Companies are under intense pressure to improve their environmental, social, and governance (ESG) performance. To date, the lion’s share of management scrutiny and investor activism has focused on wholly-owned or controlled entities.
But this worldview contains a sizable blind spot. Many companies hold large and growing portfolios of joint ventures, many of which are equally-owned or non-controlled entities. These ventures often materially contribute to a firm’s actual ESG profile and risks. And yet such ventures have been widely omitted from company reporting and commitments related to safety, emissions, human rights, community engagement, and other ESG-related parameters.
Pressure is building for this to change, quickly. Companies will need to act as investors, regulators, and other external stakeholders are beginning to turn their gaze to joint ventures as an asset class.
Increasing Scrutiny on JVs and ESG
Many companies hold interests in scores of joint ventures. Global energy companies like Shell, ExxonMobil, BP, and TotalEnergies have economic interests in hundreds of JVs around the world, often with more than half of which they do not operate. In mining, JVs account for more than 40% of the current production at the 10 largest mines in the world for numerous commodities, including bauxite, coal, cobalt, copper, diamonds, gold, lithium, and nickel. Outside natural resources, Siemens has more than 100 joint ventures, SABIC is a partner in more than 40 JVs, while Lockheed Martin, Nestle, and Walt Disney hold a dozen or more such ventures. For many companies, JVs employ thousands of people, generate significant direct and indirect carbon emissions and, especially for ventures operating in less developed countries, introduce significant human rights risks.
External stakeholders are waking up to the reality that most non-controlled JVs have been excluded from ESG reporting. For instance, the Environmental Defense Fund and Rockefeller Asset Management sounded an alarm that most international energy companies fail to report methane emissions from their non-controlled JVs, creating an “emission omission.” This gap will be partly addressed in the U.S. with the Securities and Exchange Commission newly proposed climate-disclosure rules that will require public companies to include their equity share of emissions from most joint ventures they do not control. As of today, our analysis of 30 large public companies in the energy, mining, and chemicals sectors shows that less than 20% provide any ESG reporting with regard to their non-controlled ventures. And when companies do provide reporting, it is often spotty, covering a single ESG metric.
In Europe, regulators have proposed mandatory human rights and environmental due diligence rules that will apply to a company’s own operations, as well as its established business relationships, likely including a firm’s joint ventures. Meanwhile, Human Rights Watch and other advocacy groups are paying more attention to the human rights performance of joint ventures, holding non-controlling partners to account for violations and pressing these firms to elevate their games. Demands for greater transparency on other ESG topics are likely to follow.
Companies also need to live up to their own commitments. Most public companies have published codes of conduct that define their fundamental operating principles. These codes often include self-imposed obligations to encourage the company’s joint ventures, minority investments, suppliers, and business partners to adopt similar principles and standards. If companies are not, in fact, engaging with their JVs and partners to ensure responsible practices with respect to safety, environment, human rights, and local communities, they are violating their own codes of conduct.
Three Levers to Pull
Companies that are serious about elevating ESG performance across their JVs have three primary levers to pull: partner due diligence, contractual rights and protections, and post-close governance and management practices. Effectively pulling each lever will demand companies to make important changes to their traditional ways of doing business.
Partner Due Diligence.
Done well, partner due diligence informs whether and how to enter into a JV. Such diligence drives firms to avoid new JVs with intolerable ESG risks or to structure the transaction in ways that strongly mitigate those risks. This requires companies to embrace fuller environmental impact assessments and deeper investigations of past human rights abuses, local community disputes, treatment of migrant and contract workers, conflicting land claims, and the human rights records of relevant security forces, paramilitaries, and law enforcement – and to demonstrate a willingness to walk away based on what they find.
Contractual Terms.
Contractual terms can protect both the company entering into the JV and the rights of people working for or living near it. But our analysis of more than 80 joint venture legal agreements from the oil and gas, mining, and chemical sectors shows that most agreements provide very few rights or protections for non-controlling partners on environmental, human rights, and community engagement matters. For instance, among mining industry JVs, we found that only 29% of the agreements included any provisions that explicitly referenced either human rights or community engagement — and those that did rarely addressed the topic in depth. There are also serious gaps regarding environmental provisions, as agreements rarely establish explicit environmental standards for JV operations, define clear restrictions on certain types of greenhouse gas emissions, or set minimum requirements for environmental performance and risk reporting to the shareholders.
Some companies are working to address this gap. In the mining industry, Alcoa, Anglo American, and Vale have been reexamining their approach to joint venture legal agreements and developing more robust corporate guidance on what ESG-related terms they expect to see in those agreements, especially where they are a non-controlling or non-managing partner. More will need to follow.
Governance.
Companies will need to raise their game on JV governance. They must invest the time and resources to provide strong oversight of their JVs, ensuring appropriate JV management team focus on strong ESG performance and an orientation towards serving all community stakeholders, not just shareholders.
We have found that the governance of many joint ventures is deeply flawed. Our benchmarking of the governance practices of more than 100 large joint ventures shows substantial performance gaps. The median JV board director spends only 15 days per year fulfilling his or her oversight roles and serves on the board for only 30 months — far too little to gain real understanding of the JV’s operations and its ESG performance and risks. JV boards rarely have any directors with sustainability or other ESG-specific expertise. Similarly, JV boards spend half as much time together in a year compared to corporate boards (20 vs. 40 hours per year) and dedicate a lower percent of their time to strategy and other long-term topics, including ESG, compared to corporate boards. Adjusting the dials on these key board indicators is essential to driving performance improvement on ESG or other matters.
Additionally, companies need to dedicate more internal resources to drive ESG performance in their JVs. For instance, large mining companies dedicate a median team of 2.3 full time equivalent employees to oversee their largest non-controlled JVs, which leaves little bandwidth available to influence partners and JV management teams to better manage environment, human rights, and community engagement. Companies in the chemicals, industrials, aerospace and defense, automotive, and power sectors have even smaller shareholder governance teams.
A number of companies are starting to bring more rigor to the governance of their joint ventures, including governance of ESG. For example, BHP, Dow, and SABIC all have established clear internal accountabilities and expectations for the governance of their joint ventures, regularly conduct structured governance assessments, and periodically report to their corporate boards on the state of joint venture governance. They are in the minority. Few corporate boards even understand how many joint ventures their company has, let alone how well they are governed.
It’s time for more companies to take a closer look at the ESG performance and risks across their entire enterprise, including joint ventures and other entities in which they own a partial interest. The world will be watching.
Disclosure: The authors have advised a number of companies mentioned in this article.
This content was originally published here.