue (MEI) emphasizes financial stability and risk management in the financial services industry, particularly focusing on compliance with capital requirements.
The Legacy of the 2008 Financial Crisis
- Financial institutions must ensure resilience to avoid external costs to society in the event of bailouts funded by taxpayers.Regulators have strengthened global capital and liquidity standards post-2008 crisis, examining capital buffers amid ongoing challenges like the Covid-19 pandemic.
Evaluating Risk Management Practices
- Morningstar Sustainalytics' ESG Risk Ratings evaluates both inherent risks and management practices related to systemic risk management and capital adequacy.Regulatory changes post-2008 crisis highlight the importance of bank resilience. Utilizing our ESG Risk Ratings framework, investors can identify companies managing these risks effectively.
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Efficient Raw Material Use: A Key Environmental Focus
Laura Lutton, Director of ESG Product Management
The Raw Material Use Material ESG Issue (MEI) focuses on a company's efficient utilization of raw material inputs (excluding energy and petroleum-based products) in production, along with the effective management of associated risks.
The Growing Importance of Raw Material Use: A Key Component in Decarbonization
- The demand for raw materials is set to nearly double by 2050 due to population growth, rising living standards, and the low-carbon transition that will see widespread and increasing use of low-carbon technology. While physical scarcity serves as the upper limit of raw materials availability, accessibility issues related to the unequal spread of raw materials across countries and high cumulative demand for raw material inputs are becoming more prevalent.
Although global market trade in commodities can overcome availability issues for raw materials that cannot be sourced locally, it also introduces a slew of factors that heighten environmental, social and corporate governance (ESG) risks.Subpar sovereign governance practices (bribery and corruption) and geopolitical tension (trade disputes, export bans or conflict) provide another dimension of risk, particularly where raw materials are supplied by only a few commodity-producing nations.
Transparent and responsible production of raw material inputs is essential to de-risk investments.
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Water Scarcity and Sustainable Usage
Laura Lutton, Director of ESG Product Management
The Water Use – Supply Chain Material ESG Issue (MEI) focuses on how companies utilize water and manage associated risks within their production processes and supply chains. The sustainable utilization of freshwater, a finite natural resource, gains significance amidst escalating global water scarcity. Projections from the United Nations warn of a potential 40% water deficit by 2030.
Identifying Risks: Factors Contributing to Water Vulnerabilities
Water risks predominantly arise from a company's reliance on water for internal processes and raw material production. Sectors such as mining, agriculture, and semiconductor manufacturing exhibit heightened water intensity.Navigating Geography: Contextualizing Water Risks
Assessing a company's water risks necessitates consideration of its facility and supplier locations. Factors influencing water availability encompass water reserve presence, permit requirements, water network quality, and local water demands.Hotspots of Concern: Focusing on Water-Stressed Regions
Particular attention is warranted for companies operating in water-stressed areas like portions of Chile, the United States, and Australia, where water scarcity exacerbates risks.Stewardship Strategies: Mitigating Water-Related Risks
Companies committed to water stewardship are better equipped to mitigate water risks. Embracing an adaptive business model entails water risk assessments, supplier and community engagement, and the implementation of water recycling systems.