Investment Research Metals & Mining Brazil’s Dam Collapse Underscores Need for Improved Safety Standards Alistair Godrich, Director, Research Analyst Lada Emelianova , Senior Vice President, Research Analyst Jennifer Anderson and Nikita Singhal, Senior Vice Presidents, Co-Heads of Sustainable Investment and ESG The collapse of a Brazilian dam owned and operated by Vale earlier this year has increased scrutiny of safety standards across the mining sector. The collapse near Brumadinho killed at least 160 people and is the second deadly dam failure in Brazil in the past five years. Lazard, like other investors, considers self-reported safety statistics and external audits completed by company- selected specialists to determine whether a company’s mining is safe and responsible. We have also had a series of meetings with mining companies since this tragedy. We have concluded that the mining industry needs improved global audit standards, alongside particular acknowledgement of the danger presented by upstream tailings dams. We believe that establishing global standards in mining practices and putting safety performance at the centre of companies’ remuneration policies are critical to prevent humanitarian disasters, address environmental risks, and protect shareholder value, especially over the long term. As we discuss below, our proxy voting and guidance will support efforts to establish an appropriate focus on long-term safety, thereby also enhancing shareholder value creation. LR31492 2 A Systemic Safety Challenge Establishing Global Standards The dam collapse near the town of Brumadinho, Brazil on 25 The failings of the Samarco and Brumadinho dams highlight January 2019 was caused by the failure of an upstream tailings the specific risks posed by the practice of storing wet mining dam. The Brumadinho disaster marked the second industrial tailings, but the mining industry has faced a number of safety accident involving a tailings dam in Brazil in the last five years. challenges in recent years. In 2017, there were a total of 219 coal In 2015, a burst dam at the Samarco mine killed 17 people, and mine accidents in China, causing 375 deaths.4 In February 2019, Vale, and co-owner BHP, are still in negotiations relating to a Glencore announced that a truck belonging to a contractor was lawsuit of approximately $41.5 billion (155 billion BRL)1. The involved in an accident that caused the death of 20 people.5 incident in Brumadinho resulted in a mudslide that killed at Meanwhile, the collapse at Brumadinho occurred despite Vale least 160 people, including mine workers and local residents.2 stating as recently as December 2018 that all of its dams had Meanwhile, the equivalent of 5,500 Olympic swimming passed a semi annual external audit.6 At the industry level, we pools of mining waste spilled into the surrounding area, the believe a more independent oversight of safety—e.g., for tailings environmental impact of which is yet to be fully understood. dams—and the establishment of a global standard are necessary. Currently, individual countries are responsible for setting their What Is a Tailings Dam? own safety standards. Brazil is now looking to decommission all More than 80 dams in Brazil are built like those at Samarco and upstream tailings dams, joining Chile and Peru. Vale announced Brumadinho. A tailings dam is an artificial reservoir designed to store wet that it intends to decommission all upstream dams over the by-products of the mining process, i.e., tailings. Tailings are stored as slurries—typically above ground—rather than released to the water table next three years at a cost of $1.3 billion (5 billion BRL), while as they contain metal residues and processing chemicals. ArcelorMittal stated that it aims to halt the construction of new An upstream dam is created by the tailings themselves as their edges mines using wet tailings from 2024. At the industry level, the harden to produce walls. The wall grows in increments, built on top of International Council on Mining & Metals (ICMM)—a body previously hardened tailings. Upstream dams seemingly carry a higher risk of failure, particularly in wet weather areas. The structural integrity tasked with improving sustainable development performance of the wall depends on low moisture content within the tailings that form the wall, placing added importance on the proper removal and in the mining and metals industry—announced plans to review recycling of water in the tailings themselves. As such, an upstream dam global best practices by the end of 2019, following growing calls is deemed to be most suitable for facilities in areas with low rainfall, low seismic activity, and relatively flat terrain.3 from a number of mining companies for the creation of a global independent regulator to monitor the safety of tailings dams. It is Downstream dams grow with the wall being reinforced on the down- stream section of the dam. This normally requires more material and is hoped that this review will lead to the creation of a classification therefore costlier than an upstream dam. A centreline dam is a mix of system and independent reviews of tailings dams. both of these methods as it builds the wall up using the tailings in the dam, like it does in upstream dams, but also involves reinforcement of the downstream side of the wall. The centreline therefore rises vertically. Downstream and centreline dams (see Sidebar: What Is a Tailings Dam?) are typically more expensive, which will likely Upstream bring extra costs to those companies that need to replace their upstream dams or for those looking at new dams with new mine Wall Increase Upstream production. While tighter safety standards would likely increase Tailings operating costs, all the major miners we engaged with expected this to be manageable at prevailing commodity prices, including that of iron ore, which has strengthened considerably following the significant loss of output since the Brumadinho disaster (see Sidebar: Impact on Iron Ore Prices). Downstream Wall Increase While higher iron ore prices could support some companies in Downstream funding additional regulatory costs, should they be sustained, we believe that companies with safe storage methods and well- Tailings invested assets are better positioned over the medium term. On the other hand, assets that are under invested or with poor storage methods will face substantial extra costs as safety standards tighten. Over the longer term, the risk remains that investors increasingly Centreline shun the mining sector because of its relatively poor track record Wall Increase Up Centreline in mitigating its safety, environmental, and societal impact. This would imply a higher cost of finance and lower earnings Tailings multiples, and a reduction in shareholder value that would likely exceed the cost of meeting tighter safety regulations. In addition, failure to meet safety standards could result in fines and other penalties, more stringent regulatory checks, and an inability to Source: Rio Tinto attract employees or to win new mining concessions. 3 Aligning Safety Performance with Impact on Iron Ore Prices Remuneration Capacity for about 70 million tonnes of annual Brazilian iron ore production In addition to establishing global safety standards and oversight, (of a total 1.5 billion tonnes of global production per annum) has been shut down as the safety of tailings dams undergoes a series of checks. we believe management compensation could be an effective lever to help address risks. While safety measures are included in the Lost Production Has Led to a Steep Rise in Iron Ore Prices short-term compensation frameworks for the CEOs of Anglo ($/Tonne) American, BHP, and Rio Tinto, safety targets within long-term 100 incentive plans are notably lacking (Exhibit 1). The weighting of safety in mining companies’ short-term incentive plans, and its contribution to overall remuneration, is, in our view, insufficient 90 given that the companies have such high risk exposure. Lazard’s Response to the Brumadinho 80 Disaster We have had a series of meetings and discussions with the 70 management of mining companies since Brumadinho, focusing on tailings dams specifically, as well as broader mining safety issues. We have interacted with Vale, ArcelorMittal, BHP 60 Jan 18 Mar 18 May 18 Jul 18 Sep 18 Nov 18 Jan 19 Mar 19 Billiton, Anglo American, Ferrexpo, Kaz Minerals, Glencore, Alrosa, Grupo Mexico, Ternium, and Rio Tinto. As of 19 March 2019 Source: FactSet We strongly believe that the mining industry should improve the safety of its operations and we also plan to engage with the ICMM to exert our influence where possible to help facilitate the creation of an independent review system for monitoring the safety Our Ongoing Commitment to ESG of tailings dams. Additionally, we recognise that improved safety within the mining industry requires greater focus on incentive Active engagement with companies across all sectors remains frameworks and remuneration policies. a key investment principle at Lazard. Our recent discussions In order to ensure that management is appropriately aligned and with management in the mining industry have: incentivised with these goals we will make recommendations • Further informed our assessments of the most pressing to the remuneration committees of mining companies to help challenges and sustainability issues facing the sector them develop structures that we believe establish an appropriate • Enabled us to better reflect the cost and benefit of focus on long-term operational