Responsible Investment Solutions For professional and qualified investors only ESG Viewpoint September 2017 Brazil corruption – many ways to wash a car Key summary Ongoing investigations into large scale corruption in Brazil continues to cause political and economic instability BHP Billiton and Vale’s remediation efforts to address the 2015 Samarco mining accident are complicated by a crisis of legitimacy Matthias Beer Progress in corporate efforts to strengthen compliance systems and culture Associate Director Governance and Sustainable Investment are hampered by ongoing political crisis Background Contact Us In June, we participated in a field trip to Brazil organised by mining company bmogam.com/responsible-investing BHP Billiton (‘BHP’). The purpose was to get a first-hand insight into developments in relation to the 2015 Samarco accident when the collapse of a Institutional business: major mine tailings dam resulted in one of Brazil biggest environmental +44 (0)20 7011 4444 disasters.1 We also took the opportunity to meet with other Brazilian companies, including Vale, Petrobras, CRR and Ultrapar. [email protected] Discretionary Sales During the entire trip - whether we talked to mining employees or residents in the Samarco region, or corporate employees in offices in Sao Paolo and Rio de +44 (0)20 7011 4444 Janeiro - discussions typically referred to the impact of the ongoing political [email protected] turmoil and corruption investigations in Brazil. With many political and corporate UK Adviser Sales leaders being implicated by these investigations, including two former presidents (Lula and Dilma Rousseff) and the current president Michel Temer, the country’s 0800 085 0383 political and corporate institutions are facing a fundamental crisis of legitimacy. [email protected] The corruption investigation dubbed “Operation Car Wash”, which was launched in 2014, has brought to light systemic bribery and corruption practices. This has involved dozens of politicians across all major parties as well as senior executives of major corporations, such as oil giant Petrobras, construction company Odebrecht, and more recently the world’s largest meat packaging company JBS. Corruption investigations have spread across borders, heightening political risks across the region. In this Viewpoint, we highlight how this crisis of political and corporate legitimacy is underpinning many of the key, material ESG themes we have been discussing during our time in Brazil. 1 The released tailings created a mudflow that destroyed two villages, killed at least 17 people and polluted over 400 miles of rivers. Page 2 For professional investors only Yet we also highlight ongoing implementation challenges Samarco field trip that are fuelled by the broader political crisis affecting Brazil. Samarco Mineracao SA (‘Samarco SA’) is an Key points in our assessment of BHP’s response to the independently-operated 50/50 joint venture between Anglo- Samarco accident include: Australian miner BHP Billiton and Brazilian Vale. It was Renova governance: We noted positively that senior forced to shut down operations immediately following the BHP and Vale staff occupy dedicated roles within the 2015 tailings dam collapse. Investors which held the shares Renova Foundation which manages the implementation and bonds of BHP Billiton and Vale were impacted. of a comprehensive environmental and social Samarco SA’s own corporate bonds defaulted. remediation programme. The foundation has a total Since the incident, the two joint-venture companies have budget of $1.6 billion over three years. This is split made concerted efforts to remediate the damage while between environmental and socio-economic aiming to mitigate the financial impacts and rebuild their own remediation projects. Given the scale and complexity of reputation. No date has been set for a possible restart of these activities we stressed the importance of external Samarco SA's operations, as this remains dependant on governance mechanisms designed to provide robust economic viability as well as regulatory approval, which independent oversight. We welcomed in particular the 2 takes into account factors such as operational safety and establishment of an IUCN Panel to ensure independent community support. validation of Renova’s objectives and deliverables. Building and maintaining legitimacy among the wider In March 2016, after a relatively short period of negotiations, population in Brazil is a key challenge for Renova, in a the two companies agreed with government authorities, situation where BHP, Vale and Samarco SA have been under then President Rousseff, to pay up to $5.6 billion to criticised as colluding with the government to arrive at fund a foundation scheme called Renova. This was set up to the TTAC settlement that falls short of popular restore the local environment devastated by the flood and expectations. We encouraged BHP and Vale to pay compensation to the people affected. In addition, illustrate positive impact on the ground from the independent federal prosecutors filed a $44 billion lawsuit remediation programmes and in the understanding that for social, environmental and economic compensation. such examples of good work can help overcome these This federal prosecutors’ lawsuit has in many ways been an legitimacy challenges. expression of popular distrust in the government and Federal prosecutors’ settlement: We remain companies involved. It is alleged that former President concerned that the final agreement target for October Rousseff strove to present a quick success story in 2017, while satisfactory from a legal perspective, may achieving the initial so called TTAC settlement to ward off still lack sufficient popular support. One of the key mounting pressure coming from corruption investigations at demands BHP and Vale have been confronted with is the time. Although the subsequent federal prosecutor’s the involvement of more robust local stakeholder lawsuit set a much higher financial penalty, it is widely representation at Renova, including at Board level. We expected that the final amount of the settlement will come recognise the challenge for the Foundation to balance down significantly. Yet ongoing uncertainty around the final the need for adequate stakeholder representation with financial bill have weighed on the company’s valuation and the ability to maintain effective decision-making fed into popular scepticism about the adequacy of the capability. We also urged the companies to consider company’s remediation efforts. The final date for entering an options for expanding Renova’s current governance agreement on this second settlement has been set for the framework to elevate the participation of local end of October 2017. stakeholder perspectives. Independent of the amount of We spent three days with BHP in the Samarco region and the final settlement, building legitimacy must be a key had opportunities to meet with representatives from the objective of Renova in order to ensure that the funding Renova Foundation, Samarco SA employees and and delivery of its programs leads to sustainable representatives of communities affected by the accident. positive outcomes. Overall, we gained positive impressions on the progress Long-term environmental impacts: The insights we achieved in terms of the level of management attention and gained on the trip have given us confidence that the resourcing BHP has committed to addressing the fallout of approach taken on environmental remediation so far the incident. has been comprehensive and credible. We encouraged 2 The International Union for Conservation of Nature (IUCN) is an organisation working in the field of nature conservation and influential and widely recognised independent international sustainable use of natural resources. Page 3 For professional investors only the use of the precautionary principle to factor in potential uncertainties around long-term impacts on eco-systems. The involvement of independent bodies “Today Brazil is undergoing three crises: one of such as the IUCN could provide a particularly important view on addressing outstanding questions. These ethics, one of politics and one of economics” concern scepticism around their assessments of long- Rodrigo Janot, Brazil's Prosecutor General term environmental impacts as well as the extent to which remaining tailings in the river system need to be removed or can be left in place. We asked for robust transparency around the implementation of eventual IUCN Panel recommendations in this context. Of the 86 companies that had fiscal council representatives Bribery and corruption risks: Although we do not see proposed by minority shareholders, 78 companies had at any obvious concerns with Renova’s compliance least one minority representative elected to the board. controls, there is still a need to clarify the nature of disclosure stakeholders can expect around independent Other developments include a review of the listings verification for the use of proceeds and impact on end regulations for the highest corporate governance segments, beneficiaries. Given the scope of Renova’s budget, the the Novo Mercado. The majority of Novo Mercado risk of abuse is obvious in light of the systemic companies approved additional rules such as requirements corruption that has blighted the Brazilian establishment to conduct board evaluation. However, they voted down in recent years. Renova faces the challenge of other items such as enhanced standardised reporting