Sustainability analysis Material risk involvement program works with more than 320 companies in approximately 30 different industries around the world. In 68% of our engagements, product governance is a key material ESG issue, but in our experience most companies underestimate the materiality of this risk to investors. For some sectors, product governance represents on average more than 20% of exposure to ESG risks, as identified within our ESG risk assessment framework. Moreover, as shown in Figure 1, this problem represents an even larger share of the management gap for almost all industries, reflecting relatively weak management of product governance risks. Product Governance remains one of the most under-appreciated ESG issues across all industries, despite the significant risk it poses to companies.
Product governance focuses on managing the risks to a company’s customers when using its products or services. Another product-related topic, E&S Impact of Products and Services, is about the social and environmental impact of a company’s products and services. Product quality and safety are certainly important parts of product governance, but the consequences can be significant for many sectors. Looking at the financial sector, for example, product governance focuses on responsible marketing and ensuring customer suitability to prevent misconduct, including discriminatory lending practices, predatory lending, misleading investors through poor disclosure and illegal foreclosure practices.
- For automobiles, it includes the integrity and accuracy of companies’ product claims (including the marketing of safety performance and fuel economy levels) and the sales practices of companies’ financing services.
- For pharmaceuticals, this includes informing customers or responding to complaints about unexpected side effects.
Given the materiality of these issues, product governance should be a critical consideration for companies disclosing ESG information. Poor management of product-related risks can have an immediate impact on sales and reputation and lead to huge fines.
Below, we dive deeper into the automotive and financial companies to share some insight from our engagement experiences with companies in these sectors.
Automakers show progress
The Volkswagen “Dieselgate” scandal that surfaced in 2015 continues the lawsuits and we have seen a negative impact on the brand. In 2020, Volkswagen admitted that the scandal had cost 31.3 billion euros in fines and settlements. The problem prompted the auto industry to review its fuel efficiency calculation practices, resulting in more realistic and comparable measures for consumers.
We’re talking to eleven of the world’s largest automakers and looking at product management that goes beyond fuel efficiency. The sector is under intense competitive pressure, combined with increased expectations from regulators and consumers to decarbonize products and production. This creates a focus on innovation, and companies are rapidly releasing new models. Combined with the growing technological complexity of vehicles, this increases the risk of incidents related to product quality and safety.
Investors need to have insight into companies’ performance in controlling product quality and mitigating safety risks. Yet until now, it has been the exception rather than the rule for automakers to make public statistics about product incidents and recalls. Major incidents or recalls are often disclosed in separate announcements, making it difficult to gain consistent insight into a company’s overall performance over an entire year.
Sustainalytics has been working on these issues and we have seen much better disclosures about product incidents and recalls from Hyundai and Kia. Both companies also recognize the need to improve product quality to reduce the number of product incidents and recalls, which directly add costs and damage the customer experience and the brand overall.
Our research shows that North American automotive companies have a larger management gap in product governance than in Europe and APAC (Figure 2). Note that product-related incidents from our research widen the management gap, so even if North America has better product and service safety programs than the APAC region, the management gap is larger on average. There is significant potential for more consistent quality management practices and more coherent product safety programs.
Financial services – beyond customer experience
For financial companies, including banks, insurers and diversified financial institutions, product governance goes beyond customer experience and satisfaction. Marketing and customer suitability misconduct, such as discriminatory lending practices, predatory lending, misleading investors through poor disclosure and illegal foreclosure practices, has resulted in significant operational and reputational damage, as well as costly fines.
For example, some of the world’s largest banks have been involved in customer-related investigations and lawsuits related to misrepresenting the risks of mortgage-backed securities, misleading IPO statements, and charging improper fees. The settlements of these investigations and lawsuits have cost the banks billions. Credit Suisse has reached legal settlements totaling more than $5 billion to date and is facing further litigation, which could increase the legal and financial risks associated with the Mozambican bond controversy.
Best practices to manage these risks include:
- Having a clear governance structure to oversee responsible product offering issues,
- Conducting risk assessments of new products and services to verify that they meet consumer needs before they are launched,
- Continuous monitoring of the social impact and risks of existing products and services, and
- Provide regular training for employees on responsible product offering and marketing.
Our research (Figure 3) shows that European financial companies have historically tended to outperform North America and APAC in product stewardship, in part because they demonstrate stronger programs for offering responsible products. However, APAC financial companies have recently been involved in fewer product quality controversies than their European and North American counterparts. This could be due to stricter financial regulations in many APAC countries.
From an engagement perspective, we work with financial companies to holistically integrate ESG into their operations, from risk assessment to product design and risk management. We encourage commercial banks to adopt the Principles for Responsible Banking initiative as a relevant reference point and network to apply best practices. We encourage alignment and participation in the Responsible Investment Principles for financial companies involved in asset management. Combined with ESG integration, financial companies need a robust code of conduct that addresses ethical issues related to products and customer management.
To view our latest Material Risk Engagement Report, email our team at [email protected].