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TheLessons learned from the past – Mitigating environmental and social risks in Brazil’s resources sector

Our engagement on material ESG factors such as climate change, health and safety and labour rights has increased over the years and research is pointing towards a value-add in investment portfolios as a result of the integration of these factors.

Q3 2015

We have longstanding engagements with several Brazilian companies and have recently been on the ground to continue our dialogue.

Corruption scandal

A large corruption scandal involving government officials and one of the world’s largest companies – state-controlled energy company Petroleo Brasileiro (Petrobras) – engulfed Brazil in 2014 and 2015. Senior Petrobras officials that were appointed by political parties in the ruling coalition government are alleged to have been bribed by large construction firms in return for over-inflated contracts, which in turn are said to have helped fund political campaigns. The investigation into so-called Operation Car Wash (Lava Jato) has accused over 100 people of corruption, money laundering and other financial crimes, including many politicians.

Governance

Since the corruption allegations surfaced, Petrobras has been under pressure from the public, media and shareholders to get its house in order and has taken significant steps to improve its governance and compliance in an attempt to restore investor confidence. The company has appointed independent directors to its board to replace the previous government ministers, something we had long been pressing for in our engagement because we felt that the board had neither been fulfilling its oversight function nor challenging management. The appointees included an independent chair, the first non-government official to lead the board in 12 years, marking a sharp contrast in the board to that of the past.rnrnTogether with other shareholders, we were heavily involved in the selection of two minority shareholder representatives and were pleased that Petrobras published their names ahead of its AGM. We subsequently supported their successful election. Given their rich expertise, we believe these new shareholder-appointed directors will help raise the level of discussion and improve the decision-making on the board, thus increasing the chances of the company acting in the best interests of all its shareholders. The company also added independent members to its fiscal council, which is charged with overseeing audit issues. The new composition of the board and the relative ease with which we were able to nominate and ratify the minority shareholder representative director candidates indicate a meaningful shift in board composition and quality at Petrobras and a significant step towards its depoliticisation.rnrnFurthermore, to create a strong compliance function in the company, a chief compliance officer was appointed who has been tasked with putting in place a compliance programme. In our meeting with him, we examined the progress made since the creation of the compliance division in early 2015. Having pressed Petrobras to implement a robust compliance culture since the outset of the corruption scandal in 2014, we are pleased that a credible compliance programme has been devised and were assured that senior management and the board are committed to its speedy implementation although a change in culture – particularly in a company with 20,000 accredited suppliers and 86,000 employees – takes time to take effect. We will monitor the implementation closely to ensure that the reforms are effective and sustainable in the long term. We also offered examples and contacts of companies that underwent significant change of culture after being affected by corruption, to facilitate an exchange of best practice.

Public policy efforts

At the same time – albeit unrelated to the corruption scandal – pressure for good governance is increasing in the public policy sphere.rnrnThe fifth version of Brazil’s Corporate Governance Code is under review and expected to be published in the fourth quarter of 2015, which we addressed when meeting the organisation responsible for the code, the independent Brazilian Institute for Corporate Governance. While the code is voluntary, a discussion is underway to see whether the principle of one-share one-vote embedded in it could be made more flexible, given that it is common in Brazil to have two classes of shares – voting and non-voting shares – although only companies abiding by the one-share one-vote principle have recently been listed on Brazili’s stock exchanges. In our consultation response we reinforced our view in favour of one-share one-vote.rnrnMeanwhile, Brazil’s market regulator CVM has been debating enforcement of the country’s Corporate Governance Code via a comply- code will have to sufficiently explain their reasons for non-compliance. In addition, the BM&F Bovespa stock exchange has launched a public consultation for a voluntary code for state-controlled companies. If the draft is implemented, companies will be scored against a points systemfor good governance structures to obtain a seal of approval.rnrnThe Brazilian parliament is also discussing a draft bill aimed at statecontrolled companies, although many, such as the Association of Capital Market Investors AMEC, have come out against enforcement by law. The overwhelming opinion seems to be that Brazilian legislation is sufficient but that the problem lies with enforcement.

Dam constructions

The construction of the Belo Monte dam on the Xingu river in northern Brazil has been controversial and attracted strong criticism from NGOs, the media and the public. The consortium building the Belo Monte dam – Norte Energia – for example, had been accused of failing to obtain free, prior and informed consent from the indigenous tribes affected by that construction. Although Norte Energia significantly invested in the mitigation of environmental and social risks, communication with the stakeholders was not effective.rnrnWith new dams proposed to be built on the Tapajós river in the North of Brazil – again to provide Brazil’s growing population with clean energy – we visited Eletrobras, the company involved, to see whether any lessons had been learned from Belo Monte.rnrnAlthough any construction projects undertaken – especially as they typically take place in remote areas – will always have some impact on the environment or communities on the ground, in our engagement with companies we urge them to minimise that impact and the associated risks by putting in place appropriate mitigation measures. In the past, projects had a severe impact on their locations, for example by requiring big reservoirs, flooding of a significant area and a large number of workers. More recent projects have managed this more carefully. Equipment was typically transported to the construction site on purpose-built roads. Now, to minimise environmental and social impacts, the materials are moved to the site by river barges whenever possible. Furthermore, although the construction schedule for the dams in the Tapajós river depends on many factors – such as a period of consultation by the government – Eletrobras has already been engaging intensively with local communities on the developments and informing them about the dams and hydroelectric power plants, which included the preparation of communication materials to indigenous communities in their own language. A preliminary environmental impact assessment has been submitted to the authorities and was met with criticism from some NGOs.rnrnUnlike in the past, a new town will not be purpose-built in the area to accommodate employees and their families. Workers will instead be required to live at buildings on the construction site by themselves, preferably in the area to be flooded post-construction when the reservoir is formed, thereby affecting a much smaller amount of land.rnrnIn addition, this time a population of only 800 is expected having to be relocated, a significantly lower number than at the Belo Monte project. Eletrobras acknowledged that it could improve its communications with stakeholders. It has enhanced disclosure in its 2014 sustainability report, particularly in terms of environmental and social indicators by following the 3.1 guidelines set by the Global Reporting Initiative (GRI). It told us that the 2015 sustainability report, to be published in early 2016, will follow GRI 4 and include targets for greenhouse gas emissions and water consumption for the following five yearsrnrnAfter expressing concern about disclosure and reporting in previous engagements, we were pleased to see the progress made.rnrnWe pressed Eletrobras’ environmental and social risk team to adopt best practices in its relationship with the communities affected by the project and in the reporting of performance. The company has established an environmental and social risk committee aimed at sharing best practice. Furthermore, Eletrobras has attempted to be transparent by disclosing any action it takes to stakeholders, something we continue to strongly encourage.

Disaster preparedness

Overall, a lot of work has been undertaken by Brazilian companies on environmental issues and disaster preparedness. We were assured that Petrobras has taken extra measures to make its disaster response more effective, as a result of the lessons learned from two big accidents it incurred in 2000, BP’s 2010 Macondo spill in the Gulf of Mexico and the increased complexity of its new deep water fields. In addition to its large in-house capabilities, upgrading and investing in safety measures to mitigate the risk of oil spills,rnrnPetrobras joined the Oil Spill Response and Subsea Well Response projects, together with eight other international oil companies, which have invested in intervention equipment that can be deployed around the world. This includes four capping stacks – the equipment that ultimately stopped the Macondo spill and one of which is located in Brazil – three containment toolkits – again one of which is based in Brazil – and a stock of dispersants. Petrobras’ own structure is equally robust, with a 500-strong response team based in 25 cities, equipped with barriers and dispersants ready to be dispatched during any accidents. In addition, it has 40 oil spill response vessels to cover its offshore platforms. Given the scale of its oil and gas production and deep water construction vessels in the country, these measures are crucial. The company has not had any major spills since 2000 and incurred 32 small spills, amounting to 437 barrels only, in 2014.rnrnIn a meeting with Petrobras’ environmental and climate change team, we challenged the company’s strategy towards the possible impact of climate change in its operations and pressed for greater transparency and better reporting. We were pleased with the various initiatives aimed at reducing flaring, greenhouse gas and other atmospheric emissions, and at increasing energy efficiency. Petrobras has also improved the quality of its reporting of environmental indicators, which has been an importantrnrnitem on our engagement agenda with the company. It has started a detailed mapping of climate change scenarios across the various regions of Brazil. As the work is in its early stages, we agreed to monitor progress, particularly the adaptation and mitigation actions that may result from it, and to convey to the board the need to ensure there are enough resources allocated to the project, given its budget constraints.rnrnAs companies have to make cuts in the wake of falling commodity prices, we continue to seek to ensure that their environmental and social risk management is not compromised. Despite the pressure they are under, we have gained a sense of commitment to good risk management practices from Brazilian companies.

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