Semiconductors are vital materials found in many technological devices that have become an integral part of the global economy. Artificial intelligence (AI), the Internet of Things technology (IoT), and the electrification of the economy all require a growing number of semiconductors. The semiconductor industry relies on deep global supply chains and access to overseas markets. Currently, the US designs 60% of global microprocessors and other logic chips, whilst global production is highly concentrated in East Asia – mainly Taiwan and South Korea. Both the US and China are engaged in an arms race to control the regionally fragmented supply chain as they both understand its geopolitical significance. Given these developments, the semiconductor industry is susceptible to both major sustainability risks and opportunities. The industry faces three major ESG risks related to climate change, human capital, and intellectual property. This report will examine each of these risks and provide risk mitigation recommendations.

Environmental Risk: Climate change-related disruptions

Similar to many other industries, the semiconductor industry faces risks associated with climate change. The increased frequency of climate change-related events, such as extreme droughts or major floodings, are a major threat to the supply of components, due to the geographical concentration of production and the highly water-intensive production process. Water is a vital input in the manufacturing process as semiconductor fabrication plants (fabs) rely on ultra-pure water (UPW) for production, and as technologies grow more complex, water demand will increase. The semiconductor industry consumes an estimated 264 billion gallons of water per year and individual fabs use tens of millions of gallons of water per day, primarily using the water to cool down equipment and clean silicon wafers. Many centres for semiconductor manufacturing lie in regions of high-water stress. For example, fabs in Singapore, Taiwan, China and South Korea are situated in high water stress areas. This poses a major operational risk to the semiconductor industry as droughts, made more frequent by climate change, will cause major disruptions in the supply chain.

This risk is becoming increasingly visible as an increased number of companies are exposed to water stresses, causing global supply disruptions. The Taiwan Semiconductor Manufacturing Company (TSMC) which produces over 90% of the world's most advanced chips reported that it consumes 99,000 tons of water per day in production. Hence, their production process is extremely vulnerable to water shortages. These vulnerabilities were exposed in the summer of 2021 when Taiwan experienced severe droughts. TSMC’s output was severely reduced due to less water supply for chip manufacturing and a reduced power supply from hydroelectric power. Such droughts and power outages significantly reduce manufacturing capacity. UPW is needed to clean the silicon wafers used in microprocessors and chips must be produced in clean rooms with stable temperatures and pure air. Thus, with water demand expected to double from 1.6 to 3.2 billion litres per day by 2060, alongside predictions of more intense climate-related disruptions in coming years as the world warms, there is an urgent need to implement solutions within microchip production to mitigate the risks of climate-induced water stresses, to meet the growing global demand.

Recommendations:

To mitigate the risk of increased water stresses caused by climate change, semiconductor companies should undertake due diligence on the location of fabs when expanding production capacity. They should avoid expanding into arid or drought-prone regions where their operations could risk placing further strain on an already precarious water supply. Semiconductor companies can also manage water consumption, by increasing water efficiency and reducing water demand. Companies can maximise water efficiency by categorising the water quality and assigning priority to its uses in the manufacturing process. This enables companies to raise the water quality to UPW levels only when it is required, with the highest quality to be purified for use in manufacturing and inferior water quality to be treated and used for non-production purposes, thereby maximising the efficient use of its water resources. Furthermore, to reduce water demand, chip manufacturers and foundries should increase their recycling and reuse of water. They can follow the proactive approach undertaken by water fabrication plants in Singapore which practice forms of water recycling. In 2018, they recorded recycling rates ranging from 23% to 65%, with an industry average of 45%. Focusing on both location and water management are key risk mitigation strategies which reduce the risk posed by climate change-related risks to the industry.

Social Risk: Human capital shortage

Another increasingly prominent risk facing the semiconductor industry is related to human capital. With intense competition from other technology firms, semiconductor companies are finding it increasingly difficult to attract and retain personnel. In 2021, there were an estimated 2 million direct semiconductor employees worldwide, which will need to increase by more than 1 million additional skilled workers by 2030. Yet, there is a major human capital shortage, particularly in manufacturing, that threatens to stand in the way of meeting global demand.

The talent shortage in semiconductor manufacturing is a global phenomenon, affecting smaller producers in Europe and the leading-edge producers in Taiwan and South Korea. However, these shortages vary in severity across countries. For example, despite Taiwan possessing the most advanced global semiconductor manufacturing facilities, it had 34,000 vacancies for chip industry positions in December 2021, representing a 77% increase over two years. Similarly, South Korea’s semiconductor industry is forecasted to experience a shortage of at least 30,000 skilled workers in the next decade, with domestic universities producing less than half the number of relevant graduates required. Japan’s major semiconductor manufacturers have also warned the Japanese government that the country’s shortage of skilled workers is threatening efforts to revive its domestic semiconductor industry, with an estimated 35,000 engineers required in the next 10 years. Likewise, China also has an extreme shortage of skilled semiconductor workers, estimated at 200,000 industry workers, which acts as a major barrier to developing its domestic chip production capabilities. As part of the Made in China 2025 agenda, Chinese legislators have implemented a 1-5-3 recruiting strategy, whereby South Korean semiconductor industry veterans and new college graduates are offered five times the salary in exchange for a three-year commitment to work in China. Europe also suffers from a shortage of skilled workers in the semiconductor industry which has widened over the past two years. In 2022, Henryk Schoder, the European semiconductor executive, argued that “the talent shortage is the biggest challenge to semiconductor industry growth in Europe”. Finally, the talent shortage in the U.S. semiconductor industry is forecasted to reach 70,000 to 90,000 workers over the next few years with skill shortages. Whilst the US CHIPS for America Act provides $52 billion in grants for semiconductor manufacturing and research it does not address the continuing shortages of talent.

Recommendations:

Semiconductor companies can deploy two key strategies to mitigate the risk presented by the shortages in human capital in the semiconductor industry.

Firstly, semiconductor companies could improve upon their techniques in identifying, and developing future skills across the engineering and manufacturing workforce by partnering with universities and engineering schools. The Taiwanese government and local chip manufacturers have invested at least $300 million in graduate school programs aimed at the semiconductor industry. Similarly, in the ongoing technology competition with China, the U.S. has passed the USICA bill that provides $9.57 billion for university technology centres and innovation institutes. However, such initiatives need to include a greater focus on diversity, equity, and inclusion (DEI) and try to attract underrepresented demographic categories in technical and leadership areas to create a more extensive and inclusive talent pool.

Secondly, semiconductor companies could try to transform their work methods to incorporate more automation. Currently, many semiconductor companies are lagging behind other technology players in implementing automation solutions, inhibiting their ability to maximise employee focus on higher value-add activities. Despite this, the increasing incorporation of automation in the industry has already enabled semiconductor companies to double the number of transistors produced every 18–24 months. Consequently, the world’s leading semiconductor companies are predicted to spend $300 million on internal and third-party AI tools for designing chips in 2023, which will grow by 20% annually for the next four years. Given the escalating costs to hire and retain semiconductor talent amid an increasingly competitive talent war across the technology sector, the increasing use of automation provides another solution for semiconductor companies in solving the current labour shortages.

Governance risk: Intellectual Property (IP) theft

Finally, there is also major intellectual property (IP) risks within the semiconductor industry. IP is essential to protect and enable a company’s ability to innovate and develop new technologies and methods. Within the semiconductor industry, IP covers a wide range of items, ranging from the equipment used in foundries to the chip designs created by integrated device manufacturers (IDM). The semiconductor intellectual property (SIP) market was estimated to be worth $6 billion in 2022 and is expected to grow by 6.2% per year to reach $7.5 billion by 2026. IP is becoming increasingly important for semiconductor companies as they try to protect their investments and maintain their competitive edge.

As the industry is heavily concentrated and controlled by a few key companies, IP theft has been increasing and has affected many companies in the semiconductor industry. For example, in October 2020, Taiwan’s UMC pleaded guilty to stealing trade secrets in the United States where it was accused of helping a Chinese state-owned chipmaker, Fujian Jinhua, steal secrets from Micron Technology which has strong control of the DRAM market. Similarly, Dutch chip toolmaker ASML, which has an effective monopoly on the production of extreme ultraviolet lithography (EUV) machines, revealed in February 2023 that an employee in China recently stole information about its technology. Both the U.S. and Europe have expressed concerns about the loss of IP to China and IP theft has been hugely influential in the US decision to impose chip sanctions on China in October 2022.

Recommendations:

Amid heightened geopolitical tensions and national security concerns, many countries are already addressing the risks posed by IP theft by enticing semiconductor companies to onshore and establish domestic production bases. Japan, for example, announced in November 2021 that it plans to invest $6.8 billion in funding the domestic semiconductor industry to increase its chip manufacturing production capacity. Following Japan’s announcement, the European Commission (EC) announced the European Chips Act in February 2022 which provides more than €43 billion to support Europe’s semiconductor industry. The US soon followed and passed the CHIPS and Science Act in July 2022 which provides $52.7 billion for the development of semiconductor manufacturing in the USA. As a result, patenting activity should increase to ensure the competitive advantage is maintained as these countries scale up their domestic semiconductor manufacturing capabilities.

Additionally, chipmakers and policymakers need to understand that self-sufficiency in chip production may be unattainable due to many kinds of chips and manufacturing processes. As Ursula von der Leyen, president of the EC, announced when introducing the EU Chips Act: “It should be clear that no country—and even no continent—can be entirely self-sufficient”. Instead, friend-shoring and near-shoring can be more widely used as a solution so companies can rely on trusted friends and allies for parts of their supply chain. Within such agreements, cross-licensing deals of intellectual property could be facilitated, and common research agendas promoted. Cybersecurity certifications based on commonly recognised methods and standards can also provide the necessary trust and confidence. Despite hostile geopolitical relations between the US and China, common policies introduced through altering the semiconductor supply chain will significantly reduce IP theft and help to accelerate semiconductor innovations.

Concluding Remarks

Semiconductors are driving various efforts to mitigate the impacts of climate change. They play a crucial role in advancing information and communication technology, which can enhance energy efficiency and promote clean energy generation. However, the industry must continue to innovate to overcome the significant ESG challenges posed to their operations by climate change, human capital, and intellectual property. Those companies that effectively manage these risks stand to be heavily rewarded with greater supply chain security and heightened interest from a growing number of environmentally conscious stakeholders intent on seeing companies take a proactive stance in this critical period.

The Global Chip Quandary: Unveiling ESG Risks in the Semiconductor Industry

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